On August 10, Deutsche Bank released a market research initiating coverage on Alrosa with a Buy recommendation and a RUR40/share target price, offering almost 60% upside potential for investors.
Introducing its market research Deutsche Bank offers the following Investment Thesis:
Outlook
OJSC Alrosa explores, mines, processes and sells rough diamonds through a global distribution network. On 34.5mnct production in 2011, Alrosa was the world’s biggest rough diamond mining company by volume and second by value. The group’s main operations are located in Yakutia, in northeastern Siberia, near the cities of Mirny, Udachny, Nyurba, Aikhal and Anabar. With 1.2bn ct at 0.90ct/t in reserves, Alrosa also enjoys a world leading reserve position that can support current production levels for at least 35 years and provides Alrosa with growth options. Alrosa is currently transitioning from mainly open-pit to more underground production and, by also broadening its open-pit operations, Alrosa plans to further expand production by 18% (vs our estimate 12%) over 2011-21F to 40mctpa. With a constructive outlook on the diamond market (we forecast 4.5% CAGR 2012-18F), we take a positive view on Alrosa, as the company stands to benefit from improving cash flows and a stronger balance sheet with a potential for higher dividend yield. Given poor liquidity, we believe a liquidity event could be key to unlock value in Alrosa.
Valuation
Our RUR40 target price is based on an aggregate DCF model with a seven-year horizon to 2018. We use a 12.7% USD nominal WACC based on a 4% risk free-rate, a 2% country risk and a 7.5% equity risk premium. We use beta of 1 and an 8% long-term pre-tax cost of debt on a 25%/75% long-term target debt/equity capital structure. With an historical effective tax rate meaningfully higher than the statutory 20%, we forecast a 23% effective tax rate for Alrosa. We add a 1% discretionary liquidity. In terms of multiples, our target price implies 6.1x/5.3x EV/EBITDA and 8.2x/8.0x earnings on our 2012/13 forecasts, which is in line with historical average forward multiples for the diversified miners, lower than precious metal, and, although with patchy data, lower than pure diamond averages.
Risks
Key risks to our forecasts are related to a weaker diamond price environment. A 10% parallel negative shift in our diamond price forecast would reduce our EBITDA by ~20% and earnings by ~30%, and lead to renewed balance sheet concerns. With ~70% of costs rouble-denominated, Alrosa is also exposed to rouble appreciation. We estimate that a 10% parallel shift of the rouble would reduce 2012/2013E EBITDA by 8%/10% and lower our target price by 27%. In terms of production, key risks relate to Alrosa’s execution of its plans to convert to underground mining. In mining in general and diamond mining in particular, there are also exogenous geological risks. As a government company, there is, in our view, a risk that political or social concerns could dominate profit driven objectives. In addition, there are risks of changes to the fiscal and regulatory regimes that could materially impact earnings and value.
You may read the full text of this market research by Deutsche Bank here.
