Kristall Production Corporation is the leader of Russia’s diamond-cutting industry. The company produces almost half of the total amount of diamonds, which are cut and polished in the country. Having over 50 years of diamond manufacturing experience under its belt, the diamond cutting factory located in the City of Smolensk is making top-quality goods sold in international markets. In recent years, the global diamond trade was undergoing great transformations and Kristall is making efforts to maintain the diamond cutting industry in Russia. Maxim Shkadov, CEO of Kristall talks on this and many other issues sitting for an interview with Rough&Polished.
What are the results to be posted by Kristall in 2016? Are they expected to be better or worse than in 2015?
They will be worse than in 2015 and this is caused by several factors. If you take the results for the first nine months of 2016, the year, it could be said, was going to look good, but the fourth quarter influenced the results in a very serious way. This is due primarily to the fact that state measures in support of the diamond manufacturing industry in Russia have virtually been eliminated along with the abolishment of the 6.5% export duty, whereby rough diamonds immediately went up in price by 8% in September and then there was a slight increase in October - on average, the product mix we are using appreciated probably by about 9%. Given the small added value generated in diamond cutting, it is certainly a significant blow. Therefore, the fourth quarter results have a powerful impact on the company’s annual performance. So, of course, it is very difficult to compare it with 2015, as it is clear that the result will be much worse.
What are the changes taking place in diamond manufacturing after the 6.5% export duty on rough diamonds was cancelled?
There was an increase in rough prices. This is the first thing. At the same time, of course, there was no increase in polished prices. It is to say that the margin - the added value earned between rough and polished goods – diminished in a flash. To sustain such an impact, you need time. It is necessary to undertake certain measures in order to be ready for this. We fought at all levels against abolishing this export duty, but unfortunately the decision related to the country’s accession to the WTO prevailed.
Some time ago, you said that in search of rough Kristall was reaching out to international markets. What is the situation now? Where do you get rough diamonds from?
Of course, we are mainly geared to Russian rough and the contract with ALROSA, because our production activity is predicted and quite stable, although we always take part in all possible tenders held in overseas markets. Being a sightholder of De Beers, we get only a small amount of rough from this company, but nevertheless we get it. Certainly, we have the possibility to use rough from external sources, but for those goods, which we produce, Russian rough diamonds are, of course, our priority. From its start, the company has been specialized for quite many years - almost throughout its entire history – in processing rough diamonds mined in Yakutia, so our production of high-quality polished diamonds is based on rough that we buy in Yakutia, as it is the most suitable material for our goods.
We are not some separate production entity that can work independently, without interacting with external factors, because almost all the goods - 98% of them, – which we are making, go for export. The Russian market consumes about two percent. This determines the picture. Today, we see a long-running downward trend in diamond prices, which in my opinion is caused primarily by the volume of supply, that is far exceeding demand, because virtually there is no one to regulate this market today, and it is in a chaotic movement. These trends greatly affect the operations of our company, and actually the entire diamond manufacturing industry of Russia.
What is most important, that I would like to point out speaking about what is happening now in the industry, is that we have to compete with and fight against those tendencies, which are determined today by our Indian colleagues. In my opinion, they are engaged in classic dumping and generate significant losses in the sector, reducing polished prices and thus reducing margins. At the same time, they are ever and again fueling high demand for rough diamonds permitting mining companies to raise prices. The result is a completely illogical game, because any growth in rough prices must be accompanied by an increase in demand for polished goods and a stronger market. However, we see that growth in rough prices is usually accelerated every time India is increasing the volume of lending, which should be urgently spent through direct or indirect purchases from ALROSA.
Currently, India has concentrated almost 80% of the world's diamond manufacturing, and hence 80% of rough diamonds go to India. This is a very big risk. It is necessary to understand how added value is generated in this sector. It is bad for everyone, if the diamond pipeline will cease to produce added value. Unfortunately, it should be noted that starting from 2012-2013, the margin reached almost zero levels or remains very small. This suggests that the industry is generating losses that are covered by working capital loans, and this is a classic model of a financial pyramid.
It is known that 40% of all polished goods produced in Russia are made by Smolensk’s Kristall. Could you describe the assortment manufactured by your company? What kind of diamonds are most in demand? And where do you sell them?
In view of the long downward trend in demand for large diamonds – weighing one, two, three carats - we shifted our production to a smaller range. We are keeping an eye on what is in demand and what gives added value. Taking into account these two parameters, we make up our mind as to what kind of rough is to be selected. We can see that the emphasis has shifted to small-size rough and that polished diamonds made from this rough meet more or less steady demand. So, last year we kept working in this range. Our sales markets remain unchanged for us. In fact, these are the major dealerships in Antwerp, Hong Kong, New York and Israel. Our products are distributed among them in equal amounts. If you look at the trend in the market in principle, of course, the United States market is of greatest interest, as it shows the most positive dynamics – you have to admit that more than 50% of diamonds are sold there.
How small are the diamonds you are now producing?
Currently, we are operating in the range from one carat and lower - depending on demand. However, we continue to produce large diamonds as well, but not to the extent that we did earlier - we see that large diamonds are decreasing in price and how it is difficult to produce added value in that range.
Do you maintain your total output on the previous level or lower?
Given that we now have small-size and thus cheaper rough we stayed on the same level in terms of carats, but [in terms of money] our output went down, because earlier we used rough diamonds worth $ 1,000 per carat, while now their price has decreased to about $ 600 per carat.
In connection with the decreased ruble exchange rate, some people say that now Russian diamond cutting companies can compete with India in the production of diamonds weighing over 0.3 carats. What is your take on this?
We can compete even in smaller sizes. Indeed, production costs in US dollars in the Russian Federation have become smaller due to the strengthening of the dollar against the ruble. But the problem is not only that. The issue of costs is, of course, very important, but not decisive. The crucial point is the price of rough and what kind of added value you can get out of it. Rough prices are denominated in US dollars and do not depend on the exchange rate in any way. The year of 2016 started with the rate of 71 rubles per one US dollar and ended at 60 rubles. These fluctuations also affect production in our industry, especially if we buy rough denominated in US dollars, say, at the rate of 71 rubles and then sell polished goods at the rate of 65 rubles - we cannot have any margin in this case. It is a question of financing and financial institutions, which will hedge currency risks in order to offset this negative impact.
But if we talk about the competition per se, for example, with India, then yes, of course, we can compete, though in terms of wages, given that they stand there now on average at $ 200-250 (which is equivalent to RUB 12,000-15,000 at the current exchange rate), it is very difficult for us to find qualified personnel even in Smolensk, with its low level of wages in comparison with the Moscow area or Yakutia and the Far East. If we talk about prime cost, then yes, we do it cheaper producing comparable types of diamonds, for example Triple Excellent goods. It is true. But the problem again is that when you have minimal added value, this does not influence the result in terms of profit-earning capacity.
The Indian government says the demonetization carried out in the country is aimed to increase tax collection. Can this bring about higher production costs in diamond manufacturing there?
This step taken by the Government of India is leading the economy towards greater transparency at the time when the entire world is moving in this direction. Transparency begins with providing loans and financing for businesses and extends further on to sales of finished goods. Of course, the demonetization hits the black market. Those who work in the legal market are greatly suffering from the black market. Of course, as a result of this step polished prices are to grow to a certain extent and demand should rise - India is a potentially huge market, given the size of its population and middle class - but it is necessary to achieve full transparency, which is, unfortunately, afflicted in the sector financing Indian businesses.
In my opinion, the game, which has been going on in this area in the past few years – and it is not the first time I’m speaking on this subject – involving unsecured financing is totally opaque. If you count the number of issued loans and compare it with the actual value of total collaterals, taking into account the current situation in the market, I fear that the result will be very negative. Incidentally, Belgium is currently going along the road of transparency after introducing the so-called "Carat Tax", and local companies prefer completely transparent ways of doing business. But if we speak about the above-mentioned 80-percent share of India in global diamond cutting, the state of things there may produce an extremely negative impact on the whole current situation.
In the current environment, many diamond cutters say they need to use internal reserves to improve cost efficiency. What is the situation at Kristall in this regard?
Same. We apply a stress scenario and seek to maximize internal reserves. They certainly exist, and we reduce costs down to the limit, optimizing the processing of rough to find ways to increase added value and labor productivity. We use all the latest techniques, modern equipment for mapping rough diamonds and examining them for making future polished goods. We have introduced laser systems for 99% of diamond sawing operations and they show good performance being today one of the best tools for such works, providing the lowest waste and lack of splits. In addition, we have introduced a logistics system, which allows the fastest way to make polished diamonds. Our production mechanism is running smoothly, and we are not worrying about it. We are more worried about the external environment, in which we exist, carefully watching how it is changing, and it is changing sometimes "categorically," seriously affecting our operations.
The need to make customs procedures for rough and polished diamonds easier has been discussed for some years. Is there any movement in this respect?
There is. This situation should be viewed not so much in terms of exports, but in terms of general movements across the border, because the diamond business involves a number of different ways of action with stones - not only direct sales, but, for example, sending goods for certification to a laboratory abroad and their return to this country; sending goods on consignment and returning unsold goods; that is, permanent movement across the border. It is often the case that we do not have such mechanisms for returning goods or they are very complicated. This is the problem. You have to use a subsidiary abroad, which has no such problems. And this affects the trade in a serious way. Even to take part in an exhibition it is necessary to exit the country with your goods and then bring them back, and this is an extremely complicated procedure, while other companies in the world do not have such difficulties. However, the matter has turned much easier today for rough diamonds. There is obvious progress in the import procedure for rough. In fact, diamond sorting and identification performed at a customs terminal is now a thing of the past. However, rough imports to Russia are very small, because the earning power of this business fell. But the issue of moving polished goods across the border remains.
In your opinion, what measures are needed to support the diamond cutting industry in Russia?
As for diamond manufacturing in Russia, we call on all the levels of our government to take a series of measures that will protect domestic producers. This approach is currently widely discussed and declared as a basic industrial policy of the Russian Federation. Being engaged in rough diamond processing and producing finished goods we are willing to participate in it. We must. Now that the export duty on rough diamonds is cancelled, we are seeking protective measures for the domestic diamond manufacturing industry, because the protectionist policy, which protects diamond cutters in India, is simply disastrous for us, and we should clearly tell everyone that either we in Russia put an end to diamond manufacturing or we continue to maintain and develop what we have already attained in this industry.
Our company is the leader of the Russian diamond manufacturing, it is a state enterprise, and therefore we are occupied with these problems. We have attained that Igor Shuvalov, First Deputy Prime Minister issued an order prescribing to the Ministry of Finance to outline a strategy for the development of the diamond cutting industry in Russia until 2030, indicating measures of support to the industry. The work on this is underway. We have prepared our proposals and handed them over, and now we are waiting for the result. At the same time, we are pro-actively working with ALROSA, which is the major supplier of rough for Kristall and, accordingly, the main company, which formulates the rules of the game on the Russian market. We continue to say that unless there is urgent action, we will lose the diamond manufacturing industry in this country and the experience gained in the course of 55 years of its existence.
If we talk about global issues, the creation of added value should be put on the main agenda for the entire diamond community. The Diamond Producers Association (DPA), which is now filling its budget for marketing activities to promote polished diamonds across the world, should start its work in a most businesslike manner, taking into account the fact that, on the one hand, there is the emerging market of synthetic stones and that, on the other hand, the lack of generic marketing is producing an absolutely negative impact on demand for diamond goods across the world, which does not grow, despite the fact that other luxury goods demonstrate significant growth in sales. And here, perhaps, it should be once again said about the problem of transparent financing in the sector, so that lending was accompanied by real collaterals and real stocks, which will not permit to generate losses in the industry. I’d like to repeat it that the bubble, which we have mentioned many times, is there and the problem remains.
You mentioned your proposals, which were submitted to the government. Tell us what they are.
First of all, these measures should compensate for the abolition of export duty through the mechanism of stimulating the production of finished goods. Above all, this should be done to eliminate speculation in rough diamonds. This requires the support from operating companies and real manufacturers of polished diamonds. It is the responsibility of companies selling rough, which are primarily ALROSA and partially Gokhran. We propose to use several different mechanisms, including a mechanism for deferred payments under relevant bank guarantees, as well as the volume of product mix and prices for the domestic market. This is a more difficult part, but there is nothing to prevent setting prices for the domestic market. The legislation does not prohibit it. The Federal Antimonopoly Service says there should be equal conditions for everyone. I do not see any problem with this either.
The most important thing is that both ALROSA and Gokhran should outline a profile for their domestic customer based on appropriate conditions - this customer should be a real manufacturer having production capacities, people who work in this industry, taxes paid, a payroll fund properly taxed, an actual report featuring activity in diamond manufacturing, which is absolutely not difficult to organize in accordance with our reporting forms. Based on these requirements, we will have real incentives to produce polished diamonds.
In what way diamond manufacturers in Russia are given loans?
We have a very complex system. Each business here is trying to find its own way to get loans. However, by and large we do not have a crediting system for diamond polishing factories in Russia. We use our own lending model, which is based on collaterals - we have found a formula with our lending banks permitting to pledge rough and polished diamonds in turnover. But such a borrowing company as Smolensk-based Kristall cannot be compared with a small private business, which has no credit history and assets. Therefore, it can be said that in general there is no system for this part of the industry.
Is it expensive to take loans for your business?
Certainly, it is. Once, we used to take loans abroad and did it rather often, when the ruble rate was stable and it was safe to do this. We also attracted syndicated loans. A year ago, we tried to get a loan from ABN AMRO Bank through our Belgian subsidiary, but we were denied due to the sanctions. Therefore, we are now counting on local banks and local lending. It must be said that it is safer to have loans denominated in rubles, though it is more expensive.
In what way does Kristall view the year of 2017 in terms of production?
Unfortunately, 2017 started with another decrease in prices for polished diamonds announced by Rapaport. This is quite a negative sign that sales did not meet expectations. After all, how do we usually start a new year? We summarize the results of the sales season across the world to realize the volume of goods sold and the extent of future restocking to replenish the retail network. As Rapaport prices went down, this caused some negative reaction in the market. We have no reporting forms in our global industry, by which we could know the precise amount of goods sold. But judging by the amount of diamonds now present in the Internet and on the Rapaport website (where their values sometimes peaked to $ 10 billion), we can probably trust the trend. The amount of goods, which poured into the market by December 2016, started to weigh very heavily on prices, and as a result Rapaport responded by lowering its price index. So, we have to wait for another month and see the amount of unsold goods coming back from the market, after which we can say what the first quarter will be for us. Although I believe that if 2016 was on the rise for rough, then 2017 will accordingly tilt in the opposite direction, in line with the tradition.
Vladimir Malakhov, Rough&Polished
Photographs by Evgeny Sapozhnikov