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

Good day, and welcome to the ALROSA Q3 2021 IFRS Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Sergey Takhiev. Please go ahead.

Thank you. Good morning and good afternoon, ladies and gentlemen. My name is Sergey Takhiev, Head of Corporate Finance, and I'm happy to welcome you at our Third Quarter 2021 Results Conference Call. Today, our company is represented by CEO, Sergey Ivanov; and CFO, Alexey Filippovsky. As usual, Mr. Ivanov will start with the discussion of recent developments and market update and then pass the floor to Alexey, who will comment on the company's results. And 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. So with this, I would like to pass the floor to Mr. Ivanov. Please?

Good evening, ladies and gentlemen. Sorry for today's short delay in our presentation, and thank you for joining us. I hope all is well and you and your loved ones are absolutely safe and healthy. As in -- as it is now a tradition, I will start with a few words on the COVID situation and its impact on our business. So timely measures taken to promote vaccination among our employees and the support of local health care providers is helping us keep the situation under control. Currently, 80% of our group's total staff is fully vaccinated. Our production assets are operating normally. We, of course, continue to take all necessary matters to contain the virus spreads and to protect the lives of our employees and their families. And once more, on behalf of the company, I would like to say a great thank you to all the medical personnel working at the group's assets and our state hospitals. They really are fighting on the frontline these days. So now, let me proceed to the diamond market overview. And we see that diamond jewelry demand remains strong in all key markets. In the United States and China, which are the 2 largest jewelry markets, retailers have recorded double-digit growth, reaching the all-time high levels, exceeding the high levels of 2018 and 2019. For example, U.S. demand in the third quarter was up 56% to the 2019 level and plus 35% year-on-year driven by improved consumer sentiment, pent-up demand and higher savings. Both retailers and polishers expect strong sales during the Christmas and New Year holiday season, driving restocking and hence strong offtake for rough diamonds. Stock levels among both miners and polishers remain tight according to our sales channels' checks. We understand that miners' supply has reached a new normal, with the midterm production stabilizing at around minus 20% to pre-COVID levels. The shortage of rough diamonds is yet to fit into the pricing environment. In the first 9 months of this year, the strong demand for diamonds was satisfied by stocks previously accumulated by miners. As I mentioned during the second quarter results call, pricing policy is the only mechanism that can be used to bring market supply and demand into balance. And by the end of the third quarter, our like-for-like price index increased by 25%, which was a catch-up effect from price decreases in 2019 and 2020. In October, index prices increased by an additional few percentage points, bringing the price index to the levels seen in 2018. And before I pass the floor to Alexey, I would like to say a few words on the hottest topic nowadays, the ESG. As a key player in the global diamond industry, ALROSA has, for several years, been working on incorporating industry-leading sustainable development practices into our business model. And the most recent key news here is that we have launched a project on drawing up 2030 environmental and climate strategies, which will be adopted and presented to the market in the first half of next year. Now I'll pass the floor to Alexey, who will take you through the numbers. Please, Alexey. Thank you.

Thank you, Sergey. Hello, ladies and gentlemen. I will start with our sales. Please go to Page 4. As Sergey already mentioned, end demand remains robust. Overall, Q3 revenue was down by 18% due to a 20% decrease in sales volume as we completely exhausted our disposable inventories in the first half of the year. In addition, there was a slight deterioration of mix due to a higher share of seasonal production coming from alluvials and a higher share of production from Severalmaz. These 2 factors were partially offset by a 10% growth in like-for-like prices. Now let's move to Page 5. Following the complete destocking, our diamond inventories reached an all-time minimum by July and have remained almost flat quarter-on-quarter at 8.6 million carats. Thanks to a highly successful inventory turnover optimization project, we were able to keep our work-in-progress inventories at a historically low level for this period as well, allowing us to free up working capital worth up to $300 million. Taking advantage of the positive market environment, we expect to carry this exceptionally low level of stocks into the near future. Now let me switch to pricing environment. Let's go to Page 6, please. The like-for-like price index continued its recovery, adding another 10% quarter-on-quarter driven by strong demand in the diamond jewelry market and in the midstream. Year-to-date, like-for-like prices have grown by 25%, reaching levels last seen in 2018 before the -- yes. Our average realized gem prices were at $136 per carat, a 6% decline due to the impact of a seasonally higher share of alluvials in production, which I commented on earlier. Responding to the current structural supply deficit, we expect further price increases going forward. Now let's discuss the company's financials. Let's turn to Page 7. Total revenue came to RUB 77 billion, which is 18% below Q2 level due to lower sales volumes in carats, but it is still the highest result for a third quarter since 2010. The breakdown of factors affecting the revenue is presented on Page 8. EBITDA margin has decreased quarter-on-quarter by 4% due to weaker sales mix and the impact from the trading operation with 0.7 million carats of Gokhran diamonds that we conducted for our long-term clients. These factors, together with lower volumes, were behind the 24% decrease in EBITDA, which came to RUB 34 billion. On Slide 10, you can see a detailed profitability analysis. Q3 free cash flow grew to RUB 24.5 billion driven mostly by an increase in advanced payments from our customers. For the first 9 months of 2021, the company's free cash flow exceeded RUB 89 billion. For more information on the EBITDA to free cash flow bridge, please see Page 14. Now I would like to briefly touch upon our CapEx program. Page 11, please. As expected, in the third quarter, CapEx increased to RUB 5.4 billion. In the first 3 quarters, the company invested RUB 12 billion, and our 2021 CapEx guidance remains unchanged at RUB 21 billion. Moving on to our debt position, Page 12. Due to the record high level of semiannual dividends paid in the third quarter, our net debt turned positive to slightly above $100 million. Net debt to EBITDA stands at 0.1x, which is well below our target level of 0.5x to 1.0x. At the end of Q3, our cash pile was around $1.6 billion as we are preparing to pay another large dividend in November. Finally here, I would like to reiterate that our resilient business model and strong free cash flow generation allow us to enjoy one of the highest credit ratings among global mining peers. Information on dividends is presented on Page 15. On September 30, the General Meeting of Shareholders approved dividends for the first half of 2021 in the amount of RUB 64.7 billion or 100% of the free cash flow for that period. These dividends will be fully paid by the end of November. Total dividend cash payments in 2021 will reach RUB 135 billion, which is an all-time record for the company. Now let's move to Page 16 to discuss the current outlook and then we will be pleased to take your questions. We expect global diamond jewelry demand to remain strong and resilient in the future. The drivers here are growth in consumer confidence and an increase in disposable income and savings as well as the rise of an Asian consumer. Midstream enjoys a strong backlog of orders and a rise in profitability while facing rough feedstock shortages. By now, all diamond suppliers have fully exhausted their diamond stocks, and the volume of future sales will be limited by production. In the foreseeable future, we expect global diamond supply to remain at or below 120 million carats per year or 20% below pre-COVID levels. As I said, diamond prices are up 25% year-to-date, exceeding precrisis averages, with upside potential based on strong demand and the lack of rough supply going forward. In 2021, ALROSA production is expected to come to 32.5 million carats, exceeding the initial outlook of 31.5 million carats. In the near future, we do not see any major CapEx increases. However, we are starting to feel an impact from global logistical bottlenecks and inflation. Finally, we continue to pursue an active cost-cutting program, which is becoming more and more relevant in the current inflationary environment. This concludes my presentation, and we can open to the Q&A session. Thank you for your attention.

[Operator Instructions] We will now take our first question from Dan Shaw of Morgan Stanley.

I joined the call a little bit late, so sorry if you've answered any of these in your previous comments, but a couple from me. The first one is on pricing. We can see the index pricing quite strong, but your Q3 gem realized was a bit lower than it was in Q2. So can you comment on what you're seeing in the most recent sales? For example, should we expect to see an increase in the gem price -- realized gem price that you report in Q4? And can you give any detail on the potential magnitude of any possible increase? That's the first question.

Thank you, Dan. Maybe I'll take the question in general and then ask Alexey to comment on the pricing for the mix. So in general, we are very positive on the demand side. So it looks like all our supply capabilities, which are maximized, they are meeting the demand, and the demand is several times higher than our supply possibilities. And Q2, we were still destocking, so we had more goods to sell, and now, we're just more limited with the goods which are being produced on a monthly basis, especially with the seasonality. We are quite comfortable. We think that the situation will continue within the next several months, at least. So we're very positive on the demand side. We see supply discipline, and there's no chance -- we're, of course, in touch with all the major mining -- diamond producers, and we just understand that all the assets are working at the maximum capacity. So it's impossible to bring new diamonds -- new rough on the market. We see that the midstream made a significant destocking as well. Now midstream is on the Diwali holidays, but still, the demand is very high. And we see people looking for goods. We see strong prices on the secondary market. We see that all the auctions in Dubai and Antwerp, actually those who sell, they sell 90% to 100% of the goods, subject to the current pricing. It looks like within just the macroeconomic -- these macroeconomic issues and like all the theoretical issues, that the price for rough and polished should increase at some moderate levels, we don't expect the prices for polished to increase significantly, like 2 digits. But we think that this Christmas campaign and New Year holidays will bring very good demand. And we see shortages on the market for a lot of types of polished goods. In terms of how this will affect the prices, we'll have to see. In terms of October, we increased our pricing for rough in a 1 digit -- in a quite moderate 1-digit percentage. As for November, I guess, it would -- it looks like we will have to correct in some very moderate manner the pricing as well. And then we'll have to see how the situation will look like during the holiday season. And we don't expect that the prices for rough or polished should go down. So in general, it's the current situation. And I'll ask Alexey to comment on the mix and on the -- on some figures. Thank you.

In terms of mix, there was an unusually high demand for smaller stones and for technical stones, especially in August and October. So because of that, our inventory structure currently is geared towards the higher-value stones. And for the remainder of the year, I expect that the average value of gemstone sold should be about 15% to 20% higher than what it was in the preceding 3 months. That's pretty much it on this topic.

Great. That's really helpful. And then the second question I had was just on working capital. Normally, inventory is often the biggest swing factor, but I'm guessing that sales are probably likely to be equal to production for the time being given the market tightness. So is there -- are there any sort of significant items that we should expect over the next couple of quarters? Or is working capital likely to be fairly neutral?

If I may, my expectation is that the level of inventory at the end of the year should be somewhere between 9 million to 10 million carats driven by the production coming from the alluvials. And typically, the end of the year, level of inventory is about 1.5 million to 2 million carats higher than what you could observe during the summer.

We'll take our next question from Sergey Donskoy of Sberbank.

Starting with a small follow-up. When you said that you expect prices in Q4 to be about 15% higher than in Q3, 2 things, are you speaking about gem-quality diamonds, or is it for the overall mix? And second, does this include those modest single-digit increases that you are seeing in October?

Yes. It does not include the current increases. So I mean, that, that growth is including the increases we've done in October. That's how should I say. So it's a net increase, including what has happened in October. And this should be valid for both average realized prices for all stones and average realized for gemstones.

I see. Okay. And then a more general question about price dynamics medium-term. As you said earlier in the presentation, prices right now are approximately at 2018 levels. Do you see anything, considering the very tight market, anything at all that would prevent prices from going even higher and eventually converging with the level that we saw in 2014, 2012, which is, I believe, some 15% higher than we are seeing now?

Thank you, Sergey. I'll take this other question. So we think that, next year, the prices for polished should go a little bit up just because of the high inflation in the world, just because what we see, the inflation in luxury gold, is seen in some limited expensive things. But still, it's very important that -- well, the price at which the retail can sell the goods in different categories. So for high hard jewelry or like high-end jewelry for top brands, we are sure that for investment diamonds, like for fancy colors, we are sure that the prices should increase next year because we see a lot of competition, we see a lot of high net-worth individuals investing money into very rare pieces of art, very rare polished or exceptional diamonds or diamonds with the top characteristics. As for the mass market, we still see that, of course, there's a certain, should I say, link between the pricing and the readiness of customers to buy jewelry with -- at certain prices. So we're not -- we don't think that the prices for diamonds would increase like prices for some agricultural goods or for some -- for used cars. But we think there's a high chance that at least they would grow with the inflation -- with the world inflation rates. And really, if the demand would continue to be so strong and we don't see any reasons for the demand to cool down, we think that, according to all the like classical things, the prices should go up. But it's a different market. It's not working like a commodity market. It has its own patterns in terms of the luxury market, as a part of the luxury market. So -- and the retail is very hesitant to increase prices significantly. So they reset prices maybe 2x a year. There are a lot of firm orders, forward orders for several months ahead. So we'll have to see how it will continue. But we think that the prices for polished should go up within the mid-future.

Understood. That's very helpful. And if I may, 2 more technical questions. Firstly, speaking about inflation this year, on a like-for-like basis, on a per-ton basis if possible, where do you sit? And second, speaking of your production growth, I think that your alluvials at Almazy Anabara is one of the underproducing assets at the moment. When do you expect this unit to return to normal precrisis levels?

I'll take this question. The cost inflation on 12,000 cubic meters of run-of-mine basis for this year will remain subdued because most of the contracts for supplies were signed either at the very early stages of this year or in the fall of last year. However, we expect to see somewhere between 5% to 8% cost growth for this year. For next year, it's really difficult to tell, but I would not be surprised to see something around 10% because currently, the inflationary pressure has a tendency to increase. For Almazy Anabara, yes, there is a big alluvial deposit called Ebelyakh that is not producing this year, and it has a potential to produce up to 2 million carats a year. It will be fully operational coming into the next season, and it will be producing full output next year.

Yes. Coming back to the question, why we didn't ramp up Anabara since middle of this year, is just because of seasonality. So we have to bring fuel, we have to bring spare parts. So we didn't expect this year to be -- the market to recover so significantly. So it was a decision -- economic decision taken at the end of last year. So we had to miss this season, and they will start the new season at a maximum full capacity next year.

We'll take our next question from Anton Fedotov of Bank of America.

I have several questions. First of all, my first question relates to the sales by Gokhran. And given the strong demand for diamonds in the market and the lack of supply response, do you expect any further similar auctions by Gokhran selling diamonds into the market and to you as well? My second question relates to your longer-term production guidance. Some time ago, you guided that you are planning to increase production up to 35 million to 36 million carats in the next 4 to 5 years. Is this plan still intact? And what's your expectations for the production next year?

Thank you, Anton. I'll take the first question regarding the Gokhran. So we think it was very wise for our state to release these additional reserves from Gokhran, especially in smaller goods and medium goods. And it helped to stabilize the market not to create a bubble and to, actually, to keep the factories in India running because it's also difficult if you don't have enough rough to ramp up manufacturing facilities. So we think it was a very smart move by our state, by the Ministry of Finance, and we supported it completely. We helped our customers to acquire goods from Gokhran, and we provided all this support for them. So they didn't even need to travel to Moscow during the COVID measures, during the COVID situation. And these figures are already in -- also in the statistics of Q2 -- Q3 sales, and Sergey can and Alexey can comment on these figures. So these are sales. They didn't bring us any like -- so they brought us some revenue. They didn't bring us, of course, the -- like EBITDA for our like-for-like business, but it was a good thing to do this year. We think that -- so for me, I will try to comment very accurately because it's -- the decision will be taken by the state, by the government, the federal government, the Ministry of Finance. But if we look into the figures of the next budget of the Russian Federation, I guess, that the figures for the sales of rough diamonds would be roughly the same like this year. So I guess, it will be around like something below $200 million. It's just less than even one side of ALROSA, or 1 monthly sales of ALROSA is significantly less than monthly sales. But we think that this will also help to stabilize the market and release some funds. And we don't expect that this figure would be exceeded because, well, we don't think that the state will be ready to sell any additional amounts or to make these new supplements to the budget for next year. But we think it's important that -- if these amounts could be sold. Of course, it will be subject to the market situation, but we think that maybe already in next -- first half of the year of next year, maybe these amounts could be released. But it's nothing really significant in terms of our -- of ALROSA sales or sales by other miners, by major mining companies. And I'll ask Alexey to comment on the midterm guidance. We are still finalizing the production program for next year. So there are some challenges. There are some things related to geological issues. And we'll finalize the figures and we'll release the exact figures for next year and release them, I hope, quite soon. But Alexey will give you the guidance on the midterm and on the next year as well in terms of the forecast on the minimum and on the like maximum level of production. Thank you, Alexey.

Yes. Speaking about production guidance, going into the next year, there are 2 negative developments and 2 positive developments in terms of production output. I'll start with the negative. First of all, on our Nyurba division, we will have to increase the share of sands that we -- beneficiated the expense of ore. We have to do it to keep the development balanced, and that will decrease the output from Nyurba. And I have to say that this change in the structure of feedstock at Nyurba was behind this increase in our overall production numbers for 2021. But unfortunately, it's a one-off, and you have to revert back to a normal mix. Second negative development is Jubilee. As you know, there are 3 orebodies. The central orebody is very rich in high-grade diamonds. The other ones are not that rich. And going into the next year, we will have to limit mining of the rich central orebody and increase the share of the other orebodies, which will result in lower grade and lower output. So these 2 negative developments will be compensated -- actually more than compensated by 2 positive developments, one I already mentioned, that is the relaunch of Ebelyakh alluvial deposit at Almazy Anabara. And the other one is the ramp-up of our production underground, where we expect to produce between 4.4 million to 4.5 million carats next year. So taking it all together, we should expect something between 33 million to 34 million carats next year. And as Sergey said, more specific numbers should probably be available sometime closer towards the end of the year. But currently, we see between 33 million to 34 million carats. In '23, the number should be somewhere above 34 million and we should reach our guided 35 million to 36 million carat range sometime in 2025 or 2026, at the latest. That's how we see it now.