Alexey Filippovskiy told about possible changes in the financial policy of the company
(INTERFAX.RU) – During the first two months of 2018, demand in the rough diamond market improved, which enabled ALROSA to significantly increase rough sales – to over $1 billion. In the first quarter, diamond manufacturers and jewelers traditionally replenish their inventories, but this year, ALROSA sees the signs of qualitative changes in the situation. If demand remains strong in the mid-year, a conclusion can be made – in spite of the growing presence of synthetics – that the circle of consumers increased against the background of higher household income in the key markets, according to Alexey Filippovskiy, Deputy CEO – Chief Financial Officer of ALROSA.
- The results of January and February are indicative of a substantial revival in demand in the diamond market. How long will the situation be so favourable?
- Indeed, the company’s sales in the first two months were beyond our expectations. During the Christmas and Chinese New Year sales, demand for diamond jewellery was very strong. It helped the diamond manufacturing industry to replenish its rough inventories. Sooner or later, this will translate into higher prices for rough. On the whole, the economic situation is rather optimistic in all the key markets – the US, India and China.
Does this mean a shift in the trend? We do hope it does, as rough prices have been stagnating for quite a long time and we are expecting their recovery. However, the final answer can be given in April or May. Traditionally, the first three months on the diamond market are used to replenish inventories. If demand remains strong in May, a conclusion can be made about a shift in the sentiment on the market.
But there is also a truly alarming signal from India – the scam caused by the alleged fraud committed by one of the market stakeholders. It had no impact on financing companies and replenishing their inventories this season, but it is hard to tell what the situation will be in autumn. Taking into account the scale of this fraud, a negative impact on the diamond industry is possible as early as this year.
- Traditionally, the company used the situation in the first quarter to sell rough from its stock. Was the growth of revenues in January and February reached due to volumes of rough sold? How big were the sales from the stock during the first two months?
- Yes, the revenue growth is mainly attributed to the increase in the sales volume. The stock volume decreased, and this decrease will be shown in the first-quarter financial statement. It should be pointed out that rough sales from the stock were expected: no mining on the alluvial deposits is carried out in winter seasons and the accumulated inventories are sold in the first quarter.
- Are there reasons to revise the outlook for sales upgrading it?
- Naturally, we expect that the metrics will show a year-on-year increase and be over 37.3 mn carats that were budgeted for the current year last October. We update the outlook for major performance and financial indicators every quarter. So, the news about the revised data will be available in April. In case of continuing good market trends, it is possible to expect sales at the level of 40 mn carats.
- To what extent the accident at the Mir diamond mine will impact the company’s net profit due to a write off?
- The total effect of a stronger ruble on our operating profit in 2017 was over 37 bn rubles.
As for the accident at the Mir mine, its impact on the net profit in 2017 is neutral, taking into account all the factors. On the one hand, we wrote off the lost underground equipment for a sum of RUB 8.4 billion. Severance is being paid to the people whom we had unfortunately to put out of work – their number is small, but still there are a few such people. We are also pumping out water from the mine, which costs over RUB 1 billion. On the other hand, we expect to receive the insurance compensation of RUB 10.5 billion from the SOGAS insurance company. We will receive the money in 2018, but the amount was added to the company’s books in 2017.
In future, the impact of the accident on the company’s economics will be more negative, as there will be no ore coming from Mir anymore, which will influence our sales.
- Do you consider the possibility to tie up the dividends to your cash flow, EBITDA, so that in future the shareholders could not suffer due to write-offs?
- First of all, I would like to note that it is the shareholders’ prerogative to take decisions of dividend disbursements. At the same time, we see that the company’s net debt will come to zero even by the end of this year, if the current favourable market situation remains and the views on dividend payments are not changed.
At present, we are working on the group’s medium-term liquidity forecast and plan to submit it to the Supervisory Board in June. Together with the liquidity forecast, we shall provide a review of various methods to determine dividend rates that are most frequently used in the mining industry and among the major Russian companies that have a significant government stake, as well as the vision of the company’s management regarding the target level of required reserves of available liquidity. Based on these materials, we hope to initiate a discussion among the shareholders that can probably result in working out a new financial policy, which can also influence the size of dividends starting from 2019.
- Some time ago, the Supervisory Board instructed the company’s management to study the possibility of selling rough for rubles. Do you think it is high time to introduce this practice at least partially?
- We carried out experiments to implement this idea. I should say it frankly that I do not see any prerequisites for scaling up this practice in the foreseeable future. It would create additional difficulties for our foreign clients – they would have to convert the currency that they normally used into rubles. One way or another, though the calculations may be done in rubles, the prices would stay in dollars. The question is only if we sell in dollars converting them into rubles in Russia or our buyers convert their dollars to pay us in rubles. Currently, it is more economically expedient for us and the whole transaction chain to receive revenue and convert it at our own discretion. Besides, one may run into legal difficulties, for example, in China while paying for contracts in rubles. China’s legislation has some restrictions that do not allow tying prices directly to rubles.
Today, the company holds a long position in U.S. dollars. And I think it is optimal. Over several years, the ruble depreciated very much, so from the point of view of the company’s sustainability, a dollar position is a more viable option. The fact that many major companies in Russia hold positions in dollars adds sustainability to the economy of the entire country. It is not a mere coincidence that metallurgical and oil companies are operating in hard currency. This is an established practice.
On the whole, the best way to improve the company’s sustainability is to be more efficient than competitors and decrease costs. This is a better way than games involving financial instruments.
- What is the situation with the company’s costs, do you see any further possiblity to decrease them?
- In 2017, we managed to maintain costs at the level of 2016, making corrections for the change in production and sales. This year our target is to maintain costs at the level of 2017. It is not an easy task – we are indexing salaries based on inflation rates according to our ‘Collective Agreement,’ and it is one of the major component of our costs. However, we can offset it thanks to the efficient production and optimization of administrative expenses. Among other things, we are successful in implementing a number of initiatives to centralize the use of transport means, improve the use of mining equipment, convert the company’s power facilities from diesel fuel to oil and gas. We will keep on doing our best to increase transparency in procurement purchases.
- Do you widely use the Moscow Exchange to convert hard currency?
- Yes, so far, we do not see better options. We are open for discussions and many banks offer us their platforms for the conversion of money, but nowadays, the terms and conditions proposed by the Moscow Exchange are really more beneficial.
- Late last year, the Supervisory Board approved the Option Programme. Please tell us about it in more detail. Will the shares required for the management remuneration be bought on the market or these will be phantom shares?
- This issue was initiated by our minority shareholders. They think it to be right to motivate the management to increase the company capitalization. Last December, the Supervisory Board gave general approval to the Option Programme for key managers. Today, we can say that this programme will last for three years and involve about 100 key managers and experts of the company who will be motivated for the Total Shareholder Return during the programme period. The specific parameters and mechanisms of the programme, including the participation degree of each key manager, will be separately discussed by the Supervisory Board.
- For several years, ALROSA has been committed to the conservative strategy on the debt market. Are any big deals possible this year - either in the public debt market or in credits?
- Borrowings result from the need in them. Today, we generate more money than we invest and pay as dividends thanks to the efficiency of our mines and company. We have a rather strong financial position and so far, there is no room for new borrowings.
There is a ‘locked-in’ debt in Eurobonds that can be paid off in November 2020 only. There is no regulatory opportunity to buy back a big part of it, while buying a small part will result in higher value of this debt. With hindsight, it could have been better to make several ‘shorter’ Eurobond issues than one large-scale issue for 10 years. But the issue was made in 2010, when the company was recovering from the 2009 crisis and was in need of ‘long’ liquidity.
As for the remainder of the debt, we have already paid off $450 mn in advance and will pay off $150 mn more by the end of March for the credits from the Rosbank and Raiffeisen bank that we can settle now without penalties. After that, only the Eurobonds and small credits will remain that we took at reduced interest rates to purchase BelAZ trucks.
- In future, as it appears, the company will be forced to return to the capital market only if it will have to finance the recovery of Mir?
- In the mid-term, the company’s current operational cash flow is sufficient to support any of the possible investment programs within the framework of our strategy - including the recovery of the Mir mine. The decision on this project, as we expect, will be taken in the second half of this year.
On the whole, the investment program depends on the state of the market. The higher the prices are, the more the company is ready to invest. We have rather rich reserves, over 1 bn carats, but the economic benefit of their extraction depends on prices.
Now we are busy updating the long-term development program that will also be adopted in the second half of the year. We review each of our deposits and licences and analyze the payout time of their development under various options of market conjuncture. As a result, we shall have several scenarios for the company development that differ in production volumes and capital investments. The presentation of the long-term development program will be on the Investor Day in September or October this year. The information about the prospects and development options for our key deposits will also be provided at this event.
- While the Mir mine is out of operation, Severalmaz is increasing its contribution to the Group’s total output and the Verkhne-Munskoye mine, considered to be low-grade, is being put into operation. Has the company assessed the impact of “lowering” the diamond grade across its deposits on the average price of rough diamonds and financial performance in the mid-term?
- We are continuously assessing this effect. Economically, the Mir mine is, of course, among our best deposits. With Mir put out of operation, higher input of Severalmaz and commissioning of Verkhne-Munskoye, we see a higher share of smaller stones and declining grades. At the same time, all our mines are currently generating an additional margin for our company. If the market is stable, we expect the production at the level of 38-39 mn carats in the mid-term. With the improved market and positive consumer sentiments, we can increase the output. In case of a market disruption, we can decrease the production.
- Still no negotiations on the Grib pipe?
- Currently, no. There was an exchange of opinions several months ago. We saw that our views on the value of this asset differ greatly from those of the seller. With this difference, it is not possible to bring our positions closer. Probably, some time is required. If the price is closer to our estimates, we will be ready to continue the discussions. It should be taken into account, that there is no significant synergy between Severalmaz and the Grib pipe, as the infrastructure at these mines already exists. They should have merged earlier. That said, the time left for mining the economically viable reserves at the Grib pipe, as we know, is not long - about 5 years. This is not the horizon that can have a serious effect on the company’s performance.
- When will the acquisition of Yakutia’s interest in ALROSA-Nyurba take place? Will it be followed by consolidation with ALROSA?
- At present, we are in negotiations with the Republic of Sakha (Yakutia). I would describe these talks as constructive and having prospects to be successful. The approval of the deal will be the subject of the next meeting of the Supervisory Board. Our goal is to effect this transaction in the first half of the year. If we have control over almost 100 percent of ALROSA-Nyurba, it would make sense to integrate this company into ALROSA, which would enable us to decrease our administrative expenses.
- What is your take on synthetics and their influence on the market?
- So far, their influence is limited, it is only seen in admixing synthetic diamonds to parcels of natural diamonds, what was the case in India. However, the industry gave a rather rapid response to these facts and they did not become numerous.
We believe that natural diamonds and synthetic stones have different market niches. A good example is the difference in consuming branded and non-branded goods even when their characteristics are similar. The sales of branded goods grow faster. A natural diamond is a sort of a brand, too. In China, it is very important for consumers to have a natural stone. In the US, the situation is a little bit different, as diamond miners lost the time there and gave advantages to marketing experts employed by synthetics producers who made a certain success positioning lab grown diamonds as environment friendly and hi-tech, which attracts some potential customers.
- To curb the proliferation of illegal synthetics and ensure transparency, the company said it was possible to use blockchain technology to register transactions involving rough diamonds. When and how do you plan to introduce this mechanism? Will it be applied to your long-term contracts?
- We will welcome any technology permitting to differentiate natural diamonds and synthetics. So far, we are busy only elaborating the approaches to the blockchain technology and the details are still to be worked out. We are carrying out the work based on the blockchain technology within the development of our customer relation management service.
- Is ALROSA considering the possibility of increasing its competence in synthetics? Setting up anything like Element Six or any other possibility of diversification into this field?
- We will not go into the production of synthetic diamonds. Nowadays, there is much analytical data on synthetics and there are a lot of players in this market. We communicate with synthetic diamond producers and understand their economics and clients. We do not need our own synthetic diamond production for that purpose. Besides, we position ourselves as a natural diamond producer and it is important to adhere to this position.
- When will the deal on buying the stake in Catoca be closed?
- We made the payment in the fourth quarter last year. The consolidation of our stake will be completed in the first six months of this year. We are interested in increasing our presence in Angola and understand the specific character of Angola’s assets and business environment and we have constructive relations with the government of this country.
- How much money will be required to start up another project in Angola – Luaxe?
- The capital investments will reach $500 mn to $1 bn depending on the development concept chosen for this diamond deposit. The concept is under discussion and coordination with the Angolan party. Catoca has already invested about $60 mn in the development of Luaxe. The annual investments in the development of Luaxe will increase –they will be about $111 mn in 2018.
- Is it possible to buy assets anywhere else abroad except Angola?
- On the whole, the attitude of the company management can be described as ‘back to basics.’ We want to focus on the diamond mining in those areas where we understand the geology and business practices very well. We have a good potential for well-balanced development in Russia and Angola and we will fulfil it.
