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

I'm happy to welcome you at our Second Quarter 2021 Results Conference Call. Today, our company is represented by CEO, Sergey Ivanov; CFO, Alexey Filippovsky and Head of Sales, Yevgeny Agureyev. As usual, Mr. Ivanov will start the discussion of recent developments and market update and then pass it forward to Alexey who'll comment on the company financials. Then we'll be happy to take your questions. As always, elements of our presentation are forward-looking and based on our best view of the market. With this, I would like to conclude the formal part and pass forward to Sergey Ivanov, Chief Executive Officer. Please go ahead.

Good evening, ladies and gentlemen. Thank you for joining us today. I hope all as well as you and your loved ones are safe and healthy. At present, our company's home region, Yakutia is fighting a dreadful battle against vast wildfires. And on behalf of the company, I want to extend the warmest words of support to the people of Yakutia and say an enormous thank you to the thousands of people fighting fires on the front line. Due to the legislative restrictions, the company is prohibited from taking part in firefighting directly -- But of course, we're actively supporting local authorities, in particular, by refueling aviation equipment, auxiliary vehicles, and moreover, our economic contribution, including dividend payments, will help provide the region with much needed supplies and resources. The situation regarding the company's assets is under control, and the natural disaster presents no risk to mining operations. As for the situation regarding COVID-19, here at ALROSA, we continue to take all necessary measures to contain the virus spread and ensure the safety of our employees. Today, more than 200,000 COVID tests have been run among our employees and 4,500 were positive. As of today, more than 18,000 people or more than 50% of our employees are vaccinated, nearly 16,000 fully vaccinated and this is essential for ensuring herd immunity within our operations. Now let me proceed to the ESG slide to give you an update on the recent progress we have made on our ESG commitments. So let's look at Page 3 of the presentation. So we are striving to deliver on our ESG strategic framework for the period of 2021, though to 2025. It's a holistic program with ambitious goals encompassing areas of health and safety, environment, corporate governance and business ethics. We are reinforcing the program with organizational design improvements and motivational schemes, including KPIs for senior and middle management. As part of the program, we are designing comprehensive environmental and climate change strategies to bring in technology, align business processes and set transparent and verifiable targets. The key deliverables from these strategies include reducing greenhouse gas emissions, adding ESG components to the investment criteria and setting measurable ambitions and targets concerning all major aspects of the environment, including energy, water, land, waste and biodiversity. In addition, we want to give customers an accurate and authentic picture of how we together are contributing to sustainable development. Independent nonexecutive directors and members of the working group under the Strategy and Sustainable Development Committee, will oversee the program's implementation. We will soon announce the international experts who are joining the ESG task force under the Board of Directors to advise us on the best practice. Going forward, we will align our corporate policies and practices with international best standards, join international sustainability initiatives, including the ICMM, TCFD, PACI and United Nations CEO Water Mandate as well as further expand our cooperation with CDP and rating agencies. Sustainability should be an essential component of risk management practices. We have an excellent track record as a leader in sustainability but stakeholders, including end customers are seeking even more transparency on ESG matters. As a responsible company, we want to be able to fulfill this desire, and we feel we have a great story to tell in this regard, and we want to show off our culture and approach. Now let me proceed from ESG to the market overview. It will be the next page, Page 4 of the presentation. So the diamond jewelry demand remained robust, both in the U.S. and China. And despite year-on-year increases, we see double-digit growth to the all-time high levels of 2019. For example, Q2 this year, sales in the U.S. were up 56% on Q2 '19 and doubled against Q2 last year. Key drivers were improved macro and consumer confidence, growing savings as people cut their spending on experiential goods and services and like so-called field good factors continue to support buying activity in the luxury sector, namely real disposable income and the perception of wealth. As a result, retailers delivered some of the strongest results in their public history. Midstream enjoys wider margins and suffers from a chronic shortage of rough. As you can see on the middle chart, polished exports from India well exceed imports. The supply of diamonds remains about 20% below its pre-COVID-19 levels. Minor stock levels are at historic lows. Yet, we do not see any supply response risks due to the capacity constraints and permanent closures. In this environment, pricing policy is the only mechanism that can help achieve market balance. Our prices recovered to levels seen in January 2019 before the crisis in the diamond sector and the COVID-19. And before I pass the floor to Alexey, I would like to reiterate that we are firm believers in the long-term sustainability of the diamond market and our strong fundamentals. Our business model, cost position and team will help deliver exceptional performance and best-in-class returns Thank you.

Hello, ladies and gentlemen, let's go to Page #5. As Sergey mentioned, strong end-user demand. Have us delivered another set of strong results with $1.1 billion of sales for the quarter. Sales volumes decreased to 11.4 million carats with 4.4 million carats coming from the inventory. This compares to 15.5 million carats in the first quarter with 8 million carats released from the inventory. As a result, our end of Q2 stocks dropped to 8.4 million carats, levels our company has never seen before. You can see this on Page #6. I have to say that we managed to release these extra volumes from the inventory thanks to the optimization project we completed in 2018 and 2019 with the key goal of reducing bottlenecks in rough diamonds processing and sorting, ultimately leading to a faster turnaround cycle. Now let's move to Page 7, please. The second quarter like-for-like prices continue to recover driven by strong demand from the Midstream and polished price growth. Like-for-like prices grew by 7% quarter-on-quarter, which translated into a 16% year-to-date growth by the end of June. The average realized price for gem-quality diamonds increased by 28% to $145 per carat, substantially supported by a better mix. Moving on to the company's financials. Let's go to Page 8, please. Total revenue grew to RUB 94 billion with mix and prices fully offsetting lower volumes. EBITDA increased by 36% quarter-on-quarter to RUB 46 billion and the margin expanded to 49%. Free cash flow of RUB 12 billion on the one hand, benefited from the completion of diamond inventory destocking. And on the other hand, was negatively impacted by the fact that by the beginning of the second quarter, our customers had repaid almost RUB 20 billion for Diamond. These repayments were settled during this quarter. Now this accumulated inventory sold out, the prepayment patterns of our customers have reverted to what they were before. For the first half of the year, free cash flow totaled a healthy RUB 64.7 billion. The next few slides show revenue and profitability drivers as well as cost and CapEx dynamics nothing worth noting there. So I will skip them and suggest moving on to Page #13. Due to strong cash flow generation, our net debt remained negative at minus $0.4 billion. In Q2, we continued to actively manage our debt portfolio, the total amount of prepayments was $580 million which allowed us to bring total debt down to $1.7 billion as well as improve our debt maturity profile. At the end of Q2, our cash pile stood at $2.1 billion which so far has been partially utilized for dividend payments of RUB 70 billion in July and August. International rating agencies highlighted the company's market-leading position, its resilient business model and commitments to a balanced financial policy and transparency. Therefore, in June, Fitch upgraded ALROSA's rating to BBB with a stable outlook. In July, S&P raised our ALROSA stand-alone credit rating to BBB and confirmed a long-term credit rating of BBB- with a stable outlook. I'm proud to say that this increase of the company's stand-alone credit rating puts ALROSA among 1 of just 3 Russian companies with an individual credit rating above Russia's sovereign and one of the few global state-controlled companies with an individual rating higher than sovereign. Now let's move to Page 16. Here, I would like to comment on dividends for the first half of 2021. As always, the recommendation will be made by the Board later in August, and it will be subject to shareholder approval by the end of September. The dividend policy requires us to allocate at least 100% of the free cash flow for the period. If this decision is approved, total dividend cash payments in 2021 could reach RUB 135 billion, which exceeds cumulative dividend payments for the last 2 healthy years of 2018 and 2019. Now let's go to Page 17, where we will discuss our current outlook. We see strong demand for diamond jewelry across all geographies as consumers line up for the jewelry sets, leading to all-time high levels of sales. The vast majority of retailers are reporting an optimistic outlook for the second half of the year. Cutters and polishers enjoy a strong backlog of orders and buoyant profitability. As a result, they face shortages of rough feedstock. The global supply of rough diamonds remains under pressure, totaling around 120 million carats a year or 20% below pre-Covid levels. As a result, diamond suppliers have run to operate with the stockpiles lower than ever. As strong demand and constrained supply, diamond prices are expected to return to precrisis averages with an upside risk. A loss 2021 production outlook could be marginally revised upwards to at least 31.5 million carats with an optimistic scenario of an extra 5% on top of that. which could lead us to as much as up to 33 million carats in production for the year. CapEx was revised down to RUB 21 billion from an initial RUB 25 billion with all major mining projects expected to be completed on time. This concludes my presentation, and we are now ready to take your questions. Thank you.

[Operator Instructions] And our first question comes from Daniel Major from UBS.

A couple of questions relating to working capital and inventories sort of in 2 parts. Can you walk us through the working capital move in the second quarter? And do you expect some of those elements to reverse some of the prepayments and the inventory moves in ores and sands, et cetera, in the third and fourth quarters? And then the second part of the question, in terms of inventory and I suppose sales against production in the second half of the year, your 8.5 million carats in inventory is very low, what should we expect for movements in your own inventory as you can tell through the next couple of quarters in terms of finished diamond inventory?

Yes. Thank you, Daniel. In terms of working capital, some of the major movements in our working capital structure in the second quarter, where, on one hand, the completion of destocking, which positively impacted the cash flow. On the other hand, we saw a settlement of all the prepayments that our customers made at the beginning of the quarter. Those prepayments totaled almost RUB 20 billion. So it was a very material impact. Essentially, a large part of the goods that we delivered during the quarter were paid for in the first quarter. And we believe it's more or less a onetime phenomenon because it was driven by 2 factors existing at the same time. On one hand, the demand was exceptionally strong. On another hand, the market and our siteholders knew that the company had unsold inventory, and there was a very strong interest to secure part of that inventory for their own purchases. So at this point, our destocking is completed. We do not have any disposable inventory, and we believe that things are back to normal. And finally, one more item that impacted our working capital dynamics in the second quarter is the buildup of our ore and sands inventory. It was driven by the fact that we had a substantial turnaround repairs, maintenance repairs at 2 of our major beneficiation facilities. So essentially, we were producing the ore, but we did not beneficiate it to some extent. So that increased the inventory of our ore and sands. That inventory will be processed before the end of the year. So you should see the reversal of that item. Other than that, we are talking about just seasonal fluctuations in our supplies. Typically, they grow in the first half of the year as we stockpile all our supplies for the next year, while the litigation by rivers are possible. That's for the first question. For the second question relating to the inventory levels. As we mentioned, our inventories are at the record low level to a large extent, a lot that -- that is allowed for large extent by the project to increase the turnaround time in sorting and processing that we did a couple of years ago. It's very difficult to say what the inventory level will be at the end of the year. On one hand, the minimum feasible inventory level should be slightly higher driven by the seasonality in alluvial processing. So I would see something between 8 to 10 million carats. But the -- of course, this will mostly depend on the level of sales. So far, the level of sales have been very healthy. So assuming the sales will continue, levels we've seen them in the first half of this year, we should have between 9 million to 10 million carats at the end of the year.

Okay, cool. And if I could just ask 1 more follow-up. I know you took part in the auctions the latest -- the auction from Gokhran. Have you got any visibility on whether more sales or may come to the market in the second half? And would you look to participate in future auctions as well?

Thank you, Daniel. It's Sergey. I'll take this question. So up to now, what we see is that Gokhran will be selling just maybe $15 million to $20 million something plus million of rough diamonds at the beginning of September. So it's like 6x less than it used to be a couple of weeks ago. And -- well, then we'll see if the state would decide according to the situation, which -- how the situation on the market would be evolving the state -- the Russian state might decide to sell something, but we don't see any paperwork or any discussions in this area taking place. But I guess it will be the decision according to this market situation. So we think that the sales could be -- after the September sale of $15 million to $25 million of rough. We see that the further sales could be from 0 to something.

Okay. And how much additional revenue do you expect to book in Q3 related to those sales dollars or carats?

We'll see, as we disclosed earlier, we actually participated in these auctions only for the purpose of the offers from our customers. So it's not in that ALROSA how should I say, fulfilled our inventory. So it immediately went to the market or is going to the market. So these were offers by our clients, and we were just acting as a broker for them buying for Gokhran. So not a single diamond would land in our inventory. And as for September, so we'll see this -- I guess it will be the same if our customers would be interested, then we can just provide this service for them in September. We'll see it. According to the current situation, it looks like there should be significant interest for the next Gokhran auction as well. But it will be 5x less in size than it used to be.

And just to be clear on that, you won't -- you will or you won't include the revenue from those sales in your numbers or will you?

Yes, I guess, this revenue would be included only in our August figures.

Right. In the August figures.

It will be part of our books. The margins there are nonexistent. So there will be no impact on EBITDA just on the revenues and on the cost.

So that should be around $80 million or something in our sales for August we will disclose it at the beginning of September.

Next question comes from Sergey Donskoy from Societe Generale.

Yes. I have actually two Groups of them, hopefully, not too long. Firstly, on your prices. Could you remind me, I think you mentioned it during the call, but still, what was the growth in Diamond Price Index since end last year to present day, including the results of the July session. And second part of this question is sales mix, I think, affected -- accounted for a significant part of price increase in Q2 quarter-on-quarter. Should we assume that your sales mix during the reported period was close to some sort of a long-term norm, it's my first group of the questions.

Maybe I'll start on the index. Thank you, Sergey, and Alexey will follow up on the mix. So as we disclosed today, for 6 months, we saw index rising price index of ALROSA rising around 16%. And in July, we also increased prices. It was a 1-digit increase because of the significant demand, which we couldn't meet as a source of supply. So we think that -- well, roughly saying today, we're at the beginning of 2019 in the levels of the price index, and I'll ask Alexey to comment on the mix.

Yes. On the mix, the average value of our Gen 5 inventory, and I'm talking about very low levels of inventory is currently around between $180 to $190 per carat which means that it skewed upwards towards higher value. In terms of the normal mix assuming that the prices, the index will stay at the level as it is today, we would expect to see roughly $140 per carat for gem type stones up until the end of the year. and it is driven by the fact that supply from alluvial production is coming to our coffers. And those alluvial productions generally have lower value than open pit and underground production.

Just to clarify 1 point here. You said $140 per carat until end of year. that is assuming prices stay as you said, stable after last July price increase, right?

Yes. Yes.

I'd only add also, Sergey, that our inventory is now absolutely in line with the production. So it's actually the composition of like 3 months of production.

So basically, we should expect this higher value inventories of, as you said, $180, $190 per carat to be kind of diluted by lower grade diamonds from alluvials translating into the average of 140. Is it correct?

Yes. Exactly. Exactly.

Understood. And second part, second group of questions. In recent periods, Jubilee and Inter mines, they have been processing ore with grades significantly below historic averages. And also, I think, below a reserve statement. What is the reason behind that? And what should we expect from these mines in the near term and maybe in the longer term? And second question, second part of this question, I think that in today's press release or presentation, you have lowered midterm production target from 37 million, 38 million carats to 35 million, 36 million. Maybe I missed it, it was done before, but what is behind this change? And do you still plan to achieve a 38 million carat level at some point in the future?

Yes. This is Alexey. I will take these questions. For the grades at Jubilee and Inter, it is driven by the composition of the mining. For example, for Jubilee, there are 3 major ore bodies. And last year and the year before, we, to a large extent, we mined the central ore body, which is much richer in grade and quality of diamonds than the other two. -- but we have to keep the open pit balanced. So we cannot mine just rich ore body neglecting the other two. So this year, it's a catch-up, and that's why the grade is lower. Same is for inter. There are just 2 ore bodies. But again, at some point, you have to mine in the center of a body. And on other times, you have to mine on the sides. So on the sides, you have more ore and less diamonds. And that's exactly where we were at the beginning of this year. Over the years, it will average between all those reach grades that we saw in the last period and the poor grades that we are seeing today. In terms of our guidance for production volumes, in my interview, I didn't say that we go away from the earlier guidance that we gave. What I meant is that as of today, for the midterm, and I'm talking about like 2024, 2025, we see concrete specific set of measures that will allow us to mine between 35 million to 36 million carats. But we keep on working on identifying further potential. And as time goes by, hopefully, we will be able to get closer to those numbers that we gave you earlier.

Understood. And just one thing, you said that over time, we should expect or can expect grades at Jubilee and Inter to normalize and sort of return to historic averages. And when do you think this is realistic to happen? Should we expect any meaningful improvement by the end of this year or maybe next year? What kind of time frame are we talking about?

So we are talking about more than a year. Next year is going to be challenging in terms of the structural mining because on one hand, in Jubilee, we will continue to mine the 2 other lower-grade ore bodies to a larger extent than the central ore body. And also, this year, when we raised our forecast from 31.5 million to up to 33 million carats of production, large part of that incremental increase comes from substituting poor grade ore -- sands in our new bar facility by rich ore at our new bar facility. And this is also -- this is a onetime deal. Next year, we will still have to get back to mining sands and that will put some pressure on our production numbers. But as of now, we have not finished our planning for the next year. We know it's challenging, but I cannot give you a specific number for 2022. Hopefully, we will be able to do it in the fall.

Next question comes from Yuriy Vlasov from Sova Capital.

Thank you. Most of my questions have been answered, but there's only one left. Can you tell us how much you sold to Gokhran over the last 10 years in the very broad numbers.

Thank you, Yuriy. I'll ask Alexey and you gain it to comment, but I'm not sure. So it was -- the largest deal was done in 2008, 2009. So that was more than 10 years ago when actually the Russian late repository supported ALROSA during the hard times, like 12 years ago. But since then, as it were like just single operations for some exceptional stones so nothing really significant, just some master pieces that went to the museum to the Kremlin and to the state collection clearly there's some exceptional pieces 10 carats and up. And maybe I'll ask Alexey and you gain to help me if we can if we have information on these volumes, but these were at least as long as I'm CEO for 4.5 years, there were some couple of millions of dollars a year.

No, no, that's absolutely fine. Thanks a lot. We'll just look at how much was the deal in 2008. Thank you.

Yes, it's I would like to add, if you can agree. I would like to add for this question. So we closed all those big sales in 2011, so 2010 to 2011 they remain, but we are not in a position to comment the volumes. And exactly. So what we sold in the last years, it was only a group of very interesting unique stones. And this year, we sold 5 stones at the beginning of the year. So only like this.

In 2009, I believe the amount was $1 billion. That was -- that Gokhran purchased from ALROSA and then were also sold back. And like we commented last year, so when the situation was really hard. So actually, the state was ready to support us through buying stones from Gokhran, but not a single transaction was done because of the recovery of the market situation. Thank you.

Next question comes from Nikolay Sosnovskiy from Prosperity Capital Management.

For the presentation. I've got a couple of questions. One, on the inventory, working capital changes in receivables, you've touched it. But I was wondering, just in general, whether this big reversal can be treated as a sign of market easing i.e., people are not rushing to prepay and they have enough stones or it was just the incidence and these quarterly fluctuations, we should not consider in full? And this is one question. And the second one, on I was thinking what can spoil this market tightness or you think maybe some competitors can behave irrationally, maybe some African independent producers of countries can increase supply unexpectedly like Angola and Luaxe. Can you possibly update what's happening there? What are the production plans for '21, '22 in Angola?

I'll take this question. So -- your first question on the receivables. It's just -- you see we're at the bottom of the inventory. So actually, there's just no rough to sell, and we can now sell only the amounts which are being produced by the company. we will have some tight production this quarter. It's normal, and we could be able to sell only the amounts, which could be produced by the company. So that's -- and coming back to the market situation, we expect that -- so in July, we saw actually 100% of the available goods were sold also after some price increase. Let's see how De beer session would go in a couple of weeks also. And -- but we internally expect that the market would still take like 100% of allocations August, September, if no like Black Swan would occur, not related to our industry or to our markets. We see the situation in U.S. and China is very strong, and we're taking calls with our customers every week, and we see that the Midstream, the producers, they are very satisfied with the with the amount of orders coming from U.S. and China. We think that the situation on the secondary market would improve because now the pricing on the secondary market and the ones who don't get access to the production of mines -- to rough from the miners. We see its still there are premiums on this market, but we hope these premiums would go down. because we don't want to create any sort of bubble in the industry. We don't see any volumes which could be brought on the market. So we see that you know that other producers, except ALROSA and the other major company never held never hold any kind of stock. So there's nothing that could be put on the table and sold except the levels of production. We see -- if we look into the figures of the levels of production of first half of this year in comparison to '19 and '20, we see the production declined even to last year, so it's minus 4%. And all the producers together. And well, our company and the other major company, our supply discipline is very tight during the good times and the bad times. So we don't think -- and there's just nobody else to try to make any like crazy moves like you call it or something. Regarding the -- Some African countries and as well especially Angola where we operate. So combined Luaxe and Catoca, we don't expect next year -- I would say, we expect next year both combined Catoca and Luaxe to deliver between 6 million to 8 million carats of rough diamonds. So it's nothing significant, and it can't fulfill the gap which occurred during the last years with like 40 million carats coming off them or like 30 million carats coming off the market. So when we look into all the mines, all the open pits, we just see that the supply will be very tight for the next years.

And my final question is about your capital expenditure. There's been some delay, as you pointed out, and some CapEx slips into 2022, do you think we need to raise our projections for 2022 on the back of this redistributed payments? And also, how do you feel about the ongoing cost pressures in steel, materials, labor, you name it. So any comments on the CapEx inflation next year, both kind of -- in absolute terms in terms of projects move from year-to-year or brought forward on the back of good industry performance or cost pressures would be very welcome.

I'll ask Alexey to comment on the price inflation and on the CapEx.

Yes. Thank you. In terms of CapEx, the decrease in the overall CapEx for this year is mostly driven by the fact that a couple of our projects, a couple of major infrastructure projects, they will be taking longer than we initially expected that to take. We are talking about moving our facility of town Udachny and its mining facility to natural gas heating from electricity, and we are talking about completion of new airport in Mirny. So 2022 should not be revised. But because those projects will be completed a bit later, we are probably talking about 2024, 2025, when those numbers will add up. In terms of cost pressure, we do experience it not so much for CapEx for this year as for our overall expenses, materials and so forth. The numbers we are seeing are actually quite high. However, as you know, we have seasonal supply cycle, and that's why our overall materials inventory acquired is quite large. So the good thing of it is that if you have average costing cost on top of that, the good thing is that it will not translate into our earnings for this year to any significant expense, we might see up to RUB 2 billion to RUB 3 billion more of operational costs, but nothing more because, again, a large portion of those supplies have been procured before. And because of the average costing, all of this cheap and newly purchased more expensive supplies and they are blending together. We're also able to maintain tight control on labor costs. Recently, we indexed the salaries of our production workers and mining workers by 4.9%. And However, we have to say that the inflationary pressure on wages keeps growing. The inflation in Russia in the first half of this year is 5.8%. And it remains to be seen how well the government will be able to control it going forward. To give you a short answer to your question, for the year, not that much uptick in inflation, no more than [ RUB 3 billion ] of overall cost. But for the next year, we will see some pressure.

Next question comes from Anton Fedotov from Bank of America.