It is considered that in terms of its financial performance De Beers is more efficient than its Russian competitor, ALROSA. Seemingly, there is an obvious premise for the existence of such an opinion. De Beers is producing rough which is on the average more expensive than Russian rough, and production costs in Africa are not as high as in Yakutia, where it is necessary to grapple with permafrost and groundwater.
However, a comparison of accounting reports filed by these companies for the past year raises questions about how to measure this performance.
Prices for rough diamonds
The amount of sales generated by both companies turned clear about the end of last year. In 2011, De Beers gained $7.378 bn worth of proceeds, of which actual rough sales account for $6.5 bn. The company sold 29.29 million carats of rough (and another 2 million carats were reserved for the government of Botswana) and therefore the average selling price amounted to $221 per carat.
In 2011, ALROSA sold 32.9 million carats (1.7 million carats less than it produced) earning RUB 125.3 bn from sales or $4.2 bn at a rough estimate. Its average price of diamonds reached $129.5 per carat. Such a big difference compared to the average price gained by De Beers is explained by the fact that about 35% of ALROSA’s carat output is industrial rough - which De Beers is not producing at all. In value terms, this "bort" takes up only 5% of sales and average prices for these diamonds in 2011 reached $7.7 per carat. If we take the price of gem quality diamonds separately, it appears to be an average of $196.9 per carat. That is, the difference in price between gem quality rough produced by the two companies is not so great.
Financial performance
It is much more enlightening to skip dwelling only on sales and prices and compare the further movement of cash flows.
Accounting data of ALROSA and De Beers under IFRS for 2011:
As you can see, having high revenue De Beers, however, also demonstrates a much higher cost-of-sales level than the Russian company due to which it starts to lag behind it in financial performance starting from gross profit (being the difference between revenue and cost of sales).
In its reporting and explanatory presentations to it ALROSA reveals its structure of cost of sales. The figure of RUB 56.005 bn is derived from RUB 63 bn of production costs minus RUB 7.8 bn worth of diamonds inventory movement and cost of diamonds for resale. Within the structure of actual production costs ($2 bn) 41% is employee payments (i.e., approximately $800 m), 16% - depreciation, 13% - fuel and energy, 12% - mineral extraction tax.
Meanwhile, an offhand attempt to understand the breakdown of cost of sales in De Beers is doomed to failure. In its reporting the company does not disclose the method by which it calculates the indicator, so it is impossible to draw a definite conclusion about the cost of production and the structure of other costs. De Beers is a private company and is not traded on the stock exchange, and therefore, though it of course prepares its financial statements according to international standards, it is still not obliged to strictly follow the reporting rules in terms of disclosure, as well as explain its calculation methods. However, if we study the company’s Report to Society we shall be able to find answers to some questions.
“In 2011, De Beers paid US$6.4 billion… to governments, suppliers, employees, shareholders and other finance providers,” the report says. A total of US$4.4 billion of these payments were to stakeholders in Africa, as in previous years. Unfortunately, the Report to Society also does not specify in what manner and where these payments are shown in the financial report of De Beers.
$5.221 m of the total amount of payments are earmarked as "Payments for diamonds and to suppliers." Africa accounts for the lion's share of that amount - $3.854 bn, while $860 million is spent in North America, and $473 m in Europe. It can be assumed that the huge amount paid in Africa is the result of buying out rough from the company’s partners in its projects in Botswana (50%), Namibia (50%) and South Africa (26%). It should be stressed that this is just a guess, since the agreements between De Beers and its partners are not published, so it is unlikely that we shall ever learn what kind of diamonds are bought by De Beers and on what terms.
A crude estimate under this assumption: Debswana produced 22.89 million carats of rough in 2011 - that is, Botswana’s share is 11.45 million carats. Under the new terms of the agreement between the parties, Botswana alone can sell 10% of rough, i.e. the amount left to DTC to buy out is 40% or 9.156 million carats.
One half of Namibia’s output is 0.667 million carats and South Africa’s 26% amounts to 1.415 million carats. It turns out that all in all DTC was to buy 11.238 million carats from the parent company’s partners. At an average price of $221 per carat in 2011 (mentioned above), the value of this volume is $2.484 bn. Although it would be strange to assume that De Beers buys diamonds at prices equal to DTC’s sales prices and does not get any profit from the sale of this rough.
Apparently, payments for the purchase of these diamonds are "paying back" at the expense of rough sold under the beneficiation program: in 2011, sightholders in African bought $1.3 bn worth of rough diamonds. However, an obscure point remains - when this rough is sold? Is it left for local producers immediately after being recovered, or DTC first buys the shares of partners and then sells these diamonds to local cutters? Here, too, one can only speculate.
Another item of expense - salaries and other employee costs amounting to $624 m in 2011. With the number of personnel reaching 12,124 people, it turns out that the average payment is $51,500 per employee in a year or $4,300 thousand in a month. At the same time, the number of personnel in Africa is 10,500 people and their average salary is $24,900 per year, or $2,000 a month.
De Beers mentions tax payments twice in the Report to Society. The first item is ‘taxation,’ which accounts for $315 m. The second item is ‘revenue contributions to governments (taxation, royalties & charges),’ which accounts for $1.538 bn (including $1.13 bn spent in Africa). The first point, obviously, involves the payment of profit tax, which roughly coincides with the data in the financial statement. The second point is, perhaps, mineral extraction taxes and other payments. It can be assumed that the $1.538 bn is also contained in the structure of cost of sales.
If you subtract these amounts from the cost of sales, it becomes clear that the cost of production proper at De Beers is really lower than that of its competitor (though experts say that this applies only to the African production - in Canada, De Beers’ production costs are higher than those of ALROSA). But the great amount of payments to related parties brings this advantage to zero. Moreover, these results are not a single case in 2011, but a trend which can be observed over the past six years (De Beers simply did not publish records for earlier periods on its website).
Financial performance of De Beers over the past six years ($ bn):
The high cost of sales eventually results in that De Beers demonstrates quite modest rates of return.
Now let us revert to financial performance of ALROSA (RUB bn):
Probably, we should not compare this company’s absolute figures with the data of De Beers - to do this correctly, we shall need to have accurate data on exchange rates for each year. But if you compare the rates of return, they would be in favor of the Russian company.
A similar conclusion can be drawn comparing EBITDA - earnings before interest, taxes, depreciation and amortization. You can see that, if earlier ALROSA lagged behind its competitor by this indicator, starting from 2009 the company was apparently able to optimize its finance: during the last years, ALROSA’s EBITDA was at the same level as that of De Beers and in 2011 it was even higher than that of De Beers.
Elena Levina for Rough&Polished
