Severstal - 1Q20 Trading Update Weak Due to Product Mix; 1Q20 IFRS Preview

Severstal has reported a weakish 1Q20 trading update, which suggests a further Q-o-Q decline in EBITDA and quarterly FCF of below $100 mln. We still expect a dividend for 1Q20 of $200 mln (2% yield), as per the dividend policy. Severstal will report its 1Q20 IFRS results next Friday, April 24.> Steel sales seasonally increase; geographical mix the worst since 1Q18. Steel product sales expanded 4% Q-o-Q to 2.75 mln tonnes. The share of sales to the premium domestic market dropped 4 pp Q-o-Q to 55% (the lowest level since 1Q18) on the back of seasonally low domestic demand. The product mix also worsened as a result of lower domestic sales and maintenance at a CRC mill, with the share of HVA declining 3 pp Q-o-Q to 42% (Severstal usually sells 70-80% of its HVA on the domestic market). The average realized price across the sales mix declined 6% Q-o-Q, as the domestic premium collapsed due to the drop in the ruble in March (domestic pricing is set in rubles) and the weaker geographical mix.> Financials and dividends set to be weak. We think the Q-o-Q drop in steel prices will be only partially offset by lower costs stemming from ruble depreciation, so we expect EBITDA to decline 7% Q-o-Q to $560 mln. The end of 2019 and the beginning of 2020 were unaffected by the spread of coronavirus (except in China), so we think that in 1Q20, Severstal stuck to its initial capex guidance ($1.7 bln this year) and spent $300-400 mln during the quarter. As a result, FCF likely came under pressure from both weak earnings and high capex. We project FCF at just $60 mln, for a 0.6% yield. In 1Q20, capex may have exceeded normalized capex for dividend payments by some $150 mln. Based on the dividend formula, Severstal should distribute around $200 mln for the quarter, for a 2% yield.> Outlook uncertain for 2Q20. Severstal has not provided any outlook for 2Q20 sales. Given reduced demand in Europe due to the quarantines implemented since the end of February, we believe that the company may have redirected sales to Asian markets. This would ensure stable volumes, albeit at a reduced netback: based on the spot HRC price CFR Southeast Asia ($400/tonne) provided by Platts, the FOB price for Russian producers with delivery to this region should be just $330/tonne - below the FOB Black Sea price according to Platts. In Germany, Severstal's key export market, the coronavirus infection rate is decelerating and the lockdown is set to end on April 19, though we think it could be extended, at least partially. With regard to the domestic market, construction activity is still continuing except in Moscow, where it has been halted starting this week. We estimate that construction in Moscow accounts for around 1 mln tonnes of Severstal's annual steel sales (or around 9%).Overall, we think that in the worst case, some volumes could be lost in 2Q20, while the price environment is likely to prove extremely weak. CRU estimated the HRC price FOB Black Sea at $360/tonne this week, while it could be lower when shipped to certain destinations, as we indicated above. We think that following the drop in the ruble and contraction in domestic demand, the average premium over the export netback stands at just $70/tonne, meaning that the domestic ex-works HRC price could be as low as $400/tonne. We think that if volumes decline in 2Q20, FCF could be negative and Severstal could opt to skip the dividend for 2Q20 if the outlook remains weak.