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

Dear ladies and gentlemen, welcome to the Q1 2021 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, who will lead you through this conference. Please go ahead, sir.

Thank you, operator. Good morning, and good afternoon, ladies and gentlemen. Sergey Takhiev, Head of Corporate Finance, and it's my pleasure to welcome you to our Q1 2021 results conference call. Today, we have Alexey Filippovsky, ALROSA's CFO, who will briefly walk you through the key slides of the presentation, and then we will be happy to take your questions. As always, elements of our presentation are forward-looking and based on our best view of the market. We take questions from investment communities. So just to let the media know that we are not taking questions from the media. And now I will pass floor to our CFO, Alexey Filippovsky. Alexey, please go ahead.

Yes. Hello, ladies and gentlemen, and thank you for joining us today. I hope you and your loved ones are safe and healthy. I will open with a brief update on the diamond market, and developments around the company, and then I will briefly walk you through our recent operating and financial performance. Before we start the presentation, I would like to say a few words on what ALROSA is doing about the COVID-19 pandemic. We do and will continue to take all necessary measures to contain the spread of the virus and to ensure the safety of our employees. Since March 2020, more than 130,000 COVID tests have been carried out among our employees, which helped us to identify over 3,600 positive cases. We also facilitate vaccine supply to the regions of our operations. As of today, around 10,000 of our employees have received the first jab and about 7,000 people have been already fully vaccinated. Now let me proceed to the market overview. Please turn to Page 3 of our presentation, please. Despite an extremely challenging year, the demand for diamond jewelry has once again proved more resilient compared to other luxury market sectors. In 2020, jewelry consumption in the U.S., which accounts for almost half of the global market, virtually recovered in full to the record high levels of 2019, while China and the Asia Pacific showed double-digit growth on positive macro and repatriation of demand. Positive dynamics continued well into early 2021, showing growth, not just against 2020, but against the strong 2019 figures as well. For example, Q1 '21 sales in the U.S. were 30% higher versus Q1 2019. The main drivers of the remarkable growth were improved macro and consumer confidence, growing savings as jewelry shoppers cut their spending on experiential goods and services and growing demand from Chinese consumers, including the younger generation. It is still early in the year. So it's probably too early to make any sweeping forecasts on demand. But so far, the demand has pleasantly surprised us. Retailers demonstrated strong sales and profits across the board, generating demand for polished diamonds. As you can see on the middle chart, Polish sales in India have risen every quarter on a strong offtake by jewelers and retailers. We know that this strong demand is not our speculative nature. Based on our communications with cutters and polishers, the midstream has learned from the lessons of 2018 and 2019 and is not going to see it on a diamond stockpiles again. India's current polishing industry has not emerged from the second COVID wave just yet, and we are monitoring the situation. Since the onset of the second wave, all our clients have rationalized their capacities and shifts and introduced strict anti-COVID measures. Our hope is that these preventive measures will help minimize the impact on trade. The supply of diamonds declined and will remain about 20% below its pre-COVID levels. This is nothing new. For several years now, industry experts have been predicting this decrease and the pandemic has only accelerated this trend. As to whether there is any risk, a massive supply response. I strongly doubt that because from a structural viewpoint, capacities across the globe lack any significant capability to scale up production. On the pricing side, we can say that by now, our prices have fully recovered and exceeded the pre-COVID levels. And we believe there is still room for further recovery. However, future pricing trends will very much depend on the market situation and demand. Strong demand for our goods enabled robust Q1 financial results, which we will discuss in more detail later in this presentation. Following management's proposal, in March 2021, the Board approved changes to the financial and dividend policies with a view to enhancing the resilience and sustainability of our business. In light of the changes on the 27th of April, the Supervisory Board recommended distributing a record high RUB 70.3 billion or 80% of the free cash flow as dividends for the second half of 2020. This confirms our commitment to balancing the interest of shareholders and the stability of operations. The dividends are subject to the approval of the general meeting of shareholders, which will be held on the 16th of June. Now please go to Page #4. Following the bumper Christmas holiday and Chinese New Year, cutters and polishers were actively replenishing their stocks to satisfy the demand for polished diamonds. ALROSA was able to sell 15.5 million carats of rough diamonds in Q1, generating over $1.1 billion in revenue. With the second consecutive quarter of strong sales, and here, I would ask you to go to Page 5, our inventory reached 12.8 million carats by the end of Q1. As of today, this level has reached a historic low of less than 10 million carats. Page 6, please. At the end of 2020, we were already consistently raising our price index. During Q1, it increased by 7% quarter-on-quarter, rising 9% year-to-date by the end of March. And all COVID-related losses were recovered. The average realized price for gem quoted diamonds was $113 per carat in Q1 up 25% quarter-on-quarter on the back of a higher price index and a better sales mix versus Q4. Admittedly, virtually all sales from stocks consisted of lower end goods collected during previous periods. Now let's go to Page #7 and take a closer look at the financials. Q1 results reflect strong market fundamentals. Revenue reached RUB 51 billion, which is just 8% below the Q4 2020 levels and 45% higher than the same period a year ago, boosted by higher sales volumes and positive ForEx impact. EBITDA increased by 5% quarter-on-quarter and 12% year-on-year to RUB 33.5 billion. Free cash flow reached RUB 53 billion driven by RUB 27 billion release of excessive working capital on the back of an 8 million carat decrease in diamond inventories and increased advanced payments from our customers as well as strong operating cash flow. I would like to highlight that for the last 6 months, the company was able to generate a remarkable RUB 118 billion of free cash flow just for the 6-month period. I will skip the next slide with revenue liability drivers as well as cost and CapEx dynamics and ask you to move to Page #12. Remarkable growth in free cash flow generation, RUB 140 billion over the last 9 months, enabled us to achieve negative net debt of minus $0.3 billion. We continue to actively manage our debt portfolio. In April, we made an early repayment of 2 short-term bank loans totaling $230 million. At the end of Q1, our cash pile was almost $2.6 billion, which will be partially utilized for the second half 2020 dividend payments in July and August and to further decrease our debt. Now let's move to Page #16, where we will discuss our current outlook. Jewelry demand is expected to remain high, buoyed by pent-up demand, improved consumer confidence and saving growth due to lower spending on luxury experiences in travel. North America and China, the key regions for diamond jewelry consumption, delivered double-digit recovery in early 2021, even against the high base of 2019. The supply of rough diamonds is structurally decreasing, keeping both miners and midstream stocks at modest levels and adding upward pressure on prices. In terms of our plans, 2020 outlook remains largely unchanged. Production is expected to recover to around 31.5 million carats. But we are seeking ways to marginally increase this number. Sales volumes will depend on real market demand and diamond inventory availability. The pricing environment looks positive, thanks to resilient demand and limited inventory in the diamond pipeline. CapEx is estimated at RUB 25 billion, with no change to the previous guidance. The approval for the Mir restoration project is still pending. The decision is to be made by the end of this year. And finally, we continue to pursue an active cost-cutting program while further developing our operational efficiency and digitalization programs. This concludes my presentation. Thank you for your attention, and we are now ready to take your questions.

[Operator Instructions]. And the first question we received is from Dan Shaw of Morgan Stanley.

I have a couple, so I'll go one by one, if that's the case. So the first one you touched on it a little bit. But how significant do you think the risk is that some of these Indian manufacturers may have to shut their capacity given the situation in the country at the moment? Do you see that as a risk? Obviously, last year, imports went to 0 basically. Do you think there's a risk that, that can happen again? Or is it just a case that imports are just lower than where they would be, but not 0. I'm just interested in what your thoughts are there.

Yes. Thank you, Dan. To the best of my knowledge, currently, if Indian polishers implement all necessary measures aimed to prevent the spread of COVID, there are no bans from the government on working of their facilities, on functioning of their facilities. So currently, we operate at about 70% to 80% of capacities. And we have to keep in mind that the overall volume of goods flow in their way from upstream is actually less than the levels we saw pre COVID. They were able to successfully process the levels coming in the first Q, resulting from the destocking at miners, and they did well. So I think there will be no problem for them to keep on satisfying -- to keep on processing all the volumes that can potentially come from the upstream.

Okay. Very clear. And the second one, just on your production levels. Of course, your inventory levels are quite low now versus your history. And as you point out, demand does seem to be quite strong. So what's the sort of the time line around when you might decide whether or not to increase your production plans for 2020? Is that something that we can expect perhaps at the half year results that you might have a decision then?

Frankly, I do not think there is much potential for 2021, although -- I mean, there are some initiatives that we are discussing right now. And as a matter of fact, our CEO is currently in [indiscernible] speaking right about the potential to -- discussing the potential to further increase production this year. However, I would not envision any significant number in 2021. Our current guidance is between 31 million to 32 million carats, and we would like to reiterate this guidance.

Okay. Great. And the next one, just on realized pricing. This has been a bit volatile in recent quarters as a result of mix, as you highlight already. Is it possible for you to give us sort of an indication of roughly where you think this will come out on average for the rest of the year? For example, if we're assuming kind of $130 to $140 per carat for gem, is that in the right ballpark in your view? Or do you think it will be significantly different to that?

I think it's about the right number because the average value of gemstones in our current inventory is above $130 per carat. It was driven by relatively high demand for smaller stones in the first quarter. So our inventory is geared towards larger and more expensive stones. In addition, I think this remarkable price growth that we observed in the fourth quarter of last year and the first quarter of 2021 has still room to go on. The market is in a structural disbalance, there is limited supply, which went down by at least 20% versus 2019. At the same time, the demand is -- keeps beating our expectations. The only way to reconcile them is to adjust prices. So far, even the -- even taking into account the relatively aggressive price increases that major miners were implementing throughout the last 6 months, the market was taking them surprisingly well. Most of our customers choose to buy 100% of their maximum allocations.

Understood. That's clear. And then just the last one for me. Just wanted to ask about Catoca. Are you able to confirm how many carats were produced in 2020 and what the production plan is for 2021? I understand that in 2020, production fell quite significantly. Why was that? Was that a deliberate decision to reduce supply? Was it forced because profitability was not good enough? Or was it COVID related, for example, employees were not available? Yes, that's my last question.

Thank you, Dan. 2020 production at Catoca was 6.5 million carats. The decline was mostly explained by COVID restrictions. The facilities were under quarantine in the spring of 2020. In terms of financial performance, they did quite well. Their net profits are above $160 million, and we will get 41% of it in the form of dividends, hopefully, by the end of the summer. Speaking about plans for 2021, the biggest bottleneck in Catoca are the -- in reaching facilities, beneficiation facilities that are still subject to a very strict quarantine rules. In addition, some of those capacities are devoted to process the output from Luaxe. By the way, Luaxe was able to produce 0.9 million carats so far. However, the bottleneck with processing capacities does not allow us to give any forecasts for the overall production of Catoca and Luaxe for 2021. But it will definitely be higher together than what we saw in 2020.

Okay. And sorry, just to clarify, the 4.9 million carats. That's cumulative production from Luaxe rather than for 2020. Is that right?

6.5 million carats for Catoca in 2020, first 4 months of 2021, while was able to produce 0.9 million carats, 0.9 million carats. This is 4 months of this year.

The next question received is from Anton Fedotov of Bank of America.

You mentioned that you are seeing quite a significant price increase, which started in the fourth quarter and is likely to continue during this year in the following quarters. Would you please quantify this price increase maybe year-on-year or maybe versus the previous 6 months?

In terms of pricing index, today, we are at approximately the level we were in September of 2019. And so the price had fully recovered all of the COVID turbulence and more than that. Speaking about the price dynamics in the first quarter of this year, the average price quarter-on-quarter went up by 7%, and I'm talking about index. And the price growth between January 1 and March 31 this year was 9%. So every site, we were able to raise prices to the tune of between 1.5% to 3%.

The next question is from Daniel Major of UBS.

A couple of questions. Thinking about 2022, given the strong demand outlook, can you give us some guidance or whether there's been any changes in your outlook for production and for CapEx in 2022?

Yes, sure. Just give me a second. Our current plan is to produce no less than 33 million carats in 2022. In terms of CapEx -- one second, I think it will be slightly less than RUB 25 billion that we had -- that we plan to have in 2021. Sergey, would you please remind me the number? I think it's in our presentation. I don't have it in front of me.

Yes. It's -- for 2022, we have RUB 26 billion outlook. And for 2021, we have RUB 25 billion. It's Page 11 of the presentation for the audience.

Yes. The increase is driven by the construction of the new airport at Mirny.

Okay. So slightly higher CapEx year-on-year, RUB 26 billion, is unchanged. Okay. Cool. And then next question, just on the dividend. And just to be clear, it's clear in your policy, but with net debt to EBITDA, well, with net debt 0 or small net cash position. Can you just reaffirm, in line with your policy, would it be likely that you'll distribute 100 or more than 100% of '20 -- first half 2021 free cash flow's dividends?

Yes. That's what the policy says. I would like to stress that the final decision will be taken by our shareholders and the Supervisory Board, but frankly, I see no reason why they should deviate from this policy.

Okay. And just to follow-up on that. Do you -- now you're sort of close to net cash. Is that a reasonable sort of target of where you'd like the balance sheet to sit going forward?

Well, really, not really. We have a large cash pile, which is unusual for us at this moment, but we have to keep in mind that, first of all, we have almost $600 million of short-term debt that we have to pay in 2021 and first half of 2022. In addition, there is a sizable dividend for the second half of 2020 that will be paid in July and August and assuming they will be 100% dividend payout for the first half of this year. And I'll just remind you that the free cash flow just for the first quarter was RUB 53 billion. The picture is that we will have sizable cash outflows in the second half of this year. And our own internal modeling shows that even with the current debt level and the current cash pile, our net debt-to-EBITDA level at the end of the year will be between 0.7% to 0.9%, which is exactly where we should be in line with our financial policy.

The next question is from Bore Sinitsyn of VTB Capital.

Firstly, 2 follow-ups from me, please. Now you mentioned that the capacity utilization in midstream has decreased 70% to 80%. The question is, do you expect this decrease to affect your monthly sales in the second quarter, probably from May and June and probably -- and like July? The first follow up.

No, we do not expect that. I think currently, they have capacity to process all the volume that is coming from the production. I will remind you that in the first quarter -- in the fourth quarter of last year and the first quarter of this year, when most miners were actually destocking, the midstream was able, despite the COVID restrictions in place, process all of the supplier that was coming from the upstream. So I see no reason to believe that there will be a bottleneck in the midstream.

Perfect. The second follow-up is on your -- you mentioned basically 2020 production plan, at least 33 million carats. The question is, is it the final figure? Or if not, when we would -- we might expect a final decision on your 2022 production?

We should expect a final decision by the end of October, when most of the top-down targets for our budgets will be approved by our Supervisory Board. But we will have a pretty good idea by the end of September.

Okay. Fair enough. And probably 2 more questions. From me, if I may, please. Firstly, we noted that in the second -- actually, in the first and second quarter this year, in terms of structure of revenues, you saw quite an increase in United Arab Emirates in the revenues? The question is, what is driving that? And do you expect this to be in place going forward?

The United Emirates took all necessary measures to take the spread of COVID under control, testing, vaccination, et cetera. So COVID-related restrictive measures have been softened or canceled unlike other diamond centers such as Belgium or Israel. So -- and that explains why there was a temporarily spike in the allocation to United Air Emirates. I think once the COVID restrictions are lifted in Europe, we should get back to more or less a normal spread.

Okay. And the last question from me would be on the -- your next contract period, which, if I'm not mistaken, starts from July. Do you expect any change in the number and probably the composition, the structure of your client base going forward?

We will keep a balanced client base in terms of the type of business, polishers, retailers or traders. In terms of the time line, currently, we are aiming to sign new contracts by the end of June. However, given the current restrictions on supply, this time line may be moved further to the right. The decision about that will be made by the end of May and communicated to our clients.

The next question is from Nina Dergunova of Goldman Sachs.

Congratulations with a very strong start of the year. I have 2 questions. Probably the first one is related to your inflation expectations. So we already see inflation accelerating globally. We see material prices beating record highs this year. So 2 parts of this question: first one, what do you expect to see on OpEx, and this year and next year potentially from this accelerating inflation around? And the second part is, do you see risks to CapEx guidance from railing materials prices probably for this year or only for next year as this year has already procured? Would appreciate your thoughts. And then I will follow-up with the next question.