The outgoing year was marked for the diamond market by the most significant drop since the 2008 crisis
(INTERFAX.RU) – “I took over the company at the time of a sharp decline in prices. Looking at what was happening, I thought: “Why should it all fall to me?” But as much as I got upset, Philippe Mellier felt even worse" – this joke of Andrey Zharkov, President of ALROSA made at a meeting with the company’s long-term customers in December 2015 eloquently describes the situation in the diamond market. Zharkov took the helm of ALROSA in late April, when only the most pessimistic experts could predict that this year would be marked by the most significant drop since 2008-09. Although it was painful to everyone - from not so numerous diamond mining companies to thousands of diamond cutters and jewelry retailers, - De Beers looks as the most affected party.
At the end of 2014, nothing - at least apparently - foreboded any sad outcome for the industry. ALROSA started 2015 on a wave of success after a record revenue growth in 2014 caused both by increased prices and higher sales. The fears expressed by a number of midstream players - diamond manufacturers - about rough sales being increased by diamond miners and the lack of correlation between rough and polished prices were not entirely ignored, but being regular, they were perceived as part of the struggle for a more comfortable pricing policy. Key indicators in the diamond market promised if not explosive, but steady growth - demand for diamond jewelry in the United States was stable and China's economy caused no worries.
Taking this into account, ALROSA projected a 3-percent rise in prices.
It was a rather modest price forecast compared with 7 percent in 2014. However, it relied on a high pricing base and besides it promised to make possible the long-term growth scenario pledged in ALROSA’s strategy and based on two pillars, one of which was the presumption of reduced rough supply due to depletion of existing diamond mines, while the other was the promise of continuously growing demand for jewelry due to improved well-being of the middle class in China and India.
As it was proved by the year of 2015, the main catalyst in shedding a tub of ice water on the diamond market was not even macroeconomics and not the situation in China in particular. It should be said that the anti-corruption policy of the Communist Party of China resulting in dropped sales of luxury in this country was not the big news of 2015, because its effect had been felt two years before and did not prevent the growth of 2014.
The industry was affected by those fundamental excesses, which were so much talked about among diamond manufacturers. Rising prices for rough in 2013-2014, the time of inflating a “diamond bubble,” undermined their margins, while accumulated inventories slackened their appetite for new purchases of rough. “In 2013-14, the market was hit by a significant influx of polished goods, putting it under pressure and bringing about an absolute mismatch between supply and demand. As a result, we see a downward trend in diamond prices for quite a long time, going lower and lower. This trend affected rough as well,” Maxim Shkadov, CEO of Smolensk-based Kristall explained. Finally, a downturn in the economies of the countries, which used to be major jewelry consumers, with the exception of the United States, did not contribute to the growth of demand for diamond jewelry.
Diamond miners, primarily De Beers and ALROSA, each of which controls about 25% of the world's supply of rough, having deftly skimmed the cream off the growing market earlier, happened to face impoverished clientele in 2015. Moreover, this included not only their direct customers - a narrow circle of long-term sightholders – but those operating in the secondary market, which, in turn, had cleverly been milked dry by sightholders.
The market is seeing “a battle for the remaining cash” between the largest suppliers of rough, ALROSA and De Beers, and in this struggle ALROSA is scoring more points, as it was noted in September by Maxim Shkadov. ALROSA appears to be more flexible in dealing with its customers, and it managed to limit its price discounts by 15 percent compared to the 18-percent price correction of De Beers. The system of sales practiced by these major diamond miners is almost identical: more than 70% of sales revenue is generated by their long-term clients (sightholders) receiving boxes of rough containing diamonds needed by themselves, as well as those to be sold to dealers in the secondary market. They have the same clients and the only difference is in the number of trading sessions: ALROSA holds them every month, while De Beers 10 times a year. They also differ in the rules set for rejection of goods by their customers, as well as in the way they compile their assortments to fill diamond boxes offered for sale. As it turned out, the devil is in the details.
The greater number of trading sessions allowed ALROSA to adapt to market realities in a more flexible way, taking into account the time lag and the possibility to adjust its product mix, as it was explained by Sergey Goryainov, an analyst at Rough & Polished.
An important role was played by the fact that ALROSA permitted its customers to refute parts of their monthly purchases in particularly difficult periods for them (for example, during the “quiet” third quarter) avoiding to overburden them with excessive rough. For example, ALROSA set a 20-percent limit for purchasing rough in August, while in November and December the limit was 30 percent, i.e. clients could refuse to buy 80% and 70% of goods respectively under their obligations. De Beers did not allow such liberties to the last minute, trying to charge customers as much as possible. One of the exemptions was to allow sightholders to defer their commitments one to two months ahead. Such a strict discipline has played a cruel joke. In the middle of the year, industry media were full of reports about contracts broken by customers, and in November, De Beers had to permit their sightholders to buy nothing. The November sight brought just $ 70 million for De Beers, while in December the company sold $ 150 million worth of rough. These are woefully small numbers. “The overall mood of sightholders was not to take any goods, if they see they are loss-making or to take just some minimum amount,” a spokesperson of one of the company’s clients said. De Beers is not a monopoly in diamond supply, and it is not excluded that its clients could go to more customer-loyal ALROSA. All the more so, judging by a number of signals especially in the second half of the year, customer preferences shifted towards smaller diamonds of the mass consumer segment, which ALROSA had in greater numbers.
“De Beers had to allow sightholders to reject 100 percent of boxes, while ALROSA managed to avoid this making its boxes more attractive to customers due to re-compiled assortments. Apparently, the company added rough diamonds paying attention to the needs of customers and retrieving less required varieties. Despite the fact that clients are the same, yet their needs vary, especially in such a volatile market,” Sergey Goryainov said. “ALROSA has a more flexible and more market-specific policy, if I may say so, and the company was better able to come to agreement with its customers. ALROSA managed to handle the pool of its customers in a plausible way,” he concluded.
At the same time, due to higher cost of diamonds and relatively good sales in the first half (vs the second half of 2015) De Beers earned $ 3 billion in revenues (down 21% y-o-y). ALROSA lagged behind in the first six months of 2015 having gained about $ 2.3 billion (at an average exchange rate of 57.2 rubles per USD set by Russia’s Central Bank during the period), its results in terms of revenue and EBITDA being positive due to the ruble devaluation. De Beers has so far not released its results for the first 9 months of 2015, however any comparisons of results produced by the Russian public company, which reports in rubles, and the diamond mining division of Anglo American are somewhat far-fetched. But there is a reason to believe that in view of weak sales in the end of the year, the difference between the two could have been levelled. “Theoretically, ALROSA can get ahead of De Beers this year, given that ALROSA all the time maintained a lesser limit of rough rejections permitted to its customers. For example, De Beers allowed to reject 100 percent of goods in November, while ALROSA only 70 percent. ALROSA should have sold more,” Oleg Petropavlovski of BKS said.
With all the conventions of comparison, it should be noted that the grand title of “the largest diamond mining company in terms of revenue” is now at stake and ALROSA is striving to acquire it having won the leadership in sales by carat. But the most important thing is that the lack of flexibility in sales has forced De Beers to hurry up with flexibility in production.
In response to falling demand, De Beers reduced its production target three times in 2015 finally decreasing it from 32-34 million carats to 29 million carats, and in the end of the year the miner announced the closure of its least profitable mine, Snap Lake in Canada. In late December, Debswana, the major company of De Beers announced its intention to mothball Damtshaa and decrease production at Orapa. Similar measures are taken or being prepared by all diamond mining companies - for example, by Rio Tinto, Petra and Dominion. ALROSA, which is operating in the permafrost of Yakutia finds it more difficult to manipulate production due to climatic and social reasons. The possibility to adjust the production program is usually considered based on the results of the first quarter. By the way, analysts are not optimistic regarding the first quarter, as well as the whole coming year. However, the competent sales policy pursued by ALROSA in the outgoing year permitted at least to avoid an “overhang,” which, if increased, will become unwelcome for ALROSA and for the market.
