Alrosa - 1Q20 Trading Update Good, As Expected; 1Q20 IFRS Preview

Alrosa has published a 1Q20 trading update showing a pickup in sales volumes and a deterioration in the sales mix, coupled with a further decline in like-for-like prices. We reiterate our 1Q20 EBITDA forecast of $410 mln and expect 1Q20 FCF to be solid at $350 mln thanks to an inventory release. That said, we remain bearish on the stock (see our report), as the outlook for 2020 remains bleak given the drop in end demand due to global Covid-related restrictions and the issues along the diamond production pipeline. Alrosa will report its 1Q20 IFRS results on May 22.> Strong sales volumes, weak product mix and prices. Gem-quality diamond sales volumes grew 19% Q-o-Q to 7 mln cts in 1Q20. Total sales including industrial diamonds were up 15% Q-o-Q to 9.4 mln cts. The sales mix in gem-quality diamonds was much worse than in 4Q19, with the average realized gem-quality price slumping 17% Q-o-Q to $122.9/ct, the lowest since 1Q17. As a result, the average realized price for the total mix declined 14% Q-o-Q to $93.5/ct. The like-for-like diamond index continued to decline 1.9% over the quarter (it was down 9.1% in 2019).> Production guidance reiterated; no guidance for sales volumes. Alrosa reiterated its production guidance for this year of 34.2 mln cts. It did not provide any update on its outlook for sales volumes, which will largely depend on how the coronavirus epidemic develops and the measures taken to fight it across the globe. As we wrote in our recent trade idea, we believe Alrosa's sales volumes this year could be as low as 18-20 mln cts if there is no state support (i.e. no purchases by Gokhran). Given the reported results, that would mean that half of this year's volumes were sold in 1Q20.> Strong 1Q20 FCF. We leave our 1Q20 EBITDA forecast basically unchanged at $410 mln, for a 43% margin. As sales volumes exceeded production in the quarter, Alrosa is likely to record a working capital release, so we expect FCF to be strong at $350 mln, for a 6% yield.> Gloomy year ahead. Operations along the diamond value chain have ground to a halt across the globe amid lockdowns in key end markets (the US and Europe) and the main polishing hub (India). The lockdown in India was recently extended until May 3, while the amount of coronavirus tests per capita in the country is among the lowest globally (just around 200 for every 1 mln people so far), which poses risks of further quarantine extensions. According to Rapaport, midstream inventories increased by 20% from the beginning of the year until mid-March, meaning that more than half of the 2018-19 midstream destocking has already been wiped out. To recap, inventories had come down as much as 25% from the 2018 peak levels, according to diamond analyst Paul Zimnisky. Even after the global economy restarts and demand for polished diamonds picks up, it will take time to relaunch the Indian midstream and clear the glut in the diamond pipeline. In addition, the structural risks from LGDs and poor marketing by diamond miners may continue to weigh on demand. On April 1, we opened a trade idea to SHORT Alrosa ahead of the 2Q20 sales report.