In the third quarter, ALROSA sold only 42% of its diamond output in this period. Despite the conventionality of this reckoning and understanding the seasonal factor associated with July, August and September, most analysts estimated the miner’s sales as weak. But along with the downward trend in sales, ALROSA’s prices set for gem-quality diamonds were bound upwards, though the company decreased prices for the entire product range by 8% at its September trading session. So, was it a success? It was, but relative. In fact, having maximized its sales revenue, ALROSA could not avoid a drop of 34% in terms of money against the previous quarter. Nevertheless, we think it useful to perceive how exactly this maximization is achieved, which makes it possible for ALROSA to keep close to De Beers as far as the value of best-selling rough is concerned.
LOW SALES VOLUMES
During the first nine months of 2015, ALROSA sold 23 million carats of diamonds, down 20% compared with one year ago (28.8 million carats). The company expects to gain at least $ 2.7 billion in revenues for the first 9 months, which is 27% lower than in the same period in 2014.
In the third quarter, ALROSA’s revenue estimate exceeds $ 550 million with sales reaching 4.9 million carats, including 3 million carats of gem-quality diamonds.
The company’s sales turned out lower by 46% QoQ and by 36% YoY. This is a consequence of ALROSA’s decision to allow its customers to buy 50% of their allocation during the trading sessions in the third quarter, which reflects weak demand and lack of liquidity on the part of Indian manufacturers, according to a review of VTB Capital.
The Otkrytie Bank describes the decline in sales in the third quarter as "dramatic." This investment bank expected the company to sell 6 million carats of diamonds.
Deutsche Bank noted that ALROSA’s revenue from diamond sales for the first 9 months was not sufficient to achieve the year-end task of $ 5 billion set by the company. The bank anticipates that the miner’s sales in the fourth quarter will be lower than usual.
Despite the 8-percent cut in prices by ALROSA in the third quarter, the average price of gem-quality diamonds during this period ($ 182 per carat) was the same as one year ago and by 3.4% higher than in the second quarter. Compared to the level of January-March this year ($ 161), this figure is higher by 13%. The average selling price, taking into account industrial diamond sales, also went up QoQ by 1%, reaching $ 115 per carat.
BUT HIGH SELLING PRICE PER CARAT
The high average price of gem-quality diamonds sold by ALROSA in the third quarter was no less a surprise than the low sales volumes. For example, Otkrytie had predicted that the average price of gem-quality diamonds offered by ALROSA for sale in the third quarter would be $ 140 per carat. ALROSA achieved higher average prices for gem-quality diamonds due to smart stock management and control of product range, VTB Capital said in its review.
Deutsche Bank drew attention to the decreased share of gem-quality diamonds in the company’s sales in the first 9 months, going down by 5 percentage points - to 68%. The fact that the average price of gem-quality diamonds was higher, proves that ALROSA has sold more expensive stones, trying to offset the drop in market prices, Deutsche Bank believes.
Alfa Bank points to the "strong" strategy pursued by ALROSA, which is aimed at reducing sales in order to maintain prices. Although ALROSA lowered its prices by 8% in September, the average selling price per carat jumped 3% to the previous quarter, as the company sold higher quality stones in the third quarter, according to Alfa Bank.
"Apparently, the company continued to sell more expensive stones to maintain the level of revenue," Sberbank CIB said. The bank predicts that ALROSA will drive its revenue to $ 4 billion in 2015, i.e. the company will have to earn more than $ 1 billion in the fourth quarter in order to "meet the target". "To do this, the company needs to continue selling more expensive stones and thus significantly increase its sales. In view of the high level of inventory still present in the system and thus weaker demand from diamond manufacturers, this task can be hard to achieve and this may entail lower results compared to our forecast for the whole year," Sberbank CIB stated in its review.
The sharp drop in ALROSA’s sales caused by deterioration in the dynamics of global diamond consumption was generally expected and taken into account by market players, which follows from the reports that the company allowed its customers to defer 50% of their allocations, BKS said, adding that now it would be more important to see the reaction of demand after the price reduction in September.
Nikolai Sosnovsky of UBS predicted that ALROSA’s total revenue in the first 9 months of 2015 would reach $ 2.7 billion, and it did, but at higher sales and lower selling prices. "I think that top-quality stones are still in demand and it is the less expensive goods, which experience the lack of it. Thus, the company is intentionally or unintentionally improving its product mix despite the fact that sales are falling,” the analyst said.
Incidentally, the situation with prices for gem-quality diamonds of De Beers is similar, Oleg Petropavlovski of BKS believes. In the first half of this year, diamond prices at De Beers reached $ 206 per carat (vs $ 192 in the previous year), although the company reduced its selling prices by 5-6% during this period. This was due to the fact that De Beers was changing the assortment to offsets a drop in sales. What does it mean in practice?
IS IT ALROSA’S STRATEGY OR MARKET IMPACT?
"Changing the product mix" is a phrase, which is so often used by diamond miners to explain the divergent trends in pricing, that its inner workings seem absolutely clear to observers of all degrees of sophistication. What can be simpler than selling as much rough of low and medium quality as possible on a high market, but if the market is low, you will have to get the best out of your vault.
However, if you go deeper into this issue, questions arise. For example, how does this axiom derived from the 6th grade textbook on economics fit with the sightholders system, within which they buy - or do not buy under the risk of losing their contracts – diamond assortments stipulated in these contracts? If we recall that it is the sightholders, who account for the bulk of sales both at ALROSA and De Beers, the clarity of this process will be completely lost. However, the question relating to the ability of companies to maximize the average diamond price in a weak trading environment or, in other words, to sell top quality goods at premium prices, is by no means routine. This allows, for example, to understand what kind of role is played by diamond monopolists in difficult market periods – that of a price maker or that of a price taker.
According to Nikolai Sosnovsky, the growth of average prices for gem-quality diamonds on the background of a global slump in the value of precious stones is not due to the strategy pursued by ALROSA to maximize revenues, but stems from market preferences of customers in the current situation. "I'm not sure that this is a deliberate policy of ALROSA, and here we mostly talk about market realities," he said.
This trend may originate from spot trading where buyers are free from contractual obligations to the selling company and are guided only by business logic, Nikolai Sosnovsky said. Spot sales account for 20% of ALROSA’s total sales. Note that this estimate refers to high-market periods; at other times, such as the downturn in 2008-09, spot sales are simply not available. At spot auctions, buyers are likely to choose only high-quality rough leaving everything else unclaimed. This makes it possible to push up prices, as well as the quality of purchased diamonds, while reducing the total number of purchases made, he said.
As for the long-term customers (accounting for about 70% of ALROSA’s sales), the quality of rough diamonds in their boxes remains essentially unchanged, according to Nikolai Sosnovsky. "Of course, deviations are not excluded, but it is hardly the case that ALROSA started now to substitute high-quality rough for low-quality rough in the boxes offered for sale striving to increase revenue," the analyst believes. The sight system under which customers receive their boxes and under which most of the assortment is stipulated in their contracts well in advance, does not leave any possibility for the seller to influence the product mix, according to the UBS analyst.
The assortment within a single box is always the same and does not change - it is strictly agreed in the documents issued by ALROSA, customs service and other regulators, explained an expert familiar with the procedure used by ALROSA to compose diamond boxes for its clients. "But boxes differ in price. And customers may take different boxes, cheaper or more expensive - they are not limited in that," he said. In other words, if selling prices go up, this usually means that customers are taking more expensive boxes.
BUILDING UP STOCK
One direct consequence of lower sales is a growing stock of diamonds, accumulating extracted but not sold rough. Most investment banks have expressed concern over such increased inventory, which creates an "overhang over the market," all the more dangerous because demand fluctuations do not inspire much optimism.
"ALROSA returned to re-stocking," this was how Renaissance Capital started its review, noting that the company’s stock will absorb further 6.8 million carats of diamonds mined in the third quarter.
According to Otkrytie, at the end of September ALROSA had a stock exceeding 21 million carats.
"In the first 9 months of 2015, ALROSA produced 29.6 million carats, while its sales reached 23 million carats, which means that the company increased its inventory by 6.6 million carats during the period, and this is expected to result in significant pressure on its cash flow," Sberbank CIB said.
An increased diamond stock will bring about a significant growth in the miner’s working capital in the second half of the year, according to VTB Capital.
Besides the fact that ALROSA has a stock of rough, experts fear that much of it consists of diamonds, which do not belong to the top-quality category. "Of course, if ALROSA is now selling better stones, its stock is left with lower-quality stones. And sooner or later the company will have to sell them. If next year, the market will be much stronger than it is now - although no one expects this, - these amounts will hit the market partially offsetting its growth. Conventionally, prices could go up by 20%, but due to the remaining stock of rough they will increase only by 15%. And things can turn worse if prices in the nearest year or two will not change or even sink," Nikolai Sosnovski said.
ALROSA has a mechanism for the sale of goods in case of negative developments in the market or even if it grinds to a halt – it is a deal with Gokhran. So far, the management of ALROSA denies such a possibility, and in fact the company does not need it, Oleg Petropavlovski of BKS believes. "The current situation is not as difficult as in 2009, when the miner’s net debt rose sharply, while its sales actually stopped," the analyst said. He noted that ALROSA had not reduced prices at the October trading session, and this was an indication that its goods found their buyers. In his opinion, the fourth quarter will inevitably see revival of trade, especially in the context of stable consumption of jewelry in the United States. "But if we imagine that the entire year of 2016 will stay at the level of the third quarter of this year - which means a double contraction of the market, - then the company may resume its practice to sell diamonds to Gokhran," he said. However, Gokhran is a state agency acting within a budget limit for the purchase of precious stones and precious metals, and in the current situation this agency is on a tight budget, stressed Oleg Petropavlovski.
TRENDS ON THE EXAMPLE OF PETRA
ALROSA and De Beers do not specify preference of their customers and are stingy in the details of their trading sessions, especially in hard times for both. Rio Tinto, Dominion, Gem and Lucara do not offer lavish data of this kind as well. Let us turn to the reports released by Petra Diamonds, the largest diamond miner listed on the London Stock Exchange to find, which categories of diamonds are sought for by market players.
By the way, Petra discontinued sales in the third quarter working for stock, which increased 3.5 times in value terms. Petra held a tender only in October. It managed to sell about 90% of its offer (by value), but prices fell by 8.8%.
In its trading update Petra notes the following trends:
- prices for gem quality stones in the 2 to 5 carat range remained fairly stable;
- prices of gem quality stones in both the 3 to 6 grainer (0.75 carat to 1.5 carat) and the 5 to 10 carat size ranges were significantly softer with prices decreasing by ca. 12% to 15% in both categories;
- prices in the 2nd and 3rd tier quality goods remained fairly stable, whilst prices in the lowest quality assortments were weak.
Petra, whose asset portfolio is based on the Finsch and Cullinan mines bought from De Beers, promises to have a better product mix in the second half of the 2016 financial year due to further input from the new diamond areas to be included into the mining perimeter and due higher gain from tailings. Does it mean that the company is gearing up for a heavy 2016, having lost faith in market growth, and will try to do its utmost to neutralize the effect of low prices? No, if we consider that simultaneously Petra - unlike De Beers and ALROSA - confirms its output task of 3.3 - 3.4 million carats in the financial year of 2016, and even plans to increase production to 5 million carats by 2019. One thing is clear - in the fourth quarter of this year and in 2016, we will pay more attention to any information on product mix in the press releases issued by miners. It is there where it is possible to find information most interesting for the market, in contrast to their triumphant reports about record-breaking performance or assurances of stable long-term demand.
Sergey Bondarenko for Rough&Polished
