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Alrosa: Back tall in the saddle after major restocking

  • TP upgraded from RUB118.8/share to RUB139.6/share; Overweight (O/W) maintained
  • End-consumer demand in 4Q20/1Q21 took the rough diamond inventories of major producers into deficit
  • Midstream polished stocks are moderate which implies further restocking

TP upgraded from RUB118.8/share to RUB139.6/share; Overweight (O/W) maintained

After major restocking in 4Q20/1Q21 ALROSA’s 2021 diamond sales are anticipated to reach 43 mn cts, a rise of 37% y/y. We expect the major working capital release to support free cash flow in 1H21 and to contribute RUB147 bn LTM dividend payout, which implies an attractive 17% dividend yield. We upgraded our rough gem-diamond price forecast from $140/ct to $150/ct in 2022 and from $145/ct to $154/ct in 2023. Based on a valuation of 50% DCF, 25% 2022e EV/EBITDA of 6.5x and 25% P/E of 10x, we have upgraded ALROSA’s TP to RUB139.6/share, representing 17% upside.

End-consumer demand in 4Q20/1Q21 took the rough diamond inventories of major producers into deficit

We expect ALROSA’s inventories to come below 10 mn cts as of end-2Q21 which represents limited upside for further inventory release in 2H21 though the value of these stocks should be ~2x more expensive. Production guidance of 31-32 mn cts in 2021 leaves us with 24 mn cts to be produced in April-December 2021, which means selling straight from the mines balancing client needs with the actual number of carats produced. With ALROSA’s 2022 production not expected to be much higher y/y at c.33 mn cts and with a lack of upside in the supply from other producers, we do not expect the rough diamond supply shortage to evaporate any time soon. After the 1Q21 production results, where total rough diamond output dropped 7% y/y due to operational challenges, De Beers left its 2021 production unchanged at 32-34 mn cts after downgrading it again earlier this year from 33-35 mn.

Midstream polished stocks are moderate, which implies further restocking

After major production cuts due to the virus outbreak, stocks in the midstream of India are moderate, justifying the price over volume strategy maintained by major rough suppliers. In 2020, the average price index dynamics for rough diamonds followed the sales mix changes while polished prices rose. According to Rapaport, the polished diamond index for 1ct grew 5.6% while the 0.50 ct stone index grew 12% in 2020. In 2021, the polished price indexes continued to advance for sizes over 1-ct with smaller size price indexes demonstrating overall resilience. We rightfully assume that the current midstream profitability is supportive of further restocking which allows rough diamond prices to increase amid competition for volumes. ALROSA also highlights gradual rough diamond prices growth.

US polished imports recovered to pre-Covid level while Hong Kong imports rose sharply y/y amid the improved market conditions

It looks like the stimulus measures and the vaccination rollout have led to luxury sales recovering earlier than anticipated in both of the core markets for polished diamonds: the US and China. In 1Q21, sales of jewellery, watches, clocks and other goods in Hong Kong grew 19% y/y only by means of local consumption growth as inbound tourism remained restricted. The rebound in retail luxury sales in the US have also exceeded expectations driven by stimulus checks. Jewellery sales in January-April in the US were 30% higher vs the all-time record levels of 2019. Another sign of economic recovery in the US is the recent US ISM services PMI statistics which rose to 64.0 in May from 62.7 in April ahead of the forecast. US jobless claims last week revealed the first drop below 400k during the pandemic, as hiring accelerated and the economy strengthened heading into the summer months. We expect the ongoing economic recovery to support household finances and lead to higher sales of personal luxury items.

Risks

The low level of inventories at major mid-stream producers (miners stocks were largely sold out in 1Q21) imply polished supply side risks. Miners are entitled to sell their output only. That puts polished diamond inventories at risk, thus pushing prices higher. Should consumer confidence remain strong in the core markets for polished diamonds, the upside risk for further price increases will remain in place.


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The contents of this document have been prepared by Joint Stock Company “Alfa-Bank” ("Alfa Bank") as Investment Research within the meaning of Article 36 of Commission Delegated Regulation (EU) 2017/5...

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