Alrosa - 3Q20 Trading Update Strong; Earnings Preview

Alrosa has reported a healthy 3Q20 trading update that showed a significant recovery in sales volumes, as well as a strong sales mix. We expect its 3Q20 EBITDA to come in at $315 mln. We update our financial forecasts for 2H20 and the full year. We now see 2H20 EBITDA at around $700 mln, which is 40% above the current Bloomberg consensus. Meanwhile, we are 15% below the consensus on 2021 EBITDA. In our view, once the restocking demand passes, we expect the company to start facing a structural decline in diamond end-demand. We reiterate our HOLD recommendation and target price of R80 per share.> Diamond production in 3Q20 was down 24% y-o-y to 9.2 mln cts. Output in 9m20 was down 23% y-o-y to 22.9 mln cts. The full-year production guidance is unchanged at 28-31 mln cts, thus in 9m19 Alrosa produced 74% of the upper bound of the guidance. We think that full-year production will likely come closer to the upper bound of the guided range.> Sales of gem-quality rough diamonds came in at 4.1 mln cts (versus 0.4 mln cts in 2Q20), down just 3% y-o-y. The reported like-for-like diamond price index declined 7% Q-o-Q and 13% YTD as of end-3Q20. The gem-quality diamond sales mix was strong, with an average realized gem-quality price at $133/ct, down just 2% y-o-y. > The share of gem-quality diamonds in the total mix was abnormally high, at around 80% versus the normalized level of around 70%. Thus, the average realized price for the total mix was $110/ct, up 17% y-o-y and well above the average price for Alrosa's current production mix, which we estimate at around $90/ct.> We reiterate our 3Q20 EBITDA forecast of $315 mln and raise our FCF forecast to $150 mln for a 2.1% yield. Alrosa will report its 3Q20 IFRS results in mid-November.> According to Rapaport, jewelers are increasing their expectations for the US holiday season. Retailers have begun early promotions and are planning a longer than usual 4Q20 selling period. Polished prices have recently stabilized, but Rapaport thinks they will be further supported heading into the holiday season as polished manufacturing was down 50% y-o-y this year. We think that Alrosa will generate strong October sales of around $300 mln as the midstream restocking continues. > As for 4Q20, we plug in 9 mln cts of sales (bringing 2H20 sales to 14 mln cts, slightly below Alrosa's 15 mln cts guidance) and expect the share of gem-quality diamonds in the total mix to normalize down to 70%. We expect the average realized price to be in line with its production mix price at close to $90/ct. In the case that momentum in the market deteriorates in November-December, Gokhran might step in and buy diamonds from Alrosa, so that the latter's 2H20 sales turn out closer to 15 mln cts, we believe. Though for now it looks like Alrosa does not need Gokhran support this year. > We have updated our financial forecasts for 4Q20. We expect EBITDA to be close to $390 mln and FCF around $290 mln for a 4% yield. This should bring 2H20 EBITDA to $700 mln (40% above the current Bloomberg consensus) and FCF to $440 mln for a 6% yield. Net debt/EBITDA as of end-2020 should be 1.0, and in this case Alrosa can pay out 70-100% of FCF as the final dividend for 2020 (payment to be made next summer) with the yield in a range of 4.4-6.3%.