The president of the company told how it was going to confirm the investment component of polished diamonds
(INTERFAX.RU) - In the spring of this year, ALROSA initiated the creation of investment instruments based on diamonds in Russia. To begin with, the company plans to launch futures trading on the Moscow Exchange and then, if the VAT issue will be settled, it will roll out deliverable deals involving diamonds. It is not the first time ALROSA comes up with such an idea, but it is precisely the time when all the prerequisites are there for its implementation, as it is evidenced by the activity of De Beers, Rapaport and the Singapore Stock Exchange in this area, ALROSA’s management believes. One of the goals is to form alternative pricing sources for polished diamonds (right now, the RapNet Diamond Index is actually a monopolistic benchmark). Andrei Zharkov, President of ALROSA explains how his company is going to uphold the investment component of polished diamonds in an interview to Interfax.
- In team with the Moscow Exchange, ALROSA is working on how to organize the exchange trade in polished diamonds. Is it about deliverable transactions or about diamond-based financial instruments?
- As a pilot project, we consider the possibility of launching non-deliverable transactions, the so-called cash-settled futures contracts for polished diamonds. In this way, we solve several issues at one stroke. Firstly, all market players will have a possibility to take part in trading, regardless of whether they have a license for operations with precious stones or not. Secondly, there is no VAT on financial instruments. The presence of VAT when diamonds are bought by a natural person and the absense of VAT on the sale of diamonds are currently making diamond investments very questionable. We discussed this issue with the Ministry of Finance at our work meetings. All this is not so simple, but the Ministry of Finance understands the problem and is willing to consider options for its solution. We plan to organize trading in deliverable contracts only after the taxation issue will be solved.
- Investment diamonds are a completely new instrument on the market. Will this trade be financially liquid enough?
- We are considering a possibility to take up the function of a market maker at the initial stage. That is, to become a trading participant, which provides buying and selling prices and is willing to buy and sell at announced prices, taking into account the spread. Later on, the liquidity will be provided by other market players. At the same time, we cannot guarantee that our price will be the highest, so if an investor will find a more attractive option to sell investment diamonds, we shall only be glad. This will mean that the market works without our participation.
- ALROSA is primarily engaged in diamond mining. What are the goals the company pursues launching the investment diamond project?
- The main goal of this project is to confirm the investment component of polished diamonds. This is completely in agreement with our strategy guidelines.
We have not discussed this with our industry colleagues, but we see that launching of such projects is becoming a trend. For example, De Beers launched a service to purchase polished diamonds in the US market through its International Institute of Diamond Valuation at the beginning of this year. This is a pilot program for 18 months; it is designed to ensure the turnover of polished diamonds in the secondary market. Other major players are also showing interest in this investment instrument. In Singapore, the SDiX trading platform will start its operations in the near future selling boxes with polished diamonds. The Rapaport Group in conjunction with the GIA began issuing Investment Diamond Reports (IDR).
Another reason is the need for alternative pricing sources. Currently, many market participants in different diamond centers say that is not quite correct to depend on a single source. To date, the pricing of diamonds is solely based on the RapNet Diamond Index and to a lesser extent on IDEX. I am not going to say that we need more transparent pricing sources, but we need alternative sources – this is certain.
- What will be taken as a benchmark in determining the price of polished diamonds put up for auction? It is precisely the RapNet Diamond Index, which is the most authoritative source of pricing.
- Benchmarks may be different. You may use not only the RapNet Diamond Index, but also prices resulting from transactions with physical diamonds, including those concluded with foreign customers. ALROSA and Russia-based diamond cutting and polishing companies sell polished goods of various weight categories and characteristics to their customers. The value of these transactions is often geared to international price indices, including Rapaport, but in reality they are very often made at a discount to the Rapaport price.
- During the five years after 2011, RAPI for top-selling diamonds - 0.3, 0.5 and 1 carat – was almost continuously going down. Does this kind of price movement give an opportunity for investors to earn?
- Indeed, there has been some decline in prices for polished diamonds in the past few years, but if we compare this decline and the dynamics of prices for other commodities, we see that the fall in the value of diamonds is less significant. We focus on the long-term forecast, which shows a steady increase in the value of diamonds. We also believe that on the backdrop of economic downturn, currency fluctuations and decline in oil prices, investors are starting to search for new investment vehicles and diamonds have a reputation as the most stable investment instrument.
- What is the target range of customers ALROSA is counting on?
- We expect that investments in diamonds will attract the wealthy and the middle class, who intend to protect their available funds from market fluctuations, inflation and other negative effects in the market. There is no way to have big speculative earnings on diamonds.
- We spoke about the organization of deliverable transactions in diamonds. What measures should be taken to form a commodity market, in addition to solving the VAT problem?
- Firstly, to start trading on the exchange, you need to study the issue of how to make diamond lots uniform. You need standard lots to trade at the exchange, but it is virtually impossible to find identical diamonds. The range of prices for each of the four main characteristics of diamonds - carat weight, color, clarity and cut – is very broad.
Secondly, it is necessary to create conditions for identification of investment diamonds, i. e. an investor, being not a qualified gemologist, should be sure that he or she has bought the diamond, which is mentioned in the specification. In addition, you have to protect the investor against counterfeiting, to develop a procedure for trading at the exchange, create attractive conditions, including in particular tax regulations, provide for the liquidity of the exchange instrument – i. e. giving an opportunity to buy and sell the lot on the exchange.
- What categories of diamonds will be put up for sale at the exchange?
- Initially, we planned to organize trading in investment diamonds belonging to two weight groups: 0.5 carat and 1 carat.
- How much money is required to start the project?
- For us it is a startup, the results of which will make it possible for us to judge about the capacity of the market, its activity and growth potential. So far, we have not planned to spend significant funds on this project in its startup format.
- Will Brillianty ALROSA change its functions if diamond trading will start at the Moscow Exchange? For now, the company is mainly specialized in producing rare stones for Sotheby's and Christie's.
- The company’s business profile will not change. Brillianty ALROSA will continue to carry out its functions in the same format. Their product lineup is not limited to unique and rare stones.
- In what way is it planned to reorganize ALROSA to provide for the exchange needs? Are there enough production facilities and personnel in Barnaul and Orel to manufacture medium-size diamonds, which will most likely be sold to natural persons?
- We have enough production facilities to meet the market demand for investment diamonds, including medium-size goods, without increasing the production capacity of the company’s manufacturing complex.
- May it be that your Moscow Exchange project will compete in some way with the Diamond Exchange in Vladivostok?
- No. In the diamond business, the place which concentrates a large number of offers for the sale of rough diamonds may be called an exchange with great reserve. The Diamond Center in Vladivostok is an infrastructural platform, which will create favorable conditions for market players transacting in polished and rough goods. A certain cluster will emerge around this center comprising diamond manufactures, jewelry and tool making companies, gemological laboratories, banks and insurance companies. This platform will be focused on export-import operations with Asia-Pacific countries, especially with China, India, Japan and South Korea.
We have partners, who are ready to join the project. Unlike it is done at the exchange, trading in Vladivostok will be organized by ALROSA itself, which will sell rough and polished diamonds to customers. We shall play the role of a framework, which will attract investments to this area to establish there such a diamond center and a cluster around it. The development of a port and logistic infrastructure there, the growing flow of tourists and preferential visa regime will help to increase export operations in the region.
- It is exactly one year that you are at the helm of the company. Almost immediately after you turned to be the president of ALROSA, you said that the company’s long-term strategy will continue. Does your position remain unchanged despite the fall in demand in the diamond market in 2015?
- Yes. In the short and medium terms, there are certain events that affect the company one way or another. These include the decline in demand in the past year, the threat from synthetics and the need for generic marketing. We have certain means at our disposal, which permit to overcome the challenges we are facing. For example, making adjustments to production volume, which may be possible under the influence of the situation in 2015.
Volatility is inevitable, but in the long term, we confirm that the course chosen by the company is absolutely correct. Regularly updated market research confirms the correctness of our long-term strategy with a key focus on diamond mining. This strategy was adopted by our shareholders and is valid until 2023. Although, no doubt, there are certain areas in which it is possible to enhance our competence. In fact, this work is permanently going on in all directions. Inside the company, we are continuously carrying out programs to optimize expenditures. For example, this is taking place during the transfer of our heavy haulers to gas fuel, which we produce – thus, switching over from diesel fuel to oil. We are currently working on the localization and general production costs management, including many other things.
- Are any changes in your sales policy possible?
- The company’s sales and marketing policies are being improved and this process will continue. Our end-customers are changing their preferences. We think about improving our services offered to customers, mulling to change the product mix of our boxes and pricing principles. In periods, when demand is temporarily falling, we are busy working with our inventories.
Last week, there was a meeting with the representatives of our industry and our shareholders focused on the sales and marketing policy of the company. It was convened as it was necessary to develop common understanding among the company's shareholders and management with regard to the challenges facing ALROSA.
This year, Las Vegas will see a generic marketing strategy to be presented there at the end of May or in the beginning of June, which will be launched in the American market and then will be transferred to the Chinese market, and so on.
- Can ruble-based contracts be an innovation in your sales policy? This possibility was approved by the company’s Supervisory Board prompted by a directive from the government last year.
- I would not call it innovation in marketing policy. This is related to the payment terms under long-term or one-time contracts that we conclude. In general, such a possibility is there, and we see the feasibility of such calculations. But this is only an option, not an obligation. No one planned to transfer the contracts that we have today to ruble payments.
- You have mentioned the possibility of adjusting the output benchmark for 2016. There were voiced two possible targets – reducing the company’s output to 34 million carats and to 37 million carats. Which option will be adopted?
- My colleagues and I have discussed this, and now we shall raise the question of reducing our output this year to 37 million carats at the Committee for Strategy of the Supervisory Board and then at the Supervisory Board itself. This decision is not solely ours, it should be taken at the level of the Supervisory Board, because it carries certain implications for the budget of the company. Let me remind you that our goal is, as a minimum, not to build up inventories, which increased significantly in 2015.
- Will this reduction be achieved at the expense of production at the company’s alluvial operations?
- To a large degree it will, but not only.
- Have you summed up the results of the April trading session with your long-term customers? How much has the company earned in April?
- We have not yet tallied up its results. However, according to preliminary data, the April session should be somewhat weaker than the March session.
- The Federal Property Management Agency is mulling to bind ALROSA’s dividends to its cash flow. Is it possible that your dividend policy will reflect such transformation based on the results achieved in 2016?
- The discussion about binding ALROSA’s dividends to its cash flow and "releasing" its net income from the influence of exchange rate differences is going on from time to time. But there are no specifics in terms of changing the dividend policy.
- Is there any final decision on how to float some part of the state-owned stake in ALROSA?
- To date, there are no any formal government decisions. The basic idea, which is being discussed today, is to privatize a 10.9% package of shares by way of public offering. Being the CEO of this company, I believe that it is the most effective way. Higher free float will increase the liquidity of ALROSA’s stock and it will attract investors of another level in the future. Different investors have their own limitations depending on the amount of free float.
- You said that the main goal of the company is not to increase its inventory. If the situation in the market will deteriorate, the problem of excessive inventory could be solved by way of selling it to Gokhran. Are the company’s sales to Gokhran possible in 2016?
- We cannot say that Gokhran’s plans are correlated with the company's plans. Right now, Gokhran’s plans are Gokhran’s plans, while ALROSA’s plans are ALROSA’s plans. Even if such sales will take place in 2016, this will not be linked with some kind of support rendered to the company, but with the desire of Gokhran to replenish the State Fund with certain types of valuables, including rough or polished diamonds. Naturally, if Gokhran will wish to buy a certain amount of rough diamonds, we shall be pleased and ready to carry out such a transaction. This year, Gokhran has an opportunity to purchase rough diamonds, though this opportunity has not yet been embraced.
