Alrosa - Offering Carbon's Good Side

We reinitiate coverage with a target price of R130 per share and a BUY rating, reflecting the stock's 30%+ TSR potential over 12 months. Diamond prices performed strongly late last year, but we believe they still have potential to move higher, underpinned by low inventories and restocking among jewelry retailers. We think this should bring the company's EBITDA close to the 2014-18 average this year, a level we see as sustainable in the medium term. With capex well below the 2014-18 levels, we expect FCF to stabilize at around $1.5 bln over 2022-26, translating into a 14% yield to equity.> Diamond prices: Annus horribilis followed by a monster rally. The last two years were among the most volatile in the history of the diamond market. Trading came to a near standstill in 2Q20, but demand returned in 2H20 and then continued growing in 2021. This led to major destocking across the supply chain, igniting a price rally. Rough diamond prices ended 2021 at their highest point in more than six years, erasing the losses suffered in 2019-20. Considering the limited potential for mine output expansion and the low inventory levels globally, we see rough prices staying firm despite a likely normalization in jewelry trade.> Financial outlook: Sunny days are back. We expect a circa 30% rise in revenues per carat in 2022, driven by higher diamond prices and a normalizing sales mix. This should more than offset the pressure from industry-wide cost growth (not fully manifested last year due to the long inventory cycle). The EBITDA margin should grow more than $20/ct, lifting EBITDA 17-18% y-o-y to $2.3-2.4 bln despite a 20-25% drop in sales volumes (reflecting a high base due to destocking during 2021).> Capex: Today's tailwind... We see capex rising toward R30 bln this year from R21 bln last year due to the deferral of certain investments and higher construction costs. This should be followed by a drop in the following 3-4 years, bringing capex to R21-22 bln in 2024-25. With EBITDA set to stabilize near historic highs, this should translate into about $1.5 bln in FCF per year and a 14% yield to equity over 2022-26, which is not unrivalled in the mining sector but very attractive considering the strong outlook for diamond prices.> ... is tomorrow's headwind. The fly in the ointment is that about 50% of the company's production capacity is at risk of running out of reserves over the next 15 years, including some of the most profitable units. Alrosa has options to mitigate the depletion, including restoring Mir and converting Jubilee into an underground operation. These projects could replace 35% of the lost capacity, but at a cost of $2.5 bln or more in capex. Stronger diamond prices amid dwindling global supply should help Alrosa sustain an FCF yield in the low double digits until 2035, but we see the decline in cash generation accelerating beyond this point.