Even though Severstal represents less than 1% of the global steel industry in terms of production volumes, it remains an unrivaled global leader in profitability for the sixth consecutive quarter. Specifically, in 2015 Severstal posted a new record, achieving the highest EBITDA margin since the Company’s IPO on the London Stock Exchange in 2006.

This leading position and the Company’s continued improvement in performance have been driven by the lean structure of our operations, which is one of the cornerstones of Severstal’s business model: low indebtedness and absolute cost advantage versus both local and global competitors, underpinned by Severstal’s vertical integration.

Being relatively small Severstal is obviously unable to substantially influence global overcapacity issues. In 2015 the Chinese contribution to global steel production rose to more than 50% whilst Chinese demand continued to decline as a result of the economic slowdown. Initiatives to shut down excessive capacities and address the glut of steel in global markets will have a delayed impact on readjusting the supply/demand balance.

Growing protectionism is another substantial risk triggered by overcapacity and the global downturn in the steel industry. Increasing trade barriers are transforming the dynamics of the global steel market, with global steel trade routes adjusting, localisation of trade within regional rather than international markets, and pressure on exporters.

Among the other main potential risks the following should be highlighted.

Category	Description	Reaction	Probability
Strategic (political)	Intensification of protectionism in foreign trade	Favourable location of the main producing assets for reallocation of sales between export and domestic markets; Diversification of foreign markets	High
	Introduction of export taxation; Administrative price regulation in the domestic market	Favourable location of the main producing assets for reallocation of sales between export and domestic markets; Further enhancement of the sales portfolio in order to improve quality	Medium
Finance (credit risk)	Deterioration in account receivable turnover at Severstal Russian Steel and Severstal Resources	In 2015 a new version of Severstal’s Credit Policy was approved. Account receivable management at Severstal continues to be one of a key focus	Medium
Market	Russian economic recession and fall in steel consumption; Increasing inflation in Russia and growing production costs; Increasing interest rates in Russia; RMB depreciation, RUB appreciation	Hedging instruments; Optimising regional sales: home markets and exports; Focus on the most stable segments; Focus on customer care	Medium- to-high
	Raw material market risks; Falling global raw material prices; Scrap collection decline in Russia due to lower scrap inventories levels	Optimisation of blast furnace raw material charges; Optimal planning of scrap procurement; Cost optimisation at mining operations	Medium
	Slowdown in Chinese steel demand and increasing steel exports from China; Excess steelmaking capacities; Falling Russian market premium due to increase in competition (imports, new projects)	Further diversification into foreign markets; Further cost-cutting in steelmaking; Monitoring trade barriers	High
Operations (compliance/bribery risk)	Compliance/Bribery risk level increasing	Necessity to intensify anti-bribery and corruption control procedures	Medium- to-high

The Company employs focused initiatives to offset those risks. These initiatives are employed with due consideration to Severstal’s core values (for more details see section Sustainability):

• People;
• Health & Safety;
• Team work.

Severstal Business System

Taking into account the existing risks and weaker fundamentals of the global steel market, Severstal is implementing a “defensive growth” strategy. This strategy targets focusing on enhancing product quality rather than increasing scale of production underpinning the ability to generate higher earnings per tonne of product. By creating incremental value through further efficiency improvements and cost control projects Severstal maintains a leading competitive position against peers and offsets market risks. Severstal commenced the first stage of the Severstal Business System six years ago. With the primary aim of enhancing cost controls the Business System set specific targets for each division and at each production asset (in RUB terms excluding inflation trends):

These targets will enable Severstal to remain cost competitive throughout the cycle regardless of foreseeable price fluctuations.

Severstal constantly evaluates the results of this program via implementation of regular benchmarking processes and the Operational Audit programme, where, with the active involvement of the global steel network, it comes under review by celebrated international experts looking at specific segments of the operational process.

An additional angle of longer term cost cutting planning is capex effectiveness, which is managed by the Department of Largescale Investment Projects. Among the projects to be launched in 2016:

• Tailings thickening at Karelsky Okatysh with an approximate cost of 1.0 billion roubles to be spent over the next few years;
• Air shafts at Vorkutaugol with an approximate cost of 2.5 billion roubles to be spent over the next few years.

In addition to larger cost-cutting projects, Severstal’s internal Expert Network focuses on improving operational processes at ground level throughout the whole company structure. The programme was launched in mid-2015, with 300 experts, and has already introduced around 600 small scale initiatives. Taking into account the positive results of these first initiatives, Severstal plans to expand this network to 1,500 specialists by 2018. Specifically in 2015 the main focus of these initiatives were transport, maintenance process and utilities. Areas of focus for 2016 will be:

• Electric arc furnaces process at Russian Steel
• Underground coal mining, beneficiation process and open pit mining at Resources.

Although the majority of the positive impact from Severstal’s efficiency improvement mechanisms have already been realised, we target a further US$80 million of positive impact on EBITDA line in 2016 assuming unchanged macro parameters.

Customer Care

In the meantime, defensive growth is not only subject to a smart investment program and cost cutting. The next integral part of defensive growth is customer care improvement. Good customer care involves being responsive and flexible to clients’ changing needs. In Severstal’s business, this includes consistent quality of products, discipline in deliveries, fast processing of orders, and providing additional services that meet our customers’ requirements. We strive to be the company of choice when it comes to purchasing steel.

Severstal’s key customer care projects fall into three key groups:

Service Quality

There is a calendar of improvements which consists of 80 particular measures to be implemented in order to enhance service quality.

In 2015 we continued to develop IT-related customer tools, including our mobile service and online orders. In 2016, Severstal is relaunching its online shopping platform and online customer accounts.

Proactive and regular engagement with customers is key to ensuring Severstal continues to meet their evolving needs. This enables Severstal to understand the balance of price and non-price factors affecting customer decisions. Hence, another aim is to make communication between Severstal and customer easy and transparent from product order to delivery and after-sales service. Ongoing client feedback enables Severstal to enhance and adapt its customer service tools to satisfy their requirements.

Product Quality

Severstal is changing its approach to product quality assessment. Today Severstal evaluates product quality from the consumer’s perspective. Improvement initiatives are centered around:

One of the most important projects, which is the next step for the whole industry, is branding our products. By branding we guarantee the quality standards and protect company property.

Supply discipline

During the year we implemented integrated planning tools. This IT-system covers all processes from getting an order and production planning through supply chain control. Our key goal for 2016 in supply discipline is to significantly improve the number of deliveries that are made on-time and in-full.

We also revised our Supply Chain Management strategy. Product Portfolio Management enables the Company to differentiate specific market segments and define optimal sales, production, planning and logistic strategy to fully address customer expectations. For Severstal’s commodity products, which have a diversified customer base and numerous purchases every month, Severstal employs simple forecasts in planning its production cycle in order to improve the lead-time without building up inventories. For clients in the automotive segment, who demand considerably lower volumes of specific higher value added steel products, the Company’s production planning method is more complex.

Even though our financial investments in customer care projects are relatively small at the moment, it is a key element in evolving our internal processes and culture, which allows us to better respond to a changing macro environment. Severstal is shifting from a B2B focus to a more customer centric model.

When assessing customer care enhancement the Company employs Net Promoter Score (NPS) metrics, whilst benchmarking results against previous performance.

Short-term investment programme

Our operational priorities remain focused and consistent. We continue to see opportunities to deliver cost reductions and to develop our market leading customer focus. Together these priorities are supported by a prudent and smart approach to investments.

Severstal plans to invest approximately 43 billion roubles across the business in 2016. This investment will primarily focus on developing key areas of the company’s strategy including cost control, increased production of high-value added products and enhancement of customer care.

Severstal Russian Steel

Planned investment across the Severstal Russian Steel division in 2016 is approximately 26 billion roubles, 15 billion roubles of this will be invested in development projects including the construction of a new coating line and ladle furnace #2, and revamping of the four-stand continuous tandem cold rolling mill 1700 at the Cherepovets Steel Mill. Both of these investment projects are aimed at delivering increased capacity of high-value added products and reducing costs.

Severstal Resources

Planned investment across the Severstal Resources division in 2016 is approximately 17 billion roubles, 7 billion roubles of this will be invested in development of the assets. The majority of this will be spent on improvements to the stripping works. In 2016, 10 billion roubles will be invested in the maintenance of Severstal’s coal and iron ore operations as well as health and safety improvement projects.

Next steps

To secure a position as the global leader in value creation, Severstal is developing its technology to support the next phase of defensive growth:

• Big Data;
• Internet of Things;
• Predictive maintenance.