Summing up the trading update of ALROSA: When the "hazard zone" is so close

The data on ore diamond grades and amount of processed sands contained in the operating report released by ALROSA on July 21, 2015 were the least thing expected by industry experts and investors. The reason for this bears no relation to the exact conformity of the reported data to the targets announced by the company before the IPO in October 2013, which makes the results predictable. Right now, the market does not demand from ALROSA clear-cut reports stuffed with numbers and percentages, but it is in greater need of the company’s statements regarding its further plans. The plans, which will permit to secure the company's profit-earning capacity and resist the negative influence of business trends.

In the second quarter, ALROSA applied all the range of remedies to partially compensate for the drop in world prices using an improved sales pattern. Without reducing the total volume of sales, ALROSA cut down the share of gem quality diamonds, but improved their mix. Thus, on the backdrop of unfavorable situation the company sold the most fast-moving goods at higher prices, which made it possible to neutralize the scale of the slump in absolute revenues. This slump was inevitable taking into account the 6-percent decline in prices in the first half of the year. Diamond prices are on a three-year low losing 18% since the peak in July last year. The situation may be affected by the willingness of manufacturers to adjust sales volumes. De Beers, one of the two largest diamond miners, has already gone down this path. ALROSA has not yet made such a decision, but an absolute majority of industry experts believes it is inevitable, noting that the tasks set by ALROSA for this year are in the "hazard zone."

Production growth

ALROSA Group produced 18 million carats of diamonds in the first half of 2015, which is up 13% over the previous year. In the second quarter of 2015, ALROSA produced 9.6 million carats of diamonds (versus 8.4 million carats in the first quarter), which is 20% above the comparable level of 2014. Totally, ALROSA processed 16.3 million tons of ore (up 4.5%) in the first half of the year, while its diamond grade increased to 1.11 ct/t compared with 1.02 ct/t a year earlier.

Production growth in the first half compared with the same period last year was due to:

- The performance attained in the Karpinski-1 Mine (belonging to Severalmaz), which started production in October 2014 (and reached an output of 600,000 carats);

- The larger amounts of processed reserves in the Udachny Mine, which had a higher diamond grade (resulting in an output of 600,000 carats);

- An increase in production at the Mir Mine helped by the implementation of measures to reduce water flooding (resulting in an output of 497,000 carats);

- The recovery of first diamonds at the Botuobinskaya Mine launched in March 2015 (resulting in an output of 481,000 carats).

The growth in the second quarter compared with the previous period is primarily due to the seasonal start of mining operations on the alluvial diamond fields (totally, Almazy Anabara and Nizhne-Lenskoye produced 1,940,000 carats of diamonds during the reporting period). Typically, during the startup of new diamond mines or seasonal boosts in production ALROSA used to carry out repairs at some of its concentrators, thereby preventing excessive output, which is fraught with premature depletion of deposits and supply of excessive rough to the market. In the second quarter of 2015, the company initiated the scheduled maintenance at the concentration plant of its Nyurba Mining Division, which decreased its production by 44% to 1.15 million carats.

The Yubileynaya Diamond Pipe (belonging to the Aikhal Mining Division) was once again a top producer by carat in the first half of the year accounting for 25% of the total output (4.76 million carats). Production growth in the Yubileynaya Mine in January-June by 2% was due to the extraction of ore from the central ore pillar with a higher diamond grade. The performance of Yubileynaya in the second quarter did not change in comparison with the January-March period of this year. The diamond grade of the Yubileynaya ore in the second quarter reached 1.09 g/t (vs. 1.1 g/t in the previous period).

The second place in production, which belonged to the Nyurba Mine for several years (Nyurba Mining Division), this time was taken by Udachny in the first half of 2015 (or rather, by its open pit mine, as its underground mine will start full-scale operations only in the second half of the year). By the way, both Nyurba and the open pit at Udachny are depleting and if the output of the first one will be made up for by the Botuobinskaya Mine, it will mean that the open pit production numbers will be replaced by those of the mine already this year. Production growth at Udachny in the first half of 2015 - by 29% (to 2.67 million carats) – may be explained by the planned increase in the processing of the ore stock mined from the western ore body having a higher diamond grade (1.15 g/t in the second quarter against 1.05 in the previous one).

The Internatsionalnaya underground mine (11% in the production of ALROSA in 2014), slightly lagging behind Udachny, increased its diamond output by 18% (to 2.54 million carats) in the first half of this year due to higher amount of ore processing by Concentration Plant № 3. Internatsionalnaya had a diamond grade of 8.53 g/t against 8.17 g/t in January-March.

It is very important that the problem of flooding at the Mir Mine has been solved, which will ensure a stable growth in the long term, Deutsche Bank said in its review. Mir produced 1.05 million carats in January-June, which is almost 2 times as much compared with one year ago.

Totally, ALROSA processed 16.3 million tons of ore (up 4.5%) in the first half of 2015, the diamond grade of which went up to 1.11 ct/t versus 1.02 ct/t a year earlier. Underground mining operations accounted for 23% of all diamonds recovered, while open-pit mining produced 61% and diamond placers yielded 16%.

SALES MANAGEMENT

Total sales in the first half of the year matched the amount of rough produced - 18 million carats, which is 15% below the amount mined one year ago. Despite the continued weak market conditions in the second quarter of 2015, diamond sales remained at the level of the previous quarter - 9 million carats. However, it is below the level of quarterly production; in other words,  this is the evidence that the company accumulated some inventory, as opposed to the reverse trend observed in the first quarter, according to Sberbank CIB. Alfa Bank estimated that ALROSA had accumulated 1.1 million carats of gem quality diamonds in the second quarter of 2015. "The company is managing sales to counter the weak demand and to avoid a slump in prices,” Alpha Bank summed up.

ALROSA reduced its sales of gem-quality diamonds by 20% compared to January-March (to 5.6 million carats), but apparently, the company sold higher quality stones, which allowed it to increase selling prices by 9% to $ 176 per carat (despite the May price adjustment of 3%). The overall share of gem quality diamonds in the company’s sales declined to 62% from 78% in first quarter. Generally, the selling price of gem quality diamonds in the first half of this year fell by 5%, reflecting the difficult market environment.

According to ALROSA's forecasts, the miner’s diamond sales revenue in the first six months of 2015 will be at least $ 2.1 billion. On this basis, the second quarter of 2015 will bring ALROSA a revenue of $ 1 billion, which implies a decline of 10% to the first quarter.

REDUCING FORECAST

Against the backdrop of weaker demand, producers will have to limit supply, the Otkrytie Bank said in its report. De Beers has already twice reduced its annual output target - from 32-34 million carats to 29-31 million carats - in the light of current market trends. ALROSA could not manipulate its production, and so far the company has not changed its sales target being 40 million carats (including 2 million carats from the stock), although the company management did not rule out its revision in late August, on the basis of financial reporting for the first half of 2015.

This revision may occur with a very high probability, according to the vast majority of industry experts from investment banks.

"The chances that ALROSA will sell an amount of diamonds equivalent to its annual production plus 2 million carats from its stock are very low. Most likely, the company will not sell anything from its stock," said Otkrytie, which expects that ALROSA’s sales will reach 38 million carats in 2015. The Bank also revised its outlook for global diamond sales in 2015, suggesting this time they will decrease by 10-15 percent and noting that "this figure seems optimistic." Global diamond sales in 2014 were estimated at $ 16.7 billion.

Morgan Stanley expected ALROSA to announce a reduced sales target on July 21, when ALROSA published its operating results. This investment bank predicted that ALROSA would reduce sales to 8.5 million carats based on the results of the second quarter (the actual result was 9 million carats) due to a weaker market caused by large stocks accumulated by producers, as well as by limited funding and low margins in diamond cutting. Morgan Stanley believes that ALROSA will reduce sales by 1.2 million carats (to 38.8 million carats) compared with the planned 40 million carats.

The most radical reduction forecast regarding ALROSA’s sales was given by CreditSuisse, which expects the company to sell 36.1 million carats in 2015.

Deutsche Bank noted that ALROSA’s sales target in 2015 was in the "hazard zone". According to Sberbank CIB, the willingness of producers to adjust sales will limit the scale of price cuts.

The fact that ALROSA is in no hurry to cut sales, once again highlights the difference between the two major diamond miners - ALROSA and De Beers. For ALROSA such decisions are harder to take because of the inability to manouver its output, most of which is concentrated in Yakutia. Shutting down the mines and factories in the permafrost environment of Yakutia is fraught with layoffs of residents living in the company towns, as well as with additional costs associated with the subsequent recovery of production. However, this "indecisiveness" may at the same time mean that the company is still hoping for a successful fourth quarter with its pre-New Year rise in demand for jewelry. With all the accompanying consequences - because such an increase, in theory, should be at least explained by a recovery in US consumption and economic growth in China. De Beers does not cherish such hopes any more. According to the company’s statement on July 24: “In the meantime, working capital concerns in the midstream are likely to cause some short-term volatility in rough diamond demand.” The official view of ALROSA with regard to this will likely be aired on August 28, when the company will publish its report in accordance with the IFRS for the first half of 2015.

Sergey Bondarenko for Rough&Polished