Annual report and accounts 2012

Credit risks

Counterparties’ risks: clients

Our practice of selling products on deferred payment terms exposes us to credit risks (clients’ default).

Mitigating factors:

  • We have developed and implemented policies and procedures to manage credit risks, including credit committee approval and on-going credit evaluation of the customer base.
  • Credit committee approval is required prior to the sale of products to key customers under deferred payment terms. When necessary, we use collateralisation or risk transference arrangements (for example, bank guarantees from approved institutions, letters of credit, or credit insurance).

Counterparties’ risks: financial institutions

The bankruptcy or insolvency of any of the banks we work with could adversely affect our business. Another banking crisis or the bankruptcy or insolvency of any of the banks at which we hold funds could result in a loss of income for several days, or affect our ability to complete banking transactions. Furthermore, any shortages of funds or other banking disruptions experienced by our banks could have a material adverse effect on our ability to execute planned developments or to obtain the financing required for our planned growth. All the above factors could have a material adverse effect on our business, financial position, operational results and future prospects.

Mitigating factors:

  • Severstal has centralised bank risk management procedures
  • In order to minimise the potential risk of bank default, we have a diverse client base and hold liquid assets in several banks under flexible conditions.
  • Severstal cooperates with financial institutions based on credit risk limits established on a regular basis. These limits are determined and regularly approved by the committee, according to internal procedure.
  • We regularly monitor the financial standing of banks and the overall financial environment to foresee defaults and minimise the potential negative impact.

Interest rate fluctuations

Financial markets volatility and low economic recovery rates could limit Severstal’s access to external creditors, which could affect current debt refinancing and operational activities financing. Increased liabilities on loans could negatively affect Severstal’s financial indicators and decrease cost efficiency. Our debt financing interest rates are either fixed or variable, with a fixed spread over LIBOR, EURIBOR or MOSPRIME.

Mitigating factors:

  • By maintaining a diversified debt portfolio we minimise potential adverse effects of interest rate fluctuations.
  • We also monitor the economic environment closely, and current debt trends on the capital markets. Severstal operates all necessary tools to convert viable rates to fixed and vice versa in key loan agreements.
  • We can also use our existing cash cushion to repay debts affected by adverse interest rate changes.

Foreign currency exchange rate fluctuations

Severstal is exposed to translation and transactional foreign currency exchange rate risks. Translation risks arise when assets and liabilities are translated into currencies other than US dollar amounts for financial reporting purposes. Transaction risks arise as a result of payments we make or receive in foreign currencies. Currently, our operations in foreign currencies balance, i.e. revenues, expenses and borrowings related to international operations are all denominated in the same currency. Revenue from our Russian operations are denominated in roubles, US dollars and euros, with meaningful fluctuations year on year.

Our expenses are mostly in roubles, and our borrowings are in US dollars and euros. As we report our financial results in US dollars, and frequently exchange or translate foreign currency into roubles or roubles into foreign currencies, exchange rate fluctuations could have a material adverse effect on our business, financial position, operational results and future prospects.

Mitigating factors:

  • Our existing natural hedge of export sales against financing in US dollars or euros covers much of the existing rouble-dollar exposure of our Russian operations. To manage these opposite cash streams more effectively, we have entered into a number of cross-currency swaps and forward contracts.

Credit agreement provisions

Credit agreements signed by Severstal include provisions triggering default in the case of material adverse changes or covenant violations.

Mitigating factors:

  • We regularly monitor possible credit covenant violations on the basis of our business plan. Beforehand we amend agreement provisions or get waivers, if required, to prevent defaults and adverse impacts on our financial statements.

Investment effectiveness

Steel production and mining are capital intensive businesses. We have undertaken a capital expenditure programme focused on modernising and developing our existing steel production and mining facilities. We plan to rely on cash generated from our operations, and on external financing, to provide the capital needed for the programme. However, there is no assurance that we will be able to generate adequate cash from operations, or that external financing, if necessary, will be available on reasonable terms.

In addition, our capital expenditure programme is subject to a variety of potential problems and uncertainties. These include changes in economic conditions, delays in completion or delivery, cost overruns, and defects in design or construction, all of which may create the need for additional cash investment. Fluctuations in prices or on the loan market could negatively affect investment project implementation deadlines.

Furthermore, our capital expenditure programme includes plans to acquire significant amounts of new equipment, including more advanced technologies. While such new production equipment and technologies are aimed at increasing the operational performance of our facilities, there can be no assurance that the equipment will meet its intended production targets on a timely basis, or at all, and this could result in reduced production, delays or additional costs. Moreover, in financing the programme, we may incur a substantial amount of additional debt, the interest and principal repayments on which may become a significant drain on our cash flow. The failure or delay of our capital expenditure programme, or significant increases in financing costs arising from programme funding, could have a material adverse effect on our business, financial position and operational results.

Mitigating factors:

  • To mitigate technical and technological risks, we carefully select construction and equipment installation contractors.
  • Under our company-wide development program, we regularly assess employees and provide necessary training.
  • In response to the recent global economic downturn, we reduced our investment programme, protected our cash position and focused on the maintenance, repair and modernisation of equipment and near-deadline projects.

Mergers and acquisitions

Severstal has grown rapidly and we intend to pursue opportunities to grow our operations through further acquisitions. However, there can be no assurance that we will be able to identify suitable acquisition targets or successfully integrate acquired companies.

In recent years, we have increased our ownership interests in a number of companies, and acquired other companies, businesses and production assets. In particular, Severstal Resources has acquired a number of mining operations. We may consider future acquisitions of assets or companies that we believe are aligned with our corporate strategy and financial targets and offer significant potential synergies. In particular, we are considering growth opportunities in emerging markets.

The success of past, current and future acquisitions will depend on our ability to manage the assimilation of the acquired assets or companies into our operations, despite the inherent difficulties, such as:

  • existing operational inefficiencies
  • cultural differences
  • personnel redundancies
  • incompatibility of equipment and information technology
  • production failures or delays
  • loss of significant customers
  • difficulties with minority shareholders in acquired companies and their material subsidiaries
  • potential disruption of Severstal business
  • assumption of liabilities relating to the acquired assets or businesses
  • possibility that indemnification agreements with the sellers of such assets may be unenforceable or insufficient to cover potential liabilities
  • impairment of relationships with employees and counterparties as a result of difficulties arising from integration
  • poor records or internal controls
  • difficulties in establishing immediate control over cash flows.

Furthermore, there can be no assurance that we will be able to achieve the targeted synergies in our operations with recent or planned acquisitions.