Severstal - Strong 3Q20 Trading Update; Earnings Preview

Severstal has posted a robust 3Q20 trading update featuring strong steel sales volume growth and a better sales mix. We expect its EBITDA to increase 16% Q-o-Q to $610 mln and FCF to jump to $315 mln for a 3% yield. At the spot steel and bulks prices and the current USD/RUB, Severstal is trading at a 2021E EV/EBITDA of 4.9 and yield on dividends to be paid in 2021 of 12%.> Consolidated sales of steel products jumped 18% Q-o-Q to 3 mln tonnes, above our expectations, on the back of a recovery in economic activity and pent-up demand combined with seasonal factors (the peak of the construction season in Russia). Though the domestic steel price premium over the export netback shrank during 3Q20, the share of domestic sales in the total mix increased 7 pp Q-o-Q to 63%, driven mainly by the growth of HVA sales to nearly 1 mln tonnes. The share of HVA in total sales was at the highest level since 3Q17 (at 49%), supported by delayed demand. The weighted average steel price recovered 3% Q-o-Q thanks to the strengthening of the sales mix.> Coking coal concentrate sales declined 5% Q-o-Q to 1.2 mln tonnes. We calculate that Severstal's high-cost coal assets were loss-making on EBITDA in 3Q20 on a standalone basis due to the massive drop of domestic coal prices in 3Q20 (the Zh grade price dropped 40% Q-o-Q to $59/tonne). Despite this, Severstal is unlikely to switch to external coal purchases in the event of short-term price swings. This is because changing the coke charge in steelmaking and reducing production at underground mines is not an easy task. In 4Q20, the coking coal division is likely to turn profitable on volume growth (hence lower cash costs).> Sales of iron ore concentrate and pellets grew 3% Q-o-Q to a respective 1.96 mln tonnes and 2.6 mln tonnes thanks to the good performance of both Olcon and Karelsky Okatysh. Output at the growth project Yakovlevsky declined 7% Q-o-Q to 419 kt of concentrate. As a result of the ongoing ramp-up difficulties, Severstal lowered its full-year output guidance for Yakovlevsky 9% to 2 mln tonnes.> We expect Severstal's EBITDA in 3Q20 to grow 16% Q-o-Q to $610 mln on the back of strong steel sales volumes and a better product mix. Thanks to strong earnings and a massive steel inventory release, FCF should be strong at $315 mln, for a 3% yield. Severstal should pay around $350 mln for the 3Q20 dividend (for a 3.3% yield), according to its dividend policy. Severstal will report 3Q20 IFRS results on October 22.> At spot steel and bulks prices and the current USD/RUB, Severstal should earn $2.3-2.4 bln in EBITDA in 2020 (and around $0.6-0.7 bln in 4Q20), which is slightly ahead of the current Bloomberg consensus of $2.25 bln. However, FCF in 4Q20 may be pressured by $450 mln in capex if Severstal catches up with its $1.45 bln guidance. On 2021 numbers, the stock is trading at a 4.9 EV/EBITDA and a yield on dividends to be paid in 2021 of 12%.