Annual report and accounts 2012

Management Q&A

In addition to the strategy outlined above, shareholders and prospective investors often pose questions relating to specific situations and strategies. Here our management team answers questions on some of the issues we are most often asked about.

How has the global financial crisis of 2007-2008 affected the Russian steel industry, and how has Severstal responded to this challenging time?

“Many companies were poorly prepared when the economic crisis hit Russia in late 2008. Steel sales dropped dramatically. Russian steelmakers had a sizable debt in USD/EURO , and as large employers they had sizeable fixed costs. With EBITDA shrinking rapidly, many companies were in trouble. In Severstal’s case, our 2008 US acquisition became a negative in the face of the crisis. Fortunately, our debt level was affordable. Our financial responses included cutting administrative costs, selling on a pre-payment basis and adjusting capex to the steel cycle (the steel industry is cyclical). We were able to decrease debt level and improve cash balance. The 2008 crisis prompted us to revise our strategy and business processes. We divested underperforming assets and gave priority status to our set of initiatives for internal improvements (The Business System of Severstal). In addition, we now have a cautious financial policy, with potential investments in new geographies subject to rigorous KPIs. So, today we are in a much better shape for any market development scenario.”

What differentiates Severstal amongst steel producers?

“The Russian steel industry is one of the most competitive globally. So, like some of our local peers, we are naturally a low-cost producer. But in the steel industry, costs are around 70% related to raw materials, so our efficient vertical integration in steel-related raw materials is an additional advantage compared to the domestic and international competition. In addition, we stick to our strategy – presence on growing and consolidated markets and focus on our customers’ needs. Also, one of our priorities is the production of HVA products, which allows us to be one of the global leaders in EBITDA margin. Our assets are well-invested, modern and reliable, with reasonably moderate annual maintenance capex. Hence, depending on the market environment, we can afford adjusting our annual investment needs. For instance, we cut our 2012 total target capex during the year in light of the slowing market conditions, from US$1.7 billion to US$1.4 billion. As a result, our 2012 operating cash flow of US$1.8 billion more than covered the 2012 capex, and free cash flow was positive US$431 million. Last but not least, our well-established set of projects for internal improvements is already bearing fruit. All this allowed Severstal to achieve a 15% EBITDA margin in 2012 in challenging market conditions.”

How do you maintain financial stability?

“We adjust our capital expenditure to the steel cycle, and it is capped, as with M&A and dividends, by a leverage target. We maintain strong liquidity, with a cash cushion in reliable banks of US$1.7 billion as at the end of 2012, and committed unused credit lines of US$922 million covering 2013 upcoming short-term debt maturities of US$1.3 billion 1. As a credible bond issuer and borrower, we have easy access to a diverse range of funding sources at any time. In 2012 alone we made two bonds issues for the total amount of around US$ $1.2 billion. Dividends are subject to prevailing market conditions and strategic financial targets. In 2012 our dividend pay-out was around 36% 2. ROCE 3 was above 11% with constant monitoring of all projects’ return.”

What are your capital expenditure plans for 2013?

“Our 2013 target capex is US$1.3 billion and it will be again fully financed through our operating cash flow. Hence, for 2013 we target positive free cash flow. More than a half our capex will be invested in further development.”

How do you view 2013 and what will be your focus?

“Though the fragile economic environment will be restraining steel prices from further growth throughout 2013, we are seeing slight signs of recovery. However, since steelmakers globally will remain squeezed from two ends – relatively expensive raw materials and steel over-capacity – our strategy will be to further reduce costs, minimise capex and support only projects with the highest return, prioritising customer care initiatives. In addition, we maintain a prudent financial policy with restrictions on cash-based M&A in the current environment.”

How importantly do you view volume growth?

“We are managing Severstal to achieve profitability, maintain low-cost production on the global scale, and not to pursue volume growth. Our well-invested assets have low capex requirements and we have major programmes designed to improve efficiency, as well as projects enhancing our margins through expansion in production of HVA products. Thus we are prudent, and do not produce unnecessarily. We are increasing volumes in mining, as our low-cost production allows us to sell substantial amounts of both iron ore pellets and coking coal to third parties in Russia and beyond. By 2015 we intend to growth our sales of coking coal concentrate in Russia by 45%, compared to the level of 2012.”

What is your view of greenfield projects at present?

“While we retain a portfolio of attractive greenfield licenses, our policy is to minimise future cash exposure through partnerships and JVs, and a staged approach in development of such projects. Current investments in the greenfields are relatively small; in 2013 they will not exceed US$46 million for all the projects. We intend to minimise our capex exposure and preserve our financial flexibility. Balance sheet strength is our top priority.”

 

 

1 Represents principal amount of debt.

2 Includes recommended dividend payment of 1.89 Roubles per share (approximately US$0.06) for the 12 months ended 31 December 2012. The dividend is to be approved at the AGM on 13 June 2013.

3 ROCE is calculated by the following formula: profit from operations / (total assets minus current liabilities average for the period), as reported in 2012 FS.