ANNUAL REPORT 2017

CFO’s Review

Dear Shareholders,
In 2017 Severstal once again delivered a strong financial performance amid challenging industry conditions. Severstal is a fully vertically integrated producer with strict financial discipline. We are focused on delivering long-term shareholder value and industry-leading total shareholder returns (TSR), and our success is driven by a strategy committed to enhancing efficiency, customer care and long-term sustainability. In turn, progress in these areas is underpinned by our commitment to innovation and new technology and Severstal’s fundamentally strong business model.

We are focused on achieving:
• Industry leading EBITDA margins through efficiency improvement and cost management;
• Positive free cash flow;
• Controlled, prudent and disciplined CAPEX;
• A strong balance sheet with low debt levels;
• Returning value to shareholders in the form of dividends.

Industry leading EBITDA margins

In 2017, the Group achieved revenues of $7,848 million, benefitting from the strengths of our growing product portfolio and well positioned, high quality production assets. This represented an increase of 33% compared with prior year and reflected industrywide challenges of rising and fluctuating steel prices, as well as improvement in demand. Meanwhile, Severstal achieved capacity utilisation close to 100% across its assets throughout the year. Severstal’s vertical integration enables us to optimise our cost base irrespective of market conditions. In 2017 we were able to mitigate the impact of fluctuating raw material prices over the year, and our assets remain positioned firmly on the left hand side of the industry cost curve. During the year we delivered further efficiency improvements across our assets to further strengthen our margins. Although a substantial share of the Group’s production and administrative costs are rouble-denominated, short-term rouble fluctuations have a broadly neutral effect on our EBITDA as usually our rouble revenue approximately matches our rouble-denominated costs. Full year EBITDA was $2,577 million, an improvement of 35% compared with the previous year. The Group targets a cycle-average EBITDA margin of c.20% and in 2017 we once again exceeded this target, achieving an EBITDA margin of 33%, which remains one of the highest in the global industry.

Maintaining stable positive Free Cash Flow

Free cash flow generation is one of the Group’s strategic priorities for delivering value to its shareholders and maintaining a strong balance sheet. In 2017 we achieved free cash flow of $1,393 million, compared with $1,021 million in 2016. The Group works proactively to offset steel and raw materials price volatility throughout the year through focusing on working capital management and cost optimisation. This is supported by our vertically integrated model and broad product portfolio, which enables us to consistently generate strong free cash flow.

Smart CAPEX – mid-term target not exceeding $1.0 billion per year

The Group has a consistently prudent approach to all investments, with all projects required to meet an internal ROI target of 20%, and CAPEX is covered by operating cash flow. In 2017, the Group’s overall CAPEX was $591 million, covering a number of internal investment projects (including a new ladle at furnance #2 a galvanized and colour coated lines unit and modernisation of coke batteries).

Strong balance sheet with low debt levels

The Group is focused on maintaining a low level of debt, which it has significantly reduced over the last few years. The Group’s Net debt/EBITDA ratio stood at 0.4x as at the end of 2017. Our ongoing target is a Net debt/EBITDA ratio below 1.5x. Severstal’s gross debt reduction strategy is largely maturity driven and almost all of the Group’s gross debt at the end of 2017 was public debt. Cash in hand and unused committed credit lines cover several years of debt maturities. The Group continues to proactively manage its debt profile, and in 2017 it placed a $250 million Senior Unsecured Convertible Bonds due in 2022 with a coupon rate of nil% and $500 million Eurobonds due in 2021 with a coupon rate of 3.85%. We were particularly pleased to have been able to achieve such low interest rates reflecting high demand from investors and positive image of Severstal as a trusted investment. Severstal continues its work with credit rating agencies to enhance our position in the capital markets.

M&A activity

Severstal takes a prudent approach to M&A activity and evaluates potentially value-enhancing opportunities on a case by case basis. In 2017 the Group sold Redaelli Tecna S.p.A., a non-core asset, for 37 million euro ($40 million). The sale will allow Severstal-Metiz to focus on its Russian assets and enhance its efficiency.

In 2017, Severstal acquired rights to claim debt obligations of Metal-Group LLC, worth 19.9 billion roubles (including principal, interest and penalties). Severstal paid 6 billion roubles as part of the transaction. The Yakovlevskiy mine produces very high grade iron ore (Fe content is up to 61%) which will increase the quality of the Company’s overall iron ore concentrate production and strengthen its position in the domestic iron ore market.

Dividend

In line with our commitment to delivering value to our shareholders, Severstal targets dividend payments of 100% of quarterly free cash flow, provided that net debt/EBITDA is below 1.0x. For 2017 the total accumulated dividend returned to shareholders was $1.5 bn (for 2016: $0.9 bn) reflecting a favourable pricing environment in 2017 and management’s commitment to maximising shareholder value.

Sincerely yours,

Alexey Kulichenko
Chief Financial Officer