Severstal - 2Q20 Trading Update Good; Earnings Preview

Severstal has reported a fairly good trading update, featuring a smaller than expected decline in steel sales volumes and a positive surprise in terms of the sales mix and realized prices. We see 2Q20 EBITDA declining just 5% Q-o-Q to $525 mln and FCF expanding to $165 mln. We expect 100% of FCF to be paid out as dividends for 2Q20, yielding 1.6%. Severstal will report its 2Q20 IFRS results next Thursday, July 23.> Steel production flattish. Crude steel output eased 2% Q-o-Q to 2.81 mln tonnes due to maintenance works at three blast furnaces, which had been guided during the 1Q20 earnings call. > Lower sales volumes, but strong sales mix. Steel product sales fell 7% Q-o-Q to 2.55 mln tonnes mainly due to a 48% drop in semis sales to 100 kt (Severstal's lowest margin product) and a decline in sales of HVA products, which are primarily sold on the domestic market, where demand has been severely impacted by the lockdown. The share of domestic sales in the total mix was 10-15 pp below the usual level for the second quarter, when domestic demand is normally supported by the start of the construction season. On a positive note, the sales mix stopped deteriorating Q-o-Q: the share of domestic sales rose 1 pp Q-o-Q to 56% and the share of HVA climbed 1 pp to 43%. Thanks to this, the average realized price on steel products declined just 4% Q-o-Q to $500/tonne.> Higher share of iron ore concentrate sales in response to market dynamics. In 2Q20, global iron ore concentrate prices significantly outperformed pellet prices, as Chinese steel production (where the share of concentrate in hot metal production is relatively high) was strong, while European steel output (where the share of pellets is relatively high) came under pressure due to weak prices and lockdowns. Severstal adjusted to this market trend and its pellet sales declined 15% Q-o-Q, while concentrate sales jumped 30% Q-o-Q to 1.9 mln tonnes, as the pellet producing site increased concentrate production at the expense of pellets.> We upgrade our 2Q20 financial forecasts. We have upgraded our 2Q20 EBITDA forecast from $450 mln to $525 mln (down just 5% Q-o-Q) thanks to the better steel sales volumes and mix than we had expected and the resilience of realized prices. Given the fairly good earnings, we think Severstal remains committed to its plan to spend $1.5 bln in capex this year, and we forecast 2Q20 capex of around $330 mln. Taking into account a small working capital release of $50 mln, we forecast 2Q20 LFCF of $165 mln for a 1.6% quarterly yield. We calculate adjusted FCF used in the dividend calculation at $485 mln for 1H20 (including FCF of $210 mln and capex above the baseline of $275 mln). As Severstal has already paid $320 mln in dividends for 1Q20, the dividend for 2Q20 should be around $165 mln for a 1.6% yield.> Improved outlook for 3Q20. With the lockdown being lifted in Russia, domestic demand should recover in July-August. The domestic EXW hot-rolled sheet price reported by CIS consultancy Metal Expert stands at around $460/tonne, meaning that there is an around $80/tonne domestic premium over the export hot-rolled coil netback. We think Severstal will try to increase its share of domestic sales and share of HVA in the total portfolio in 3Q20, which could boost the average realized price. Overall, we preliminarily estimate 3Q20 EBITDA of $550-600 mln, up 5-15% Q-o-Q.