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ALROSA: Heavy Debts and Ambitious Plans

14 august 2009

Diamond mining company ALROSA posted FY 2008 loss due to the crisis and foreign-exchange fluctuations, and almost doubled its debt burden during the year having obtained loans for construction of underground mines.

Losses

According to the company’s financial statement, reviewed by Interfax agency, ALROSA’s net loss following the results of FY 2008 amounted to 32.598 billion rubles per IFRS compared to the net profit worth 15.981 billion rubles in 2007.

The company’s statement attributed the net loss to the decreased fair value of forward contracts in foreign currency, foreign exchange loss on loans and credits in US dollars as well as accumulation of reserves for forecast payments per forward contracts.

“ALROSA’s financial results turned out to be expectedly negative. The decline in financial performance was caused by the increase of cost of financing as well as revaluation of currency contracts,” Albert Sagiryan, a vice-president at JP Morgan, told Interfax.

In attempt to minimize currency risks against the strengthened ruble exchange rate in 2006 ALROSA concluded forward contracts in foreign currencies with a number of banks, whereby it agreed to sell US dollars at a rate of 26.56 to 26.84 rubles within the period of five years. Consequently, the loss generated due to the change of fair value of the above contracts (in fact – the amount of reserves accumulated) in 2008 amounted to 25.077 billion rubles.

Operating loss in 2008 figured up to 14.097 billion rubles compared to operating profit worth 24.43 billion rubles in 2007. At year-end the miner got a negative EBITDA worth 5.2 billion rubles whereas in 2007 it posted a positive EBITDA worth 33.041 billion rubles.

Meanwhile the company managed to retain its earnings at the level of the preceding year despite leaving the diamond market since November 2008. FY 2008 earnings fetched 91.082 billion rubles compared to 90.734 billion rubles in 2007.

Diamond sales account for 86% of the company’s total earnings which is 78.244 billion rubles. ALROSA’s diamond sales proceeds declined by 2% in 2008 compared to the previous year. Export revenue dropped by 18% to 38.88 billion rubles, mainly due to the curtailed sales to De Beers. However revenue gained at domestic market rose by 27% to 35.292 rubles.

At the beginning of 2008, experts used to forecast a significant upsurge in diamond sales and demand for diamonds. Diamond prices were actually fast-growing till last September; however in autumn 2008 the diamond industry faced severe recession. A sharp slump in demand, oversupply at the market and difficulties in obtaining loans resulted in dropped prices for rough diamonds. Consequently, diamond giants announced sales reduction, whereas some miners had to cut diamond production.

“At that time ALROSA had just initiated establishment of long-term relationship with its clients,” Rough&Polished expert Sergey Goryainov told Interfax. “The majority of ALROSA’s clients were buying on a non-recurrent basis, i.e. they could effect large-scale diamond purchases making profit for ALROSA but not involving any guarantee of further business. Moreover, most of those clients were not interested in regular diamond procurement for further polishing: rough prices were climbing and diamonds were bought for speculative purposes. Consequently, the following came to hand: since the recession economic environment changed dramatically and once-only ALROSA’s clients disappeared while ALROSA fell short of long-term customers.”

Despite the fall in revenues, ALROSA retained its capital expenditure program which amounts to 18.259 billion rubles. Furthermore, geologic exploration expenses were expanded to 4.52 billion rubles compared to 4.14 billion rubles in 2007.

The principal budget item of the company’s investment is construction of mines in accordance with the program to switch over to underground mining. As was previously reported, ALROSA is constructing three underground mines each to cost approximately $1 billion. Commissioning of the underground mine at the Mir Diamond Field is scheduled for the next week.

Liabilities

ALROSA used to raise credit resources in order to finance capital construction. Eventually the company’s net debt for 2008 increased up to 115.545 billion rubles (compared to 59.861 billion rubles in 2007). Due to increased floating debt in 2008 the company’s liquidity started to decline to become negative because of the reduced cash inflow from diamond sales in 4Q of 2008. Following the results of 2008 ALROSA’s negative liquidity amounted to 37.557 billion rubles.

The problem of huge debt is attributable to the fact that the peak of recession fell within the moment when ALROSA was in active phase of underground mine construction,” Sergey Goryainov said. “At the same time the underground construction reached the phase where it could not be suspended.  Temporary shutdown of construction would have involved larger losses compared to present figures. Moreover, the company just cannot afford suspension of such large-scale development otherwise it will be short of resources as soon as its Kimberlite open-pit development is exhausted. The company was forced to take loans lacking disposable cash resources.”

The VTB Bank is the main creditor of ALROSA, the other creditors being the Bank of Moscow, Alpha Bank, and Mezhprombank.

One of the sources of cash to pay for loans might be sale of rough diamonds to the government. Earlier ALROSA stated that negotiations with Gokhran on additional rough purchases were pending this year. A source close to the negotiating process told Interfax that an agreement was reached with the government on rough sales to Gokhran for a total of $1.5 billion in 2009 and for an equivalent amount in 2010.

Previously a Gokhran source reported to Interfax that the government had already purchased rough diamonds worth 12 billion rubles from ALROSA in 2009. The amount stated is inclusive of 3.69 billion rubles annually allocated for rough purchases in accordance with Gokhran’s plan for 2008-2010. ALROSA sold rough worth this amount at the beginning of 2009. A total of 8.4 billion rubles was allocated for additional purchasing (7.1 billion roubles for rough diamonds and 1.3 billion roubles for VAT payments). This stock was sold by ALROSA to Gokhran in June, 2009.

“Should the decision of additional purchase worth $3 billion be passed, then there is nothing to threaten ALROSA’s position within the next two years. Certainly it’s needless to speak of excessive profits, but this money should be enough for current operations and gradually paying back debts,” Sergey Goryainov stressed.

Along with the above the company will be able to lessen its debts by selling its non-core assets. According to another market source ALROSA’s hydrocarbon assets deal involving their sale to VTB for $620 million was at the final point – the company is waiting for money remittance. The source clarified that for VTB “this is an investment project which could be developed by ALROSA itself but now the company is busy with other things.”

The source did not specify the oil and gas assets in question, however previously ALROSA held negotiations to sell ZAO Geotransgaz and Urengoyskaya Gazovaya Compania Ltd. The company also owns two hydrocarbon assets in Yakutia: ZAO Irelyakhneft and a controlling stake in OAO Sakhaneftegaz, which was subject to judicial supervision since late last year.

“The actions planned in order to sell non-core assets as well improvement of market environment and access to liquidity must result in enhancement of the company’s operational and financial results,” Sagiryan said.

Outlook

During the first half of 2009, ALROSA proceeded with the investment program and did not curtail its production though hardly selling any of the rough diamonds mined. Hence the company posted negative results per RAS (Russian Accounting Standards): 1H 2009 net loss stood at 13 billion rubles compared to profit worth 112.57 million rubles during the first quarter of 2008. The company’s statement per RAS has not yet been released for the first half of 2009; however experts claim that the second quarter will be also losing for ALROSA although a lower level of loss may be expected.

ALROSA returned to the diamond market in July this year having sold rough diamonds worth $150 million. Most diamond parcels were sold per long-term contracts concluded last spring. Rough sales to Smolensk-based Kristall and Yakutia’s polishing factories were also resumed; more over, ALROSA got back to auctions for diamonds of 10.8 carats and above. During the first ten days of August ALROSA sold rough diamonds worth $35 million on the market. The company expects diamond sales in August to be not less than those in July. In general, according to a source in ALROSA, the company retains the distribution plan for 2009 at the level of $2.6 billion.

At the same time experts don’t tend to regard the July growth of diamond sales as the guarantee for further sales expansion. “The diamond market has suffered more than other commodity markets from the recession,” Sergey Goryainov notes. “We should not neglect the seasonal factor. The second quarter and summer season are usually characterized by a larger turnover compared to the first quarter.”

He added that the market experiences a slight revival but it’s too early to make optimistic forecasts. “Experts agree that forecasts for rough demand should be based on demand for polished diamonds, i.e. end product. By various estimates, demand for polished diamonds is either on the decrease or stagnating but not on the rise anyway. And the reason for that is the high unemployment rate in the countries historically regarded as major diamond consumers – the USA, Japan and European countries. Unemployed people do not need diamonds. I suppose the company will follow a cautious distribution policy to avoid a slump in rough prices. Relying on Gokhran’s support ALROSA will be able to build long-term relations with major rough consumers which in their turn are also interested in stable prices,” he noted.

“There are some positive signs. The Western market is recovering and this is a primary market for ALROSA,” Yan Tavrovsky, Head of Morgan Stanley Investment Division in Russia, said. “According to the statements of its management, the company has returned to the market and we regard this as a positive sign.”

“We take a positive view of the fact that the company has a new president, Fyodor Andreyev, and we see that he enjoys support from the shareholders. Previously ALROSA was faultless in meeting its obligations and we have no reason to think it can be otherwise in the future,” he noted.

Interfax