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

[Audio Gap] our abilities, and we look forward to enhancing further our expertise. As a Board, we have also fed the specific H&S, health and safety KPIs for the management, further entrenching ESG component in the culture of the company. Finally, we're in the process joining UN Global Compact, and we have been confirmed yet again as a responsible business partner by RJC. So if I can delve perhaps in Page 8 in the specifics of some of the environmental targets. If you look for the funds for green initiatives, the share in total revenues is 3%, and as you can see the -- cumulatively, our investment in the area has been growing. We are lucky to have a position of being able to be electrified with green energy, so 92% of our electricity consumption is generated by hydro and in terms of recycled -- of the water again, 90% of the water is being recycled. So again, we are not stopping here, and there are wide-ranging initiatives which will be embedded in the ESG strategy to be adopted by the Board in March of this year. We'll be embedding further aggressive targets to make ALROSA greener. Moving to Page 9. Communities, again, I have covered of that in my initial remarks but ALROSA remains a very steady funder of that region, making sure that, again, our social budget, which in the past may have been used by the Street as a burden but helpful it's being recognized as a reinvestment in the workforce and in the community, but the budget is well-spent. Moving to the people. Again, our key asset of [ each team ]. As I have mentioned, 80% of our workforce is based in Yakutia. You will see that we made some -- we have taken so many [indiscernible] off, the location of some of the staff to the other areas as they move -- as our -- as we think about the automated centralized system in the [indiscernible] still. Again, one portion of the workforce lives in very harsh natural environment, and again, we remain very much a big funder of the area. I often get asked how our people get paid. And if you were to work out the payroll over Russia, it is 2.5x higher than Russian average. That's a reflection again of harsh natural environment where our cities operate, and again, we are used as a very good employer. Clearly, as [ more men applied ], we engage in posting assessment of the employee loyalty and satisfaction. We have recently conducted a survey called words of ALROSA when we looked at specific -- we then surveyed over 15,000 employees and looked at very specific issues that emerged from the areas that cover work satisfaction, motivation and leadership, and we've learned a lot from that employee survey, and again, that is a survey has been used by the company as [indiscernible] as a suiter of new initiatives to make sure that, again, we remain an employer of choice. Lastly on health and safety on Page 11, we're not satisfied by already good healthy first quarter that we have. It is 0.23 versus metals and mining sector of 0.45. We understand that that's a nonnegotiable area. It's an area where a series of accidents could have -- could lead to the loss of the license to operate. And clearly, here, we are -- we have adopted a program, a new strategy in 2025 that targets 0 fatalities. That program will not be successful if it is not intertwined with the management incentives. And as I mentioned before, those are very, very much reflected in the KPIs of the company. So very much not resting on the laurels and understanding that that's an area where we have to keep making continuous progress in order not to experience the black events. Page 12, on the governance front, well, we obviously are known as the company that has made big inroads in terms of introduction of independent directors in Board of the company as well as clearly having a very specific and well-defined policy of use of cash as it relates to dividends and the financial policy. So we are proud of that and very much continue to lead to the making sure that our policy is of communication where the market is transparent. As far as the further enhancement of the Board of Directors is concerned, I mentioned the expertise survey that the Board renewal that we have undertaken. And here again, we've recognized the need to enhance the Board with industry experts, and in the past year in 2020, we've added Vladimir Rashevsky, who is a industry expert and the CEO of EuroChem as well as Mr. Noskov, who is a very, very experienced Operational Director from Polyus. Those directors became invaluable contributors both to the Audit and Strategy committee as it relates to enhancement and taking on board best-of-breed practices. So I will stop here. I will be very happy to answer your questions on any of the specifics. And now I will turn to my colleagues to Mr. Ivanov and Mr. Filippovsky to discuss the market performance after what was a very turbulent year. In 2020, I made a series of meetings with institutional investors. And obviously, the key questions were about the market, its dynamics, trying to understand how we can go from the period of absolute drop to very, very strong demand in the fourth quarter. So I will maybe turn the question to Sergey and ask him, how do you think the company can prepare? How do you interpret what's happened in the market? And how could the company prepare a full longevity in what is a volatile market. Over to you, Sergey.

Thanks, Maria. We'll comment on the market situation, of course, during my short view on the results of the year. So good morning, and good afternoon, ladies and gentlemen. In the next session, we will cover our market overview starting with demand, supply, market balance and finished by discussing how we responded to the COVID-19 and subsequent market downturn together with the action plan we are following to drive further performance enhancements in the future. So let's stick to Slide #15. After a drop in first 2 quarters of 2020, on the back of the pandemic and resulting lockdowns, the jewelry segment demonstrated a strong recovery across key markets starting from August 2020. The recovery of the U.S. market, which accounts for around 45% of global jewelry demand began to gather momentum in June. China, which accounts for 1/4 of global jewelry demand, started to recover in July. This trend then continuing through the second half of the year and early 2021, driven by the lifting of lockdowns and release of pent-up demand. Jewelry declined 15% in 2020 versus 23% decline across the personal luxury market, once again, showing that jewelry remains one of the most resilient categories of luxury goods. For reference, following the 2008 crisis, the luxury market declined 7.5% in 2009 and then grew with an average growth rate of 12.5% over 2009 and 2011. The global jewelry market is expected to continue to grow across all key markets, from single-digit rates in developed markets as we suggest and almost 2 digit rates in Asia Pacific. If we go to next slide, the midstream. Despite a second consecutive year facing challenging market conditions, midstream entered 2021 in a very good shape, and I believe it's in better health now than it has been over the past decade. The prudent approach taken during the crisis helped polishers to expand their margins during the market recovery. We saw substantial deleveraging starting in 2019 and this continued in 2020, and this has resulted in a more balanced debt profile. The sharp decrease in trading and manufacturing on the back of lockdowns and the highly flexible sales policies of miners helped polishers bring their stocks down to the lowest levels in a decade following a significant destocking in 2019. If we go to the supply response in 2020, so following demand contraction in first half of last year, miners responded by cutting supply to speed up restocking and alleviate pressure on prices. More than 45 million carats of annualized production was actually closed during March to May of last year across the board. The disciplined approach by miners is enabling polishers to scale purchasing down from previously agreed volumes to 0 helped to quickly restore balance and was a catalyst for market recovery. From mid-August, polishers started to restock following heavy destocking in Q2 2020. If we look at supply/demand and the inflection point, this comes -- in our global outlook, we see supply/demand at an inflection point. This comes following a series of production cuts during the past few years, including the most recent one in 2020, as we discussed a few moments ago. And in addition, more than 20 million carats of expected net closures in the next few years will combine to bring annual supply to 80%, 90% of the pre-pandemic levels. Meanwhile, demand is expected to grow at least in line with GDP with incremental growth coming largely from Asia. If we look at the pricing, to summarize what we've already said. So rough supply dropped by 25% last year. Stocks at polishers were down by 20%, and the jewelry demand was down by 15%, which is a good indicator that stocks of diamonds in the system are structurally low. Looking at the market today, we forecast that diamond supply will remain fairly flat or show single-digit growth in 2021 through 2025. Meanwhile, market experts believe that personal luxury demand, which includes diamond jewelry, will grow by at least 10% a year, and we expect these drivers to deliver positive impact on diamond prices. We see scope for additional price upside in the narrowing of the gap between rough and polish diamond prices observed in Q3 and Q4 last year. When we look into market trends further to what we said earlier, we see short and mid-term trends, which should shape our industry in the future. So on part of retail, the pandemic positively impacted e-commerce sales development in all industries, and jewelry was no exception. The share of online jewelry sales increased from 1%, 2% in 2010 and 10% in 2019 to actually 22%, 25% in 2020, which is an impressive leap brought about by the pandemic. We're not strong believers that ad consumers will totally migrate online, although we see potential for further growth in the share of online sales. Increasing spread between natural diamonds and synthetic products. Now we see clear segmentation between natural and artificial products, discount of LGD price to natural diamonds increased from 15% and 25% in '16/'17 to 80% and up to sometimes 90% today. In other words, the market itself place the product into a separate niche as we suggested. And we welcome the fact that end consumers have an even wider choice according to the occasion, their preferences and tastes. If we look on the localization of consumption, travel restrictions made jewelry sellers set their sites on their local markets, which will also have implications on our market from expansion of brick-and-mortar shops and subsequent need to bring stocks of jewelry locally, to the importance of just-in-time practices, lean stock management, digitalization, among other things. And here, we can definitely capitalize on our expanding digital capabilities. We see the main long-term trends as follows: an ongoing focus on ESG and sustainability by all companies in the industry as this aspect of business operation continues to grow in importance and brings the results of our ESG efforts into play; jewelry remains a top-3 desirable gift, and we don't see scope for any notable change in this since diamond jewelry is an integral part of people's lives, their personal stories, and it's a cultural phenomenon; and digitalization will further help to optimize operations, logistic change and our understanding of our best customers. By leveraging big data and building an enhanced understanding of our customer needs, we expect to see end products become more tailored and customer centric. If we talk about our response to COVID-19 in 2020, we implemented a number of measures to protect our employees and customers. Well, of course, we conduct temperature checks twice daily. We've provided our specialists who can work remotely with all the necessary things to work from home. We intensified internal communication related to this matter and reform ongoing employee testing. We have invested more than RUB 1 billion into the health-care system. We started leveraging telemedicine to network and performed more than 120,000 COVID tests during the last 11 months. We remain committed to our customers and gave them the opportunity to defer 100% of purchases from April. It's -- the system is still in place, and we won't change it in our March session with flexible sales channels and continuous communication to maintain an open dialogue with our customers. In terms of operations, we introduced the crisis management committee, implemented cost-cutting measures and strengthened our balance sheet. Our output decreased, but as we have already mentioned, this was done with the aim of supporting the market, and we expect to reverse this in the short, mid-term, and Alexey will go in detail today with these figures and numbers. Now let me walk you through what the management team is focused on today. So of course, sustainability, as Maria started, we're an ESG-conscious company, and we recognize that, while we have made a significant progress recently, there's still room for further improvements, which we're working towards. We maintain a relentless focus on our people and culture with development of our organizational ecosystem and operational enhancements throughout the production and value chain that are part of our company DNA today. Diamond production is an industry with a rich history, but we believe there is strong potential for new-state technologies and digital solutions. They will help us not only to increase through -- our output but also decrease variability of production and help us to spend less to do more. They will also make our workplaces safer for our team members and greatly improve the buying experience for our customers via both B2B and B2C platforms. In terms of growth, we have introduced a number of initiatives aimed at deepening our customer penetration, strengthening recognition of our own brand as well as the generic diamond campaign, continuous expansion of our resource base and maintaining a 25% share in global diamond supply. We walked you through our sustainability results and further initiatives, and we'll discuss some of those in more detail later in the presentation. On this slide, I will pass the floor to Alexey.

Thank you. Hello, ladies and gentlemen. Sergey has already briefly touched upon our strategic plans and priorities. And in the next section, we'll talk more about the execution. In particular, we will go through the promises we made and forecasts we gave at last year's Capital Markets Day as well as explain how we delivered on them. Slide 26, please. Let me start with laying out our key focus areas for both the past year and going forward. First, we're building a culture of operational excellence and continuous improvements, focusing on retaining our cost leadership and increasing productivity. Second, we are constantly rethinking our business model through the prism of informational technologies and are creating a group-wide digital ecosystem to allow centralized execution and monitoring of day-to-day activities as well as operational and medium-term planning. Third, we aim to emphasize our client centricity and work on enhancing our sales function through the development of online sales channels and a few adjacent innovative sales features. And last but not least, we remain firmly committed to our prudent capital allocation approach with the focus on organic development of our core business while balancing financial sustainability and high returns to shareholders through the cycle. I will now elaborate on our activities in each of these 4 areas and the results achieved to-date. Next slide, please. In 2020, we continued the implementation of our operational efficiency initiatives covering virtually all areas of our operations. This is a very dynamic process with a significant portion of the initiatives already being successfully integrated into our business model. Currently, we are working on over 600 various initiatives and projects, an increase of almost 80% year-on-year, and we have something to show for it. For example, in 2020, our overall production costs decreased by RUB 12 billion with RUB 5 million being a result of various efficiency gains. At the same time, our cost per unit went up, driven mostly by our decision to temporarily stop nonessential open pit [ diamond ] mine work with some of our lower-margin facilities, leading to a 33% drop in the overall run-of-mine volumes. So the denominator went smaller. As we gradually turn to precrisis volumes, our cost per unit should get back to its normal levels. And importantly, gains from these initiatives will fully realize its potential once the company resumes operating at optimal capacity. Next slide, please. Let's take a look at the case study on a successful operational turnaround at our Aikhal mining facility achieved in 2020. With implementation of 17 initiatives, we increased truck utilization rate and truck load capacity by 8% each, allowing us to decrease the number of trucks deployed by 5 units. Altogether, the total economic effect of our [indiscernible] Aikhal facility was over RUB 700 million in 2020. In 2021, we plan to roll out this same approach at our other mining facilities. Next slide, please. We continued to work on the large-scale reform of our equipment repair and maintenance system. Optimization of the maintenance function apart from a lower deflation in costs associated with maintenance works is essential for productivity gains. For example, decreased downtime and growth in equipment availability both eliminates bottlenecks and increases throughput. I was particularly impressed with the significant gains in labor productivity in these areas, allowing us to reduce the total repair and maintenance headcount by over 800. Next slide, please. As an update on the projects communicated during the previous CMD, we are continuing our work on improving our support functions. In sourcing and logistics, last year, we worked on the implementation of such initiatives as a new advanced Warehouse Management System, a new online supply ordering platform for mining facility, which is effectively an internal marketplace for spare parts, tools and other miscellaneous supplies. We also started the development of an MRP system in the supply chain for planning and scheduling optimization. Altogether, to-date, we achieved over RUB 2 billion of working capital release. We also continued the rollout of the shared service center to the group level. Cumulative realized cost savings in 2019 and 2020 were over RUB 1 billion and are expected to reach RUB 2 billion by the end of 2021. Next slide, please. The next step in developing the operational improvement culture is to move away from a project-based model to a more systematic approach. Together, we launched a dedicated production system development program aimed at promoting the culture of continuous improvement. The program unifies the implementation approach for all initiatives and stipulates 3 development stages: [ piloting ], system adjusting, and skilling up. In 2020, we continued building this system. And the next big thing for us will be mini-transformation projects, which we are kicking off this year. About 10,000 employees will be able to participate, run and implement best practice solutions, and share their experience with the [ whole class ]. Next slide, please. Here, we can see an overview of our digitalization program, which we launched in 2019. Among our key priorities is the alignment of analytics and reporting at all assets. This will enable us to boost productivity, optimize costs, and through improved monitoring and planning, make a safer working environment for our workers. We are continuing the development of our in-house IT expertise, including consolidating all IT professionals under one integrated and vertically aligned organizational structure. One interesting digitalization case study is the rollout of the MES system at our Nyurba mining facility, which is integrated software that allows realtime monitoring and control of various operational business processes. As shown on the chart in the middle of the slide, in 2020, this software we had an important role in reducing the truck's downtime hours by more than 1/4, improving mining transport overall production volumes by 77% and increasing technical readiness coefficient by 7 percentage points. The system already covers more than half of our loss of production capacity. And by the end of next year, we intend to make MES group-wide. Our successful integration of MES at Nyurba received the Best MES Mining Project award at the Annual Wonderware Online Forum 2020, which is dedicated to global industrial automation trends. Next slide, please. Another area of our focus is the enhancement of sales as well as its methods and channels. We have always been a client-oriented company and truly value our long-term customers as key partners. In this context, this year, we improved our feedback collection process in order to deliver best-in-class support and sales efficiency for our clients, allowing them to enjoy unprecedented flexibility in trading terms with ALROSA, as mentioned earlier by Sergey. Given the strict travel restrictions imposed after the outbreak of the virus, we presented to our clients the option to purchase diamonds remotely using online auctions. To replicate the conventional inspection process, we offered the new ALROSA Video-Viewer Service, which was very well-received by our customers. We also introduced a key account management service, which was and is available 24/7 and improved the transparency of our sales policy. Finally, an important component of our sales efficiency is reducing work-in-progress diamonds turnover. Despite the challenging environment, our work-in-progress cycle stayed 14 days below the 2018 level, which translated into over RUB 200 million of released working capital. Next slide, please. Here, I will elaborate on the 3 new sales features introduced by ALROSA in 2020. For our global customers, it's becoming ever more important to know the source of precious stones in order to ensure authenticity and ethical aspects of the final product. To that end, we have expanded integration options of ALROSA tracing platform. Diamonds or traced through the entire production chain. And in 2020 alone, it covered several thousand [ rough ] diamonds sold online. Another interesting solution is the ALROSA provenance system. Going forward, diamond passports will be issued for all polished diamonds produced by ALROSA, ensuring internal tracing and providing us with a perfect database for analysis and external communications. It's important to note that retailers are seeking to improve the transparency of their products, and our initiatives will help them to improve their competitive edge. Finally, we are working on digitalizing the host stock of our diamond inventories, external tracking platforms, such as Tracr, Get Diamonds and others, we'll be able to get live data on our available balance. Now let's move to the next slide. Our marketing strategy is evolving. Here is the list of our key marketing initiatives. General marketing to support ESG and transparency via Natural Diamond Council and image programs. Category market in [ Colorado ] stones in cooperation with leading jewelry brands and major retailers. Polished diamonds marketing, promoting unique nonconventional stores, such as fancy colored diamonds or large and exceptional quality diamonds via both existing and new channels. Let's move to the next slide, yes. A few words on our capital framework. We reaffirm and adhere to the efficient capital allocation policy, which is based on 3 pillars: Focused on organic development of our core business; commitment to prudent capital allocation with a targeted rate of return of no less than 20%; adherence to conservative financial policy, maintaining a balanced debt profile and a strong liquidity position. We believe these 3 components create a solid foundation to generate sustainably high free cash flow and return cash to our shareholders. Next slide. As mentioned by my colleagues earlier, our CapEx for 2020 was scaled back as we postponed some noncritical investment projects. Similar to the previous years, our investment program is focused on carefully selected value-accretive projects. We stick to the rigorous investment approach with required IRR of 20% or above, and we expect such level of returns from the projects currently in our pipeline, such as increasing the share of natural gas in our energy sources for development [ down in the mines ]. Next slide. We continue to maintain a balanced debt profile with a target leverage within 0.5 to 1.4 range for net debt to EBITDA and are committed to maintaining an investment-grade credit rating. Last year, in order to accommodate extreme market volatility, we're actively managing our debt portfolio from issuing RUB 0.5 billion of Eurobonds and a set of Russian ruble bonds, both with a [ typical ] raise, by the way, to early repayment of bank loans once it really improved. By the end of the year, we ended with extended maturities, growing by almost 2x to the targeted 3 to 4 years' range. At the same time, cost of debt dropped by almost 2x to an all-time low of 3.8%. Also by the year-end, our cash pile exceeded $1.8 billion, bringing our net leverage to 0.4, the lowest level since 2015. Next slide. Now let's talk about some important changes we're proposing regarding our financial and dividend policies. Three years ago, ALROSA introduced a new financial policy requiring the company to maintain a cash balance of at least RUB 25 billion at all times. We derived that amount from an analysis of all prior crisis, especially the one in 2009. However, last year, the global economy of the diamond industry faced an unprecedented demand shock, resulting in higher revenue volatility than we have ever known before. As you recall, from March to July of last year, sales went significantly down, putting pressure on our liquidity. To address this pressure, we had to take a number of actions aimed at preserving the company's liquidity, including starting production at our lower-margin facilities, creating some of our performance improvement and marketing initiatives, and reducing our CapEx program. Going forward, we believe the company should have on its balance sheet the liquidity reserve sufficient to weather such turbulence without reducing the production volumes and impacting our business development. So we have initiated a revision to our financial policy, envisioning increasing our minimum cash balance from RUB 25 billion to RUB 50 billion. This will allow the company at all times to maintain optimal utilization rates, ensure stability of funding of business development and marketing initiatives, and finally, to have sufficient cash fire power to restore market balance without resorting to external emergency health and to maintain the value of diamonds. In addition, we have initiated a tactical revision to our dividend policy, making it more straightforward on which we will elaborate on the next slide. Here, you can see a comparison of our current and proposed dividend policies. Both high- and low-leverage scenarios remain unchanged. The only proposed difference is to have a variable payout ratio between 70% and 100% for a net leverage between 0.4 and 1.4. The rationale for such a decision is to improve targeting of our net leverage and improve flexibility in managing that portfolio. Next slide, please. Let's move to Slide 44, please. Yes. To conclude this section, I would like to state that our strategic priorities remain unchanged. We will continue our efforts on increasing both our operational efficiency and sales efficiency, leveraging our successes achieved to-date and taking advantage of the strong market fundamentals. Now let's move to the next section, where I will briefly walk you through our 2020 results and future outlook. Slide 46, please. The fourth quarter saw a spectacular revival of demand for diamonds, driven by very strong end-user demand for them on jewelry, further amplified by the shortage of inventory at both polishers and retailers. As a result, our sales in Q4 have grown by over 3x in volumes and were over 2x in value, reaching $1.14 billion. This momentum continued to build up to the end of the year, culminating in over $0.5 billion of sales in December alone. However, given that the diamond market was pretty much frozen from March till July, it is not surprising that our sales in dollars for the year are down by 18%. Next slide. In rubles, 2020 revenue came to RUB 222 billion, 7% below year-on-year. EBITDA came to RUB 88 billion, 18% below year-on-year. Net income came to RUB 32 billion, 49% below year-on-year, and EBITDA margin came to 40%, which is 5% lower than last year. Despite a decrease in -- decrease in sales and profits, our free cash flow for the year has substantially increased from RUB 48 billion to RUB 79 billion, assisted by diamond inventories destocking and advances from customers received at the end of last year. Next slide, please. Here, you can see the EBITDA bridges for the quarter and for the year. As mentioned earlier, in the fourth quarter, we moved a lot of carats. Thus, the volume contribution in the EBITDA bridge was significant. However, many of those carats were cheaper diamonds, including loss used for technical applications. So the impact of sales mix on EBITDA more than offset the positive impact of volume growth. For the year, EBITDA went down by RUB 19 billion with key contributing factors being lower sales volumes, weaker mix and index, which were partially offset by the positive impact of the weaker ruble. Slide 49, please. ALROSA delivered an exceptional level of free cash flow in the fourth quarter, which was driven by both top line expansion, moderate CapEx, but also by RUB 41 billion of working capital release as our sales exceeded production by over 2.5x. An additional driver of free cash flow increase, apart from usual factors, was a strong growth in accounts payables, namely cash advances from our clients for the products to be delivered in the first quarter of 2021. The reason for this quite unusual client activity was a real market hunger for rough diamonds and means quickly shrinking stockpiles at all levels of the value chain. Slide 50, please. Inventories. Inventories were down by 32% for the quarter and by 8% for the year, driven by strong sales. The market value of inventory at the year-end was $1.8 billion. However, if you take away work-in-process inventory and inventory secured by customers' prepayments, we will have a near $0.7 billion of inventory that could be incrementally offered to our clients. Next slide. Here, you can see our production volumes, both past results and future outlook. 2020 volumes were significantly down, as in the second quarter, we made the conscious decision to curtail production in some of our assets. In 2021, as we gradually expand our production, we plan to produce around 32 million carats. And in the mid-term, we reiterate our potential to produce 37 million to 38 million carats per year. Next slide, please. My last slide is about the outlook for the future. We believe that diamond market fundamentals remain strong. Diamonds continue to be viewed as a product of choice for special moments in life. The demand for Diamond is shifting to younger generations of millennials and Generation Z who are just as anxious to buy diamonds as previous generations. End demand for diamonds is expected to fully recover as soon as the key economies are back to normal. And there is a continuous trend in structural decrease in diamond's supply. Our business is strong, resilient and well-positioned to benefit from demand growth. We already covered our outlook numbers in the previous slides, but I will briefly summarize it now. Our production in 2021 is expected to recover to about 32 million carats. We will adjust sales volumes depending on the real market demand. We have a positive outlook on diamond prices. Our CapEx will account for investment projects postponed in 2020, and finally, we'll continue working on the cost side of our business. At this point, we conclude our presentation. Thank you all for listening. We're now happy to start the Q&A session and answer any and, hopefully, all of your questions. Thank you.

I'm Anton Fedotov from the Equity Research of Bank of America. First of all, I would like to thank the management of ALROSA for such an informative presentation. And we will now open the line for the Q&A session in which institutional investors and sell-side analysts will have an opportunity to ask questions. Retail investors will have the opportunity to ask questions at separate events organized by ALROSA with retail brokers later. We will have up to 40 minutes for this Q&A session. And let me now kick in with my first question. It relates to diamond pricing. Year-to-date, we already saw several price increases by various market players, including ALROSA. Can you please discuss how sensitive is the market to these price increases and whether we can expect more price adjustments in the following months?

I will take this question. We judge the state of the market by looking at the level of allocations our customers are choosing to buy. As Sergey said, currently, there are no downside limits on those allocations. They can buy nothing if they choose to. However, in the last few months, starting in September, actually, we saw spectacular appetites from our customers. This month, the average allocation was close to 100%, which means that customers are trying to buy everything that they can get, which is unique. So currently, we believe that the environment in the market is very well-positioned for price growth. And we started gradually increasing our prices in December and continued into January and February. Our aspiration is to reach the pricing level at -- by the end of the first quarter to reach prices that were before the crisis began. And then after that, once the seasonal restocking is over, again, we will look at the real demand, and we will adjust our behavior, including pricing, accordingly. But our prevailing theme will be price over volume.

Great. I will ask the second question now. And I also want to flag the audience to raise hands in the application in the Zoom app or send us your questions by e-mail or Bloomberg chat, and we will take the next question after this one from the audience. So my question is the following. In the last 5 years, the company has passed through a period of very high free cash flow volatility. And how do you plan to address this volatility of earnings in the next period? Anything that you've learned in 2020 that you started to do differently that should minimize free cash flow jumps in the future?

Well, it's important to understand that the diamond industry is entering a period where there will be a structural shortage of supply. So in this environment, we should produce optimally, maybe close to a maximum level that the company can produce. So it's very important for us to have a sufficient liquidity cushion to absorb market shocks, including market volatility at the period of high volatility. So that is why we introduced an alteration to our financial policy raising the minimum liquidity cushion level from RUB 25 billion to RUB 50 billion. That would allow us to avoid adjusting our production volumes and curtailing production in order to stop cash bleeding at the times of high volatility. Did I answer your question?

Yes, absolutely. I'm passing the word to Anton to open the line for the questions.

And we have the first question from the call participants. That's the question from Daniel Major.

Can you hear me okay?

Yes, we can.

A couple questions. First question, you've given guidance for production in 2021 around 31 million, 32 million carats. Based on your current assessment of market conditions, can you give us any guidance on where you would expect sales to be, how much you would target to reduce your own diamond inventories by? And can you give us a reminder of where you see mid-cycle or average level of inventories?

Our aspiration is to sell 34 million to 36 million carats this year. And given the level of inventory we had at the beginning of the year and our production plans, that would probably be the maximum we could do this year. However, as I mentioned earlier, we will look at the market conditions, and we will adjust our behavior and market actions accordingly. The prevailing theme will be price over volume, and we will try not to over-flood the market with rough diamonds. Our expectation is that this year will be very positive because, as the global economy recovers, we believe that people will be in a good mood. They will be inclined to spend to give gifts, and that will be a very positive factor for the demand for diamond jewelry. In addition, as Sergey mentioned, we believe that the midstream is currently -- is in a very unique situation where, first of all, they have lots of money because they're spreads have improved dramatically in last half of the year. I will remind you that the price of polished diamonds actually increased during 2020, while the price of rough diamonds had substantially decreased. So they were able to benefit from these increased spreads, plus a similar situation is at the retail level. So the stocks are low at all levels of the value chain, and we believe that the industry and the industry of rough diamonds have more potential to grow by value rather than by volumes in 2021.

Daniel, if I may add, it's Sergey. So -- and I guess that other participants would have questions on the inventory management. I would say we offloaded a lot of inventory, a lot of millions of carats November and December last year, as you can see from our presentation. And I would say that in January and February, this trend also took place. And I think when we will report the Q1 results, Q1 this year, I think that investors will be surprised with the low level of inventory our company will have. So we should -- we still have March site ahead, but it looks like that entering Q2 will be close to the minimum historical levels of inventory. And the calculations we make with the situation with inventory with other major companies -- major mining companies, we see that it looks like they don't have inventories more than 1 or 1 and -- or maybe maximum 2 months of production. So it looks not only our company, but in general, the industry is very low on rough. And as Alexey mentioned, this will be unique situation, and this might drive prices for rough and polished mid-term. I mean, starting Q3/Q4 this year. And we see that it's impossible for the industry in general to ramp up production significantly. So after the Argyle closure, after the forecast disclosed by other major mining companies and our forecast for this year, we see that some like 20 million to 30 million -- production this year will be 20 million to 30 million carats less than it used to be even last year and 2019. So we expect this year might be quite unique in terms of supply/demand -- balancing supply/demand and really creating additional pressure in terms of demand and procuring rough for the polishing companies.

And just to give you some flavor, I would like to state some numbers. For example, for the production, the global production of natural diamonds, in 2017 and 2018, the industry produced around 150 million carats per year. In 2020, that number went down to 110 million. And according to forecasts recently published by Bain, in the foreseeable future, I'm talking about 3 to 5 years, this number will not go above 150 million and 120 million. So we saw a very significant and lasting supply decrease. In addition, speaking about the inventory levels, I would like to point your attention that, in 2020, only large producers such as ALROSA and De Beers were accumulating the inventory. All of the smaller producers, they were selling into the market because, I mean, they didn't have to preach price over volume probably didn't have sufficient liquidity resource to hope to accumulate inventory. On the demand side, what are striking -- what strikes me in particular, is the dynamic of expected number of weddings in our key markets in the United States. Normally, there are 2 million weddings per year in the U.S. In 2020, that number went down to 1 million. So they decreased by 50%. And there is an expectation and forecast that the number of weddings in 2021 will exceed 3 million, which is 3x more than what we saw in 2020 and 1.5x more than what we saw in a normal year before. So that will drive the demand, especially for a bridal size segment, which is between 1 to 2 to 3 carats.

Great. Very detailed answers. Just a follow-up question on dividend. Strong -- very strong free cash flow in the fourth quarter puts net debt to EBITDA in the low half of the 1 to 0 range, and cash on the balance sheet is greater than 50 million. Is it fair to assume you pay 100% of second half 2020 free cash flow as a dividend as a consequence of that?

It is fair to assume that we will pay between 70% to 100% of our free cash flow for the second half of the year in form of dividend. The exact number will be discussed and defined by our Supervisory Board in the second half of April. I really don't know at this point.

And the next question comes from Richard Hatch.

I've just got one question, and it's just with regards to Angola. Would you be able to provide an update on your operations in Angola and where you see production from the operations in which you're associated with there and what the production profile looks like, please?

Currently, Angola produces 7.1 million carats per year. Our expectation is that the EBITDA for 2020 will be close to $300 million and the net profit, which is subject to 100% payout in form of dividends, will be around $160 million. We have a claim for 42% of that dividend base. They're doing well. It was a challenging year for them as well. The forecast is that the production volume will go down to about 6.2 million carats over the next 3 years. And as we mentioned before, we are quite active in negotiating with our partners in Angola on structuring our participation in another interesting project called Luale that is located close to the existing Catoca facility. At this point, we have no other updates on the progress of that negotiations, but we hope that 2021 will be more fruitful in this area.

Okay. That's very helpful. And sorry, just a point of clarification. The Luale kimberlite. Do you have a steer as to what kind of production volumes that might bring on as and when it comes on?

Alexey, maybe I'll follow up on Angola. Thank you for your question, Richard. So regarding Catoca, I would say that the production for this year will depend on the COVID situation. Because, well, still, it's quite challenging. And I believe there was a downscale of production last year. So there are 2 scenarios: One is that the production will keep at the levels of 2020; and the second that the production will come back normalized to levels of 2019. But at the same time, there were significant cost-cutting programs. So we try to keep the EBITDA in the adjusted parameters, like Alexey mentioned. So we expect to get dividends from 2020. Soon Catoca will publish their operating results. I think there will be quite interesting subject to last year's market and COVID situation. So we think they've done quite a good job last year. And as for [ Luale ] project, so the investment, which was already undertaken by Catoca is close to $200-plus million. So Catoca will make some contribution this year as well. We don't plan to use ALROSA balance sheet to finance the [ Luale ] ramp-up. And according to preliminary feasibility studies because the general feasibility study was not yet approved, so we expect Catoca to bring maybe 3 million to 4 million carats starting from 2022/2023. Still, there are a lot of challenges to be addressed to start production, I mean production in significant in millions of carats because this year, we will have some hundreds of thousands of carats from Russia. But in general, it's included in the market forecast, which was illustrated 5 minutes ago. At the same time, I would like to announce that you remember in end of 2017, we entered into a transaction, increasing our stake in Catoca for additional 8.4%. And we're happy to announce that, actually, this year, we suggest that this investment will be absolutely paid back in 3 years through the dividends stream, which we got after this transaction for this precise number of shares -- and share of our joint venture with ENDIAMA. So we see that ongoing business is delivering quite good results.

And the next question we have from Nikolay Sosnovskiy.

Do you hear me well?

Yes, we do.

Thanks a lot for the excellent presentation. Sets the bar at great height. What great companies, I guess. I've got 3 questions, and I'll go one by one, if I may. The first 1 is on the inventory levels, I would like to dwell a little bit into this topic. You said this year, sales can exceed production by something like 4 million carats. Can you please elaborate on quality of these stones because, in fourth quarter 2020, the working capital release inventory sold was of lower quality. Should we expect this trend to continue into first quarter sales, or this inventory release would be of the same average quality of ALROSA, the same average realized price? So what should I think in terms of working capital release in first quarter and money-wise versus these 4 million carats?

The average value of our inventory and the prices that were at the end of last year is $90 per carat, which is more or less in line with our production structure. In terms of our outlook for the impact on mix of the structure of sales, in 2021, we expect that mix will contribute about 4% to 5% to the average sales price of the stones that we will see in 2021. And on top of that, there will be contribution of index as well.

Okay. That's very clear. My second question is on production. You said that in medium term, ALROSA is able to support production at 37 million, 38 million carats. So how quickly will you go to this level after 2021? This CapEx you have introduced back to normal levels, does it really include the necessary amount to achieve this level? And in addition to that, we all know that you still have this excellent mineral reserve of Mir mine and considering the good market and overall, as you just explained, the scarce resource and no additions and just depletions, will you be accelerating Mir development in near term?

Yes. Our base case scenario is to get to our target levels, 37 million to 38 million carats by 2024. However, currently, we are looking at some other options and tradeoffs that would allow us to increase production sooner than that. And I think we'll be able in a position to make some announcement when we release our Q1 numbers in May. In terms of the longer-term horizon, Mir mine volumes cannot potentially enter the market earlier than 2030 or 2031. By the end of this year, we should be able to have all the data necessary to calculate the NPV and other economic aspects of the project, which we expect to be positive. And at that point, we will be in a position to make a decision to go ahead. Currently, we know that there is a way to reconstruct the mine safely. We do have an idea of the CapEx. And our expectation is that, assuming that the current exploration stage of the deeper horizons of the Mir kimberlite pipe validate that the grades at the low portion of the pipe is no worse than the grade of the flooded portion of the pipe. Then these projects should have close to 20% IRR in dollars and will be economically feasible. But again, the decision will be taken by the end of this year, and we'll report it accordingly.

Nikolay, if I may add, one of your question was whether we will require CapEx to restore the operations we've stopped this last year. So you remember, these were alluvial fields at the Anabar division. So they don't require any CapEx. We just suspended operations. And if we decide to ramp up, we can do it with Anabar with EBITDA. We can do it only 2022 because it's subject to bringing in fuel, bringing in all the maintenance parts. But -- and at the same time, it was several months. And both fields, they are not marginal, or they're not so much marginal like other fields. So this would not require any CapEx. This will require just, well, bringing in fuel, hiring some people, buying some parts and something. So that would not affect the CapEx, the investment program for this year or for next year. As for other fields, as like Alexey mentioned, there are some programs we're working with consultants tightly, and it might require just buying couple of trucks or buying couple of excavators, and this would not be substantial in line with the figures for investments, which we present today.

Understood. And my final question is on dividends as the essence of it. You've mentioned that the new dividend policy change is that the company should have at least RUB 50 billion accumulated. But the question is on the necessity of this cash pile and the form of this cash pile despite all the market challenges in 2019 and 2020, ALROSA still has managed to bring down the average cost of borrowing to below 4% in U.S. dollars, which is very low by the historical standards, at least in Russia. So why do you need to keep your own cash when the market is so generous and you can borrow in the difficult circumstances at such a low rate and you can potentially pay this as dividends and you have lots of committed credit lines to take this money very cheaply from the market in case you need it and hopefully, you don't need it during the next several years? As you said, the market is good and demand is good, and there is no production coming from other producers. So why becoming more cautious in this situation?

Yes. Thank you. Well, as I mentioned earlier, currently, the diamond industry is entering a period of a structural shortage of supply. And in this period, it's wise to produce at optimal levels. Looking at 2020, I'll give you some numbers. We were fortunate that we started the beginning of March with a cash balance not of RUB 25 billion, as it currently is stipulated by our current financial policy, but with RUB 70 billion. And in March and April, it would be very difficult for us to borrow because most of the banks were not even open for discussions. Then there was a very pronounced opening of the debt capital markets in May, but that was driven by the stimulus decisions and by the easy mining era that was launched in the U.S. If you look at the operational cash drain between the beginning of March and the end of August, it amounted for RUB 53 billion. So RUB 53 billion of cash -- the cash balance went down by that. So essentially, what we had to do, we had to -- first of all, we had to curtail some of our production, which led to a 7% cost increase per carat in the last year because, when you cut production, you still have to bear fixed costs. You'll trend to variable cost only. And roughly, 70% of our cost base is fixed. In addition, we had to postpone some of our business development and marketing initiatives, which also has some opportunity costs. So we do not want to be in that position again. Again, we cannot count that the last crisis was really the last, and it will never happen again. We also cannot count that the bank system will be open for all the crisis. There where crisis before when the banking system was closed for several months or up to 6 months. Remind you, 2008/2009 crisis in Russia was very difficult to [ work ] a mine. So we're just trying to stay on the safe side and pass this RUB 50 billion, which is less than $1 million of cash cushion does not seem excessive. If you look at some of other mining companies, given that mining is a huge machine that you cannot just start at a view and then resume production. This huge opportunity. You have to lay off people. You have to still bear the fixed cost. We believe it's from a point of view of preserving the shareholder value. It's much better to have this cushion and to pay the associated costs, which are not that high given the current low interest rate area, than to be forced to stop production or do any other drastic actions when the market volatility increases. I mean god forbid, if you had just RUB 25 billion at the beginning of the last crisis, we will have to add much -- we will have to undertake stronger actions that we did. So in the future, we want to avoid the situation. So in a way, this is a risk mitigation measure that we decided to undertake based on the homework from the last crisis.