ANNUAL REPORT 2017

Strategy and Business Review

Dear Shareholders,
I am pleased to report that in 2017 Severstal has once again maintained its position as a global leader in value creation. Severstal’s high quality assets and vertically integrated business model continue to underpin our performance, as our industry leading margins are driven by a strategic focus on maximising efficiencies across our business.
As a company, we are constantly striving to do more, better, and in June 2017 we were pleased that Severstal was recognised by World Steel Dynamics as one of the world’s most competitive steel companies, having climbed four places since the previous year.
Our strategy is fully focused on driving total shareholder returns (TSR) and once again this year we have continued to deliver highly competitive returns through the generation of strong free cash flow and earnings. Severstal remains committed to paying high dividends through the cycle. Operating responsibly to create value for all of our stakeholders is our priority, and so alongside our financial performance we work to ever improve our results in ESG (environment, social and governance), including sustainability and our impact on the communities in the regions where we operate.
Critical to our ongoing success is an unfaltering focus on ideas and innovation. In a highly competitive industry with many challenges, steel producers need to adapt and innovate. Severstal aims to be a leader in this area and for 2017 our CAPEX included 1.7 billion roubles in IT and digital projects. These projects will drive increasing efficiencies across the business, enhance our customer service and deliver new products to continue to support our margins across the industry cycle. Severstal has developed a strong digital team dedicated to trialing and introducing the latest international technologies as well as developing advanced digital solutions in-house.

 

 

Thank you for your continued trust!
Sincerely yours,


Alexander Shevelev
Chief Executive Officer

Severstal’s Business Model

Severstal is a vertically integrated steel and steel-related mining company with its major assets located in Russia.

The Company is self-sufficient in raw materials which are supplied by its Resources assets (coking coal and iron ore mines) located in close proximity to Severstal’s steel production plants. Today, the Company has c. 60–65% self-sufficiency in coal and more than 100% in iron ore, selling high value-added pellets to the market. This model means that the Company has a hedge against volatile raw materials prices throughout the year, to support our industry-leading margins.

Maintaining high margins through the cycle

Whilst the Company is predominantly focused on supplying steel products to the domestic market, Severstal also exports to c. 70 countries. The Company’s steel assets are competitively positioned near to the key steel consuming regions of Russia as well as to Severstal’s export markets. This also provides the Company with flexibility to be able to shift sales volumes between domestic and export markets depending on market dynamics and to benefit from pricing premiums resulting from currency fluctuation.

The Company produces a broad portfolio of steel products and is focused on expanding this further to deliver high value products that meet the changing needs of its customers. Severstal builds long-term customer partnerships and is therefore committed to constantly improving product quality, supply discipline and service quality.

Severstal has a highly-disciplined approach to capital expenditure. Company investment projects are planned over long-term periods and each must meet the strict internal rate of return of 20%, or deliver a predetermined level of quality or environmental enhancement.

Severstal’s robust business model enables the management team to focus on maximising free cash flow and generating higher than market average earnings throughout the economic cycle, which is demonstrated in graphic form above. This in turn supports the regular distribution of competitive dividends, in line with the Company’s dividend policy.

Severstal’s Business Model

Severstal’s strategy – focus on innovation and efficiency leadership, prudent investments and customer care

Severstal’s strategy is focused on maximising shareholders’ value by ensuring that the Company remains one of the most profitable producers in the industry, generating sustainable higher than average earnings throughout the economic cycle. The Company’s ability to generate strong free cash flow allows it to return attractive dividends to shareholders. In addition, Severstal is committed to best in class governance, health and safety and sustainability, including reducing our impact on the environment.

In 2017 the Company launched a major innovation programme focused on delivering growth without significantly increasing production scale (the Company operates at consistently close to 100% capacity utilisation). The programme includes three key areas:

– Product innovation;
– Process innovation;
– Business model innovation.

We believe this will create an even better platform for future business development and sustainable growth. For 2018, Severstal plans to deliver up to an additional US$350 million to its EBITDA as a result of its enhanced sales and marketing strategy, selective production growth and operational efficiency programmes which include innovation, digital and smart procurement initiatives.

All initiatives, including innovations, potentially may deliver up to an additional US$350 million to Severstal’s 2018 EBITDA


* All figures are preliminary Сompany estimates. Actual results may vary significantly.

Supported by our focus on digital and innovation, the Company constantly works to progress five key pillars of its strategy: customer care, cost efficiency leadership, smart capex, health and safety and people and sustainability.

1. Health and Safety and People

Severstal is committed to eliminating 100% of fatalities across the business and constantly improving the health and safety standards at all of our assets. The Company’s health and safety strategy is overseen by the Board of Directors’ Health and Safety Committee who ensure the Company’s practices progress in line with the highest global standards.

Loss Time Injury Frequency Rate (LTIFR) is a key metric against which the management’s performance is measured and we invest heavily every year in improving health and safety procedures and upgrading equipment. Increasingly, we are automating operating machinery to reduce the human factor and risks that are inevitably associated with heavy industry.

The real key to Severstal’s success, at every level, is the corporate culture that unites a talented and ambitious workforce. Our business is founded on our people, whose commitment, skill and new ideas constantly drive the Company to achieve more, together. For this reason, we ensure that each individual is offered the best professional training to take their careers at Severstal to the highest level.

Key achievements in 2017 – Health and Safety and People

Since the tragic accident at the Severnaya mine in February 2016, work on testing and optimising the safety processes at all of our assets has been ongoing to ensure that all of our systems are secure and such an incident is highly unlikely to occur again.

We did not have any fatalities in 2017 amongst Severstal employees. Sadly three individuals working for Severstal’s contractors lost their lives. We are helping to investigate these cases.

Severstal’s Young Resources programme continued to go from strength to strength. The programme works with university and high school students to develop future talent for the steel industry.

Read more about Severstal’s health and safety initiatives and talent development on page "Health and Safety".

2. Customer care

Severstal’s customer care initiatives fall into three key areas of focus:

  • Product quality;
  • Supply discipline;
  • Service quality.

Key achievements in 2017 – Customer Care

In January, we announced the upgrade of Severstal’s online shop targeting online sales of 3.5 million tonnes by 2018. Customers can now order steel from storage facilities in 44 regions and choose from a selection of delivery locations. A key benefit of the portal is that it has enabled us to considerably enhance our customer outreach and feedback capabilities. As a result, we are more alert to potential issues, can better anticipate changing market demand and efficiently deliver product innovations that meet our clients’ changing requirements.

Severstal has continued to make significant progress in its customer quality satisfaction indicator since the end of 2015, which is a measure of product and service quality, as well as reliability.


* First available data
** Latest available data

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 to improve lead-times 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.

Severstal’s online shopping platform helps to support proactive and regular engagement with customers, which is key to ensuring Severstal continues to meet their evolving needs by better understanding the balance between price and non-price factors affecting customer decisions. Another aim is to make communications between Severstal and its customers ever easier and more transparent from product order to delivery and aftersales service. Ongoing client feedback enables Severstal to enhance and adapt its customer service tools to satisfy our customers’ requirements.

3. Cost and efficiency leadership

Severstal’s strategy is focused on enhancing product quality rather than increasing scale of production, enabling us to generate higher earnings per tonne of product. We are focused on creating incremental value through ongoing efficiency and cost control improvements to offset industry risks and maintain our competitive position in the market.

Key achievements in 2017 – cost and efficiency leadership

Initiatives within Severstal’s Business System continued to drive operational and organisational excellence along the business’ entire value chain, including improving customer satisfaction and promoting a safety-conscious culture. The Business System has primarily focused on a culture change within the Group’s production departments in order to achieve cost reductions, improve working conditions and industrial safety, and enhance product quality.

The Company believes that the Business System has established a working environment within Severstal that is both ambitious and collegiate, and more receptive to change and the adoption of new best-in-class business-processes.

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 has already achieved a position on the left of the cost curve and aims to keep this favourable position by delivering continuous improvement.

Severstal’s Business System ensures that the Company is constantly innovating to achieve greater efficiency across its operations.

Leading cost position***


*** World Steel Dynamics, 2016

In 2017 the Company continued to make progress on its operational efficiency programmes:

Iron ore

– Tailings thickening at Karelsky Okatysh.
– Modernisation of mining transport and equipment.
– A new steeply inclined conveyor.
– Ideal shift programme (no idle time, no product losses).
– Improved quality of iron ore concentrate to 67.5% without reducing volumes.
– Ongoing centralisation of managerial functions, with Karelsky Okatysh bringing synergies, savings, growing the share of HVA pellets in our sales portfolio.
– Energy cost control.

Coking coal

– Stabilisation of mining volumes at Vorkutaugol. Severstal will increase its vertical integration in iron ore from the current level of 60% to 65% in 2018, reflecting volume growth in 2018 and the completion of repositionings in 2017.
– Volumes to increase by 370 kt and stabilise in 2018.
– Vorkutaugol: new ventilation & degassing methods. Increase output by ~50 kt/month (mines operating at Seam #4).
– Vorkutaugol: debottlenecking of the raw coal lifting mechanism.

Steel

– Launched second ladle furnace in 2017. Cost savings of ~700 million RUB/year.
– Renovation of coke battery #4 at Cherepovets (2016–2018). Effect: higher coke quality, more environmentally friendly operations.
– Refurbishment of blast furnace #5 at Cherepovets (2017– 2020). Effect: less consumption of coke and sinter, higher quality of pig iron, more environmentally friendly operations.

Severstal continued to develop its Expert Network programme across all of the Company’s assets – 12 communities of professionals (800 experts) are participating in operational efficiency and production process optimisation. In 2017, 2,500 initiatives were put forward by the Expert Network.

We believe that investing in machine learning and predictive analytics today will deliver significant and ongoing efficiency enhancements in the future. In 2017, Severstal was particularly proud to announce the creation of the biggest data lake in Russian industry, using technology supplied by Microsoft and Lenovo. With two petabytes of capacity, the facility enables us to collect, store and analyse operational statistics. The stored data will support predictive analytics projects in areas including predictive equipment maintenance and product quality optimisation as well as other areas where artificial intelligence can improve efficiency.

In June 2017, we worked with Sberbank to develop blockchain technology enabling Severstal to securely transfer international letters of credit to suppliers and clients. The service is the first of its kind developed in Eastern Europe and significantly reduces the timeframe of each transaction, whilst improving transparency.

4. Smart capital expenditure

Our strategy is supported by a prudent approach to investments which is flexible to market conditions.

In 2018, Severstal will be more focused on hot-end projects to improve product quality and support further operational efficiencies.

In 2017, Severstal successfully completed construction of the Second ladle furnace and colour-coated and galvanized lines, and launched the coking Battery #4 modernisation project.

5. Sustainability

As part of Severstal’s focus on operating sustainably and maximising shareholders’ value, the Company is committed to reducing its environmental footprint, conserving energy and using natural resources in a responsible manner. In addition, Severstal continues to support a positive social climate in the regions where it operates and annually invests in the development of infrastructure, education, culture and sport. To support progress in its sustainability objectives, Severstal intends to further enchance its reporting on ESG (environment, social and governance).

Key achievements in 2017 – sustainability

We were pleased to note that in 2017 Severstal was named the Russian industry leader for environmental transparency by Interfax-ERA, the ecological and energy agency.

A number of further energy generator upgrades enabled the Company to increase its energy generation self-sufficiency to c. 80%.

Severstal continued its work to actively rehabilitate the environment and improve water recycling, fast-track soil recultivation and plant new trees in the regions where it operates.

You can read more about our approach and what we have delivered on page "Our commitment to sustainable development".

Outlook

Global steel demand growth was approximately 2.8% for 2017 according to World Steel. Russian steel consumption exceeds our expectations – we expect growth of 5–6% to about 40 million tonnes which will be the first year of growth after several years of decline the domestic market. We hope that 2018 pricing will be supported by global demand growth and further capacity cuts in China, but we expect some softening of steel prices in 2018. Steel demand in Russia will continue to grow 3–4% in 2018.

Prices remain extremely volatile however we are confident that our integrated business model and high share of HVA will continue to support our margins through the cycle, building on our track record.

We are also confident that Severstal’s transformation programme, including our enhanced sales and marketing strategy, selective production growth, innovative operational efficiency programmes, digital and smart procurement initiatives will create a platform for continued business growth in the future.