ANNUAL REPORT 2016

Severstal CFO’s Review

Dear Shareholders,
In 2016 Severstal delivered a solid financial performance despite challenging industry conditions. Continued focus on efficiency improvements across the business, along with our unwavering commitment to further enhancing customer care and quality, maintains the Group’s position to deliver long-term shareholder value. Severstal’s continued robust performance is underpinned by our vertically integrated business model and our financial discipline, which is focused on achieving:
• Industry leading EBITDA margin through efficiency improvement and cost management;
• Positive free cash flow;
• Controlled, prudent and disciplined CAPEX;
• A strong balance sheet with low levels of debt;
• Returning value to shareholders in the form of dividends.

Industry leading EBITDA

Over the course of 2016, Severstal continued to benefit from the strengths of its product portfolio and production assets, which enabled the Group to deliver an overall revenue performance of $5,916 million. Though this represented a year-on-year 8% decline, reflecting headwinds including extremely low and fluctuating steel prices that impacted the entire global industry, Severstal was again able to run at close to 100% utilization rate at its key business units.

The Group’s aim is to maintain a leading cost position, with all assets at the middle-to-left on the global cost curve. In 2016, Severstal continued to make good progress in improving efficiencies across its asset portfolio mostly offsetting inflation. We also continued to control general and administrative costs across the business. Although a substantial share of Severstal’s production and administrative costs are rouble-denominated, short-term rouble fluctuations have a broadly neutral effect on our EBITDA as long as rouble revenue approximately matches our rouble denominated costs.

Full year EBITDA was $1,911 million, down 9% compared with the previous year. That said, at 32.3% Severstal’s EBITDA margin remains one of the highest in the global industry and the Company once again significantly exceeded its target cycle-average EBITDA margin of c.20%. The Group saw a stronger performance in the second half of 2016, reflecting positive momentum in the global steel and steel-related markets.

Maintaining stable positive Free Cash Flow

Generating Free Cash Flow is a strategic priority for the Group and is important to our investors, resulting in dividend payments and further strengthening our balance sheet. In 2016 we achieved free cash flow of $1,021 million (2015: $1,552 million).

Proactive working capital management, cost optimisation and the strength of our vertically integrated model and strong product portfolio, allow us to offset sharp steel and commodity price movements throughout the cycle and maintain a strong free cash flow profile.

Controlled, prudent and disciplined CAPEX – mid-term target not exceeding $1.0 billion per year

Severstal maintains a prudent approach to investments, with CAPEX being covered by operating cash flow. In 2016 the Company’s CAPEX was $525 million. During the year, we completed investment into our downstream projects including: cold-rolled coil 4-stand mill upgrade, new galvanized and colourcoated lines launch, and we will be focused on upstream projects including blast furnace and coking batteries’ modernisation.

Strong balance sheet with low levels of debt

Severstal has significantly reduced its debt level over the last few years in line with our financial objectives. The Company strives to keep Net debt/EBITDA below 1.5x, and by the end of 2016, the Group’s Net debt/EBITDA ratio was just 0.4x.

Severstal’s gross debt reduction remains largely maturity-driven, with around 99% of the Company’s gross debt being public at the end of Q4 2016. Cash at hand and unused credit committed lines cover several years of debt maturities.

The Group continues to proactively manage its debt profile and, in April 2016, Severstal announced the placing of US$200 million Senior Unsecured Convertible Bonds due in 2021. Furthermore, in June the Company cancelled a portion of senior unsecured convertible bonds issued in September 2012 and due on 24 September 2017. Moreover, during 2016, Severstal’s credit rating was upgraded to investment grade “BBB-” by Fitch Ratings and S&P, global ratings which demonstrates that our strategy to focus on cost-control, customer care and HVA products in this complex economic environment is proving successful.

To ensure we maintain a strong balance sheet in the current volatile macro-economic environment we retain more than US$1 billion of hard currency in cash and cash equivalents on the balance sheet.

Dividend

Severstal constantly seeks to find the most effective balance between maintaining a low debt level and returning value to shareholders in the form of dividends. Severstal targets payout of not less than 50% of quarterly net income provided that Net debt/EBITDA is below 1.0x. Reflecting the Company’s continued strong financial position and confidence in the outlook, the total accumulated dividend returned to shareholders for 2016, including the fourth quarter dividend which is subject to approval by shareholders, dividends will amount to approximately $US1 billion.

Alexey Kulichenko
Chief Financial Officer