Morgan Stanley on Alrosa


1st Take: 4Q15 operational results show a higher rough diamond demand than expected

January 28, 2016

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ALROSA remains our favored exposure in the Russia M&M space, but the diamond market is not out of the woods just yet. A combination of decent US holiday sales, rough diamond producers’ supply discipline, and increasing polished prices has moved the diamond market towards rebalancing (EMEA – Diamonds: The PIPE – diamond intel). We also welcome the increasing efforts towards generic marketing. All this should increase confidence that ALROSA can increase sales volumes throughout 2016 and improve cash flow generation by reducing inventory accumulation. ALROSA also remains among the biggest beneficiaries from recent RUB weakness. Our key concern is that supply discipline seems to have somewhat relaxed in January: De Beers’ January trading session ($580m) seems large, even in light of the positive dynamics described above. While this might signal that inventory levels in the midstream are lower than expected and/or that rough diamond demand is higher than originally thought, we need to see continued modest growth in end-user demand for diamond jewellery to be confident that the market has rebalanced. This is all the more true if the speculated 5-7% price reduction was realized (De Beers did not comment), as this would mark a shift from De Beers’ strategy in 3Q-4Q15 (price over volume).

Some mild upside to our estimates as 4Q15 operational results better than we expected, but still showing some supply discipline. We see some upside risk to our 4Q15 revenues and FCF estimates as ALROSA reported higher than expected sales volumes (4.1mcts of gem-quality diamonds vs. our expectation of 3.4mcts) and a higher than expected revenue per carat (impacted by improved mix YoY: $166/ct for gem-quality diamonds vs. our expectation of $158/ct). ALROSA in fact guides for at least $3.4bn of revenue in FY15 from rough diamond sales, vs. our estimate of $3.28bn. Nonetheless, ALROSA showed continued supply discipline, by selling less than it produced and accumulating another 1.5mcts of inventory in 4Q15 (vs. our expectation of 2.9mcts) to 22.5mcts, up from 14.3mcts at YE14.

No guidance provided for 2016. Back in December, ALROSA stated it was looking to sell $3.5bn worth of rough diamonds in 2016, higher than our estimate of $2.95bn.

Valuation: on spot FX (and assuming ALROSA does not reduce prices) ALROSA trades on 12% FCF yield for 2016 and 33% for 2017, when we assume the market will rebalance and ALROSA will sell its entire production. This puts shares on 6.1x P/E for 2016 and 4.7x for 2017, a 40-70% discount to Norilsk Nickel.

Exhibit 1:

ALROSA sold more rough diamonds at a higher than expected price in 4Q15

FY15 FY14 % YoY 4Q15e 3Q15 % QoQ 4Q14 % YoY MSe (4Q15e) vs. MSe
Diamond output volumes (mcts) 38.3 36.2 6% 8.6 11.6 -26% 10.6 -18% 8.5 1%
Grade (cts/t) 1.03 1.01 2% 1.17 0.86 36% 1.45 -19% 1.33 -12%
Total Diamond sales volumes (mcts) 30.0 39.6 -24% 7.1 4.9 45% 10.8 -34% 5.6 27%
Gem quality diamond sales volumes (mcts) 19.7 27.8 -29% 4.1 3.0 37% 6.9 -40% 3.4 22%
% of gem-quality diamonds sold 65.7% 70.1% -4pp 57.7% 61.2% -3pp 63.5% -6pp 60.0% -2pp
Gem quality diamond revenue per carat ($/ct) 170 172 -1% 166 182 -9% 161 3% 158 5%
Average realized revenue per carat ($/ct) 115 124 -8% 100 115 -13% 106 -6% 98 2%
Source: Morgan Stanley Research

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