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ALROSA adjusts “paper loss” in the interests of shareholders - investment banks

01 december 2014

The results of ALROSA in the third quarter of 2014, despite a fall compared to the previous period (due to a seasonal decline in sales and prices caused by modifications in the miner’s product mix), surpassed consensus forecasts. The devaluation of the national currency, which allows ALROSA (where exports take up almost 90% in revenues) to maximize its ruble income, is an important factor supporting its performance. However, simultaneously it is the ruble devaluation, which has posed a dilemma for the diamond miner.
 
The revaluation of the company’s loan portfolio, 85% of which is denominated in foreign currency, resulted in a non-financial loss of RUB 20 billion suffered by the company in the third quarter of 2014. ALROSA ran into a net loss (of RUB 10.33 billion) for the first time since the fourth quarter of 2014, while its profit in the first 9 months – reaching RUB 12.78 billion - was below the level posted a year ago by 44%. The “paper loss” reduces the basis for calculating dividends, the total amount of which, according to ALROSA’s dividend policy adopted a year ago, is set at 35% of its net profit under IFRS.

Thus, there may be a paradoxical situation: on the background of world diamond prices going up by 8% along with higher revenues and profit margin posted by ALROSA its shareholders - including the Federal Property Management Agency and Yakutia - may get less than one year before, when ALROSA increased dividends by 32% paying 1.47 rubles per share (for a total of RUB 10.826 billion). In this regard, the heading of an analytical review released by one of the investment banks based on ALROSA’s statement for the third quarter of 2014 appears revealing: “Great result, but no profits.” ALROSA’s management – the current or future one - will have to solve the task similar to the mission once faced by Anatoly Chubais, who, being the head of the Unified Energy System of the Russian Federation in the early 2000s, made his best to explain the discrepancy between the giant “paper profit” caused by revaluation of financial investments and the real cash flow to the shareholders of the energy holding.

Key performance figures posted by ALROSA in the third quarter and 9 months of 2014 under IFRS, million rubles

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ALROSA has no plans to revise its dividend policy, but will consider the devaluation factor, while preparing recommendations as to the amount of dividend payments for 2014, Ilya Ryaschin, the Acting President of the company, said in a conference call dedicated to the miner’s results. "First of all, we intend to see the results of the whole year and what will happen to the ruble, and then offer our shareholders a dividend rate that takes into account the impact of the devaluation factor," he said.

There was not a single investment bank covering ALROSA to side step the issue of dividends to be paid. Most bank analysts agree that ALROSA will find a way to pay adequate dividends to its shareholders.

Forecasts of investment banks on dividends to be paid by ALROSA in 2014

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The statement made by ALROSA’s management that they will discuss several options for dividend payments for 2014 taking into account the ruble devaluation is considered by the BCS Bank as a positive point - the market had doubts that the company was going to pay any dividends at all due to the foreign exchange losses. If ALROSA will post a net loss for the whole year, it may pay dividends from its cash flow or EBITDA, BCS believes.

VTB Capital also expects ALROSA to exclude the foreign exchange factor, while calculating the amount of dividends for 2014. At the same time, a further weakening of the ruble may complicate the situation. Currently, VTB Capital predicts that the level of dividend payments by ALROSA will stay at RUB 15.7 billion (making the dividend yield reach 4.6%).

According to VTB Capital, despite the fact that ALROSA’s net debt / EBITDA ratio went up from 1.4x to 1.7x due to the revaluation of foreign exchange debt in the third quarter of 2014 (one year ago it was 2.2x), it remains comfortable for the company. Foreign exchange risks are partially offset by the miner, which redeemed $ 500 million worth of Eurobonds in November. In contrast to ALROSA’s net profit, its EBITDA will gain from the ruble devaluation, the investment bank said.

Proceeding from what has been said by Ilya Ryaschin, there is a chance that ALROSA will pay dividends based on its free cash flow (which reached RUB 22.5 billion in the course of 9 months) or on its net profit exempt from foreign exchange loss, Otkrytie says in its review of the situation. In this case, Otkrytie predicts a dividend of 2 rubles per share, which implies a four-percent dividend yield.

Otkrytie estimates that ALROSA will have a net profit of only RUB 2.4 billion in 2014 due to revaluated borrowings. For comparison, its net profit exempt from foreign exchange loss in the third quarter 2014 could be RUB 9.5 billion, according to the investment bank. EBITDA forecasts for 2015-2016 are expected to increase by 16% against earlier made estimates due to the ruble devaluation.

ALROSA’s management made it clear that they are fully aware of possible consequences for dividends from foreign exchange losses, Deutsche Bank said in its analysis. According to the bank, if ALROSA will pay dividends at the rate of 35% of its net profit exempt of foreign exchange loss, the dividend yield could reach 6.3%.

Rosbank believes that potential dividend payments by ALROSA for 2014 could amount to $ 500 million (about RUB 14 billion at an average rate of the U.S. dollar in the end of the third quarter of 2014).

Credit Suisse expects ALROSA to change its approach to calculating dividends, leaving aside its dependence on "paper loss". As a result, ALROSA’s dividend yield in 2014-16 may amount to 6-7%. According to Credit Suisse, in doing so ALROSA will not proceed from its cash flow. Rather, the miner will pay to shareholders from its net profit adjusted for foreign exchange fluctuations. Credit Suisse estimates the overall level of payments at RUB 11.2 billion, which is 3.4% higher than in 2013. The company’s foreign exchange loss in 2014 is likely to be a one-off episode, if the ruble will not fall below 45 to the dollar, Credit Suisse says.

Renaissance Capital has another view and considers the dividend issue to be one of the challenges facing the management of ALROSA in the coming year, along with a small 3-percent increase in diamond prices, leaner stocks and higher costs. The miner’s inability to meet the expectations of shareholders, including the dividend issue, "may damage the indestructible investment attractiveness of the company," Renaissance Capital says in its review.

The positive results demonstrated by ALROSA for the first nine months of 2014 go pale against the background of forex losses, which led to a 44-percent drop in net profit compared to the same period in 2013, Renaissance Capital says. The situation in the fourth quarter will not change, and in the event that ALROSA will suffer another loss of RUB 20 billion, its net profit for the year will reach merely RUB 11.6 billion, according to Renaissance Capital.

ALROSA is likely to face the dilemma of whether to make its shareholders entitled for some slice in the company’s earnings freed from forex losses or to follow the practice of paying 35% of net profit as dividends, which is approved by the government. The management’s promise to take the "paper loss" into account does not inspire optimism, Renaissance Capital says, especially in the absence of clarity on the candidacy of future president of ALROSA and understanding of his or hers objectives and strategies. According to Renaissance Capital, a pessimistic option involves a dividend yield of 1.25% and an optimistic option runs at 6.5%. In any case, it is below what is offered by Norilsk Nickel with a dividend yield as high as 14%.

Despite the fears of some of banks, market reaction suggests there is an overall positive perception of the situation with dividends to be paid by ALROSA. Being traded on the Moscow Stock Exchange, the company's shares rose by 4.3% (to 47.5 rubles per share) by the end of the day last Friday, when the company disclosed its results for the third quarter of 2014.

Igor Leikin for Rough&Polished