Public Joint Stock Company ALROSA (ALRS) Earnings Call Transcript & Summary

Dear ladies and gentlemen, welcome to the Q4 and 12-month 2019 IFRS results conference call of ALROSA. At our customers' request, this conference will be recorded. [Operator Instructions] May I now hand you over to Sergey Ivanov, who will lead you through this conference? Please go ahead, sir.

Good evening, ladies and gentlemen. Thank you for joining us on the call devoted to 2019 IFRS results. Today, we are joined by our Deputy Chairman of the Board and Head of Republic of Yakutia, Aysen Nikolaev, who will be happy to answer your questions today. As always, I will open up the presentation with a brief review of the diamond market; and Alexey Philippovskiy, who is joining us from London, will walk you through operating and financial results. In 2017 and '18, Christmas period has very strong demand and sales that were 2x higher than historical average. These led to overoptimistic expectations for 2019, following excessive inventory buildup in first half of 2019. Key miners keep focus on prices over volume strategy and adjusted the supply for 2019. In value terms, the decrease was 23% year-over-year. This strategy led to positive dynamics across the chain and the stocks finally normalized. By the year-end, supply and demand came to the balance. We aim to maximize value for our shareholders so we reacted to the challenging situation in a constructive way, aiming to maximize cash...

Ladies and gentlemen, due to a technical issue we will pause this conference for now. Please stay on the line. [Technical Difficulty]

Maximize value for our shareholders. So we reacted to the challenging situation in a constructive way, aiming to maximize cash flows and dividends in given market environments. We adjusted minimum allowed contract allocation level, production was cut at the highest cost assets with lower margins. CapEx was revised down by 28% in 2019 and around 15% in 2020 by initial guidance without negative impact on operational performance. Finally, I understand that all of you are concerned about the impact that the most recent developments might have on our 2020 action plan and outlook, namely the coronavirus and the shock in the oil markets. The coronavirus will negatively impact our sales outlook for 2020. Though our January and February sales were healthy, currently, we're seeing a decrease in demand. Given the uncertainty of the overall impact of the coronavirus on the global markets, at this point, it's difficult to estimate the effect this will have on our sales. We give our customers already in March additional flexibility in terms of sales and all the procedures within the long-term contract, but we'll have to see how the situation will evolve in April and May this year. We have reduced travel plans only to the essential travel outside of Russia. Some of our auctions were moved to other locations, for example, from Hong Kong to Israel, for example. Just to reiterate, most of our sales are done through the long-term contracts and less dependent on auctions. We encourage employees to stay at home if they suspect they are ill or if they traveled in the regions where it was high level of virus infected. We closely monitor situation, and certainly, well-being and safety of our employees is our top priority. As for the oil price situation and the ForEx impact, as history shows, lower oil prices have a positive impact on consumers' disposable income, particularly in the U.S. which should be a positive factor for diamond jewelry demand. As for the ForEx impact, close to 90% of our revenue is generated in foreign currency, while up to 80% of our costs and CapEx are ruble denominated. So every ruble decrease against U.S. dollar will be increasing our EBITDA by up to 2.8%. At the same time, over 90% of our debt and deposits are in foreign currency. That's what I wanted to bring your attention to, and I will pass the floor now to Alexey Philippovskiy, our CFO, who is in London right now. Thank you.

Thank you, Sergey. Good day, ladies and gentlemen. Thank you for being with us today. I would suggest to move to Slide #5 to recap our sales numbers. The market has recovered from its mid-2019 lows with the midstream destocking, growing consumer confidence and improved demand for larger stones. Our Q4 sales in monetary terms demonstrated a healthy growth of 8% year-on-year. Annual sales volumes in carats were down 12% to 33.4 million carats. This was in response to soft market conditions in the first half of the year. 12-month sales in U.S. dollars were down 26% to $3.3 billion. I'm sorry. Can you hear me in Moscow and online?

Yes, you're on line. We can hear you.

Yes. We now hear now, Alexey, please.

Okay. Okay. So let's move to Page #6, where we will discuss our inventories. At the year-end, our stocks were at 22.6 million carats, driven by higher production and lower sales. In 2020, we are cutting our production to 34.3 million carats, down from 38.7 million as initially planned in order to decrease production costs and to ease working capital. However, we should note that we are still keeping with our price over volume strategy. In other words, we are mindful of the balance of supply and demand. And given the large size of our market share, we understand our responsibility for price and market stability. The previously mentioned decrease in production will mostly be seen at our alluvial deposits, which have lower price to cost spreads and the higher variable cost component versus the rest of our mines. Let's move to Page #7 to discuss our price dynamics. Market conditions discussed earlier were behind a 6% year-on-year like-for-like price index decrease. This factor, along with a higher share of smaller stones in the sales mix, drove average selling price in 2019 down by 19%. Fourth quarter performance was marked by a stabilization in like-for-like prices, while average selling price was up by 9% to a healthy $148 per carat, driven by higher demand for larger stones. Now let's go to Slide #8. I would like to take you through our key financials for the year. Revenue decreased by 21% and to RUB 238 billion. The key drivers, as presented on Slide #9, were weaker sales mix, lower volumes and, to a less significant degree, lower like-for-like prices. These factors were partially offset by a weaker ruble FX rate. EBITDA came at RUB 107 billion, while profitability was at 45%. Free cash flow for the year came at RUB 48 billion. More details for this will be discussed on Slide #15. Our CapEx is discussed on Page #12. Our full year numbers were down to RUB 20 billion, revised down from RUB 29 billion as originally projected, as payments were rescheduled and some minor projects were revised. Fourth quarter numbers came flat year-on-year. Let's look at Page 13. Net debt-to-EBITDA ratio remained in the targeted range of 0.7x. The increase from last year was largely due to a lower EBITDA and net debt growth in the last 12 months. Our short-term debt is currently represented by the remaining portion of our 10-year Eurobond maturing in November of this year. Before I conclude our discussion about debt, I just wanted to reiterate that maintaining an investment-grade credit rating is important for us. Now let's move to Page #15. 2019 free cash flow came to RUB 47.6 billion, impacted by lower earnings and an increase in diamond inventories. We expect a gradual working capital release in 2020 due to lower production and higher sales. Fourth quarter free cash flow increased to RUB 17 billion, driven by higher sales and the working capital release. Let's move to Page #16, where we will talk about dividends. In September of last year, our shareholders approved dividends for the first half of 2019 in the amount of RUB 28.3 billion or 100% of our free cash flow for the period. This coming April, the Supervisory Board will recommend dividends for the second half of 2019. Based on our financial performance, the dividends will be between 70% to 100% of our free cash flow for the period. Our future outlook is presented on Page #17. I just wanted to briefly reiterate that diamond market fundamentals remain strong. Diamonds continue to be viewed as a symbol of love, commitment and affection. The continual growth in the middle class and its disposable income will lead to market growth. At the same time, the supply of diamonds continues to tighten. Our business remains strong and resilient. Our sales in 2020 are expected to recover while the exact scale of this recovery will depend on the market conditions, including what Sergey said in the final part of his presentation. We will continue to focus on the projects that make our business even stronger and more efficient. This morning, we shared our view on the execution of our strategy, where you could see the progress of some of our major efficiency improvement initiatives and projects. This concludes my presentation, and we are now ready to take your questions. Thank you.

[Operator Instructions] And we've received the first question from Daniel Major.

Daniel Major from UBS. Two questions. Firstly, you state that you think you're going to release some working capital this year. Obviously, that's, I guess, going to be dependent on market conditions and on sales volumes. Can you give us any guidance or insights towards on the other components of working capital outside of inventories? And I just -- receivables came down quite sharply in the fourth quarter. So what I'm essentially asking is if you remove inventory, I assume there was no movement in inventory, what should we expect from movements in working capital during the year?

Should we answer your first question, and then you will ask your second one or you want to ask the second question right away?

Sure. After the first one, I'll answer the second one, I say.

I'll take this question. Our working capital at the end of last year stood at RUB 107 billion. If speaking about last year dynamics, there was substantial growth in rough diamond inventories for the reasons that we just spoke about. The ore and sand inventory has slightly increased by about 10% and the materials have increased by also 10% on volume growth. The accounts receivable went down quite substantially by 28%, but it was mostly driven by the acquisition of Kristall. While it was an external party, the receivable was on our book. Once we consolidated Kristall into our books, it became an intercompany account. So that decreased the accounts receivable by about RUB 2 billion. In addition, the overall amount of receivables, excluding Kristall, on the domestic market went down by about RUB 2.6 billion as well. The other items state more was the same. The turnover of our inventory for materials had actually improved from 432 days to 356 days. The turnover of our diamond inventory had deteriorated from 169 to 217 days on poor market conditions. Looking into this year, again, as Sergey said, there is a big unknown in the form of coronavirus. Our base case scenario at the beginning of this year was that we will sell at least 37 million carats while we produce 34 million carats. So our diamond inventory should have decreased by about 3 million to 4 million carats. Now it's difficult to say. I mean, if Europe and the U.S. will shut down, as Italy just did, then the impact of coronavirus on the demand for our products will -- and for any other products just as well will be quite material. If things will subside and China reopen and no other country will follow Italy's example in shutting down part of the country, then the demand should recover, and we could meet our base case scenario numbers. For materials, we expect that next year, there will be about at least 15% increase in turnaround of our material inventory, driven by a number of efficiency improvement initiatives we are doing in our supply chain management and logistics. Accounts receivable on the domestic markets will be a function of the demand. There is payment terms that are regulated by law at 180 days. We have to give them to all domestic purchasers. So if they buy more, the receivable will be more. We have very limited control over it. Ore and sands inventory should stay at around the same level. The growth in 2019 was mostly explained by the expansion work we were doing at our Severalmaz facility. At this moment, actually, late last year, reacting to the market conditions, we stopped that expansion work. So the sand and ore inventory should stay at about the same level. The overall turnover of our working capital, assuming that the market situation will return to normal, should get down to about 100 days from 149 that we saw in 2019 on the back of rough diamond inventory buildup. Does it answer your question?

I guess, to summarize, I mean, independent of inventory, there shouldn't be huge movements in the other components of working capital. Is that fair?

Yes. That's a very nice and short way to put it, yes.

Yes. Perfect. Okay. And just second question. You obviously reiterated the dividend range of 70% to 100% of free cash flow. Can you just give us some short-term dynamics about where -- what will drive that decision is and when the decision is actually a reminder of when the decision is taken? Is it -- will it depend on kind of how the March, April sales data plays out as to where that dividend payout ratio will set for the final dividend?

Sergey, shall I answer this?

Yes. Sure.

Yes. Well, you're absolutely right. The only -- I mean our base case scenario is that we will pay 100%, and that's what we plan to recommend to the Supervisory Board. However, if we see that there is a threat to general liquidity of the company, I have to remind you that we have about $500 million of debt outstanding at the end of the year in the form of our outstanding Eurobond, assuming that there is like a terrible scenario where debt market shut down and the sales -- countries keep shutting down and our sales is profoundly impacted in March and April, that is -- that would be the scenario where we would look at recommending less than 100% in dividends. We believe that this scenario is, at this point, it looks unlikely, but we cannot exclude it. Currently, we have almost $1 billion in cash. So the liquidity is very strong. But again, with this big unknown in the form of coronavirus, we have -- you need to give us some time to really see how it will impact our liquidity.

Got it. Very clear. And just so when is the decision made on the dividend? When does the Supervisory Board meets to decide on that?

End of April, Supervisory Board will recommend a certain amount of dividends to the shareholder meeting, and the shareholder meeting will take place at the end of June. And the dividends will be paid in 2 tranches. First half to minority shareholders in July and then the other half to government shareholders in August.

And the next question is from Sergey Donskoy of Societe Generale.

Yes. Can you hear me?

Yes, we do.

I have 3 questions, if I may. Firstly, the realized gem-quality diamonds price in Q4 was $148, if I remember correctly. Was this a number anyhow affected by a higher proportion of larger stones in the mix? And what would be, if it's possible to tell, the kind of the sales price, assuming some sort of a normalized mix, if that was the case? Second question. On your CapEx outlook, you basically expect that the CapEx peaks in 2021 to see it going down all the way to RUB 21 billion by 2024. I have a question for -- about what's going to happen beyond that actually. We know that your mines have mine life to 2030 and 2035, so approximately between 10 and 15 years. So I assume that somewhere within a 10-year time frame, you will need to increase that maybe substantially to offset the deflation. So the question is, when do you expect this increase in CapEx to actually happen? I understand that it's going to happen beyond 2024. But do you have kind of any idea how soon and how big this can be? And finally, if we have Mr. Nikolaev online, I have one question for him as well.

Okay. I'll take the first 2 questions, and then you will ask your question to Mr. Nikolaev. Yes, the average gem-quality diamond selling price in the fourth quarter was at $148 per carat. It was a catch-up in demand for larger stones. At the beginning of the year, the number was much lower. And the average number for the year came at $132 per carat. It was a significant decline from the average price on a like-for-like basis of $163 per carat in 2018. Speaking about our outlook for 2020, we believe that the average price will increase to -- assuming that the like-for-like index will stay the same, will increase by about $5 to $7 from the average level of 2019. In other words, it will be between $137 to $139 per carat. Go ahead.

Yes. When you say assuming that the index stays the same, you mean it will stay the same compared to where it is now or compared to average values for the last year?

Comparing to where it stands now. Yes. To your second question, our CapEx, you're right, we will need to invest to maintain our capacity after 2030. At this point, we are doing maintenance and expansion CapEx at some of our mines, and it is actually a significant part of our ongoing CapEx. Speaking about like big projects, currently, we have reconstruction of Mir mine on the horizon. The project -- the decision will be taken at the end of the next year. At this point, the project seems economically viable. But we have to do some deep drilling to confirm the grade of ore at the lower portion of the kimberlite body. If the decision to reconstruct Mir will be given a go ahead, then we should see an increase in our CapEx starting from 2025 going forward. The reconstruction of mine will be -- I mean, at this point, it's a quite significant range between $1.2 billion to $1.5 billion over approximately 5- to 7-year period. I will be able to give you a better guidance in about 1.5 years once we have a better understanding of this -- of how we will do this project from the technology and geology standpoint.