Aleksey Kalachev: ‘Metallurgists of Russia have enough margin of safety — to end the year without losses’

yst of Finam — on the situation of the largest Russian metallurgical companies in the conditions of sanctions

Russian metallurgists have announced major problems — the risk of losses with high taxes and a strong ruble. Product sales in Russia are falling, and exports are being at a big discount, in such conditions steel production in the country will fall, and the industry will become unprofitable, warn the largest metallurgical companies. The situation in the industry is really difficult and state support will not be superfluous, admits Aleksey Kalachev, an analyst at Finam. Nevertheless, in the author's column for Realnoe Vremya, the expert explains why he is sure that the margin of safety and high profitability of metallurgical production will be enough for companies to complete this difficult year at least without losses.

Prices turn down

The price correction continues on the markets of almost all industrial metals. After soaring to new multi-year highs in early March on concerns about supply disruptions after Russia launched the special military operation in Ukraine, prices have turned down and, in fact, have already returned to the levels of the end of the previous year.

The reason for this may lie in the slowdown in the dynamics of business activity in the world against the background of raising rates by the US Federal System, as well as new anti-Covid-19 measures in China, where quarantines are being introduced in multimillion provinces against the background of a new wave of morbidity as part of a zero tolerance policy. Besides, as it turned out, the sanctions restrictions have not affected all companies and types of products of the Russian metallurgical industry.

We should immediately note that such price dynamics, combined with an unexpectedly strong strengthening of the ruble exchange rate, will not be very favourable for Russian producers, who are largely focused on the export of metals and metal products. However, we will have the opportunity to see this in specific figures no earlier than the second half of the year, since now fewer statistics are being published, the Federal Customs Service has suspended the publication of export data, and the largest industry issuers have refused to publish quarterly reports. Therefore, we will wait for the semi-annual one.

Reduced steel exports will be difficult to redirect to other markets

Exports account for a critically significant share in the sales of the largest Russian metallurgists. In previous periods, Russia exported about one third of the steel produced, more than 70% of copper and aluminum, more than 80% of nickel and more than 90% of platinum group metals. In the case of a reduction in exports, the domestic market has very few opportunities to “digest” the released volumes.

The steel industry has turned out to be one of the most vulnerable after the EU imposed a ban on the import of value-added products, primarily the main types of rolled products, with the fourth package of sanctions. Severstal, which is focused on this market, suffered more than others. After the main beneficiary of Severstal, Aleksey Mordashov, was included in the list of personal sanctions, the company was forced to completely stop exporting products to Europe, which brought it more than a third of its revenue.

Reduced steel exports will be difficult to redirect to other markets In addition to the actual logistics problems associated with long distances and the exhausted capacity of railways in the eastern direction, there is a demand problem. Unlike raw materials, oil, gas, coal or ore, which are in demand in the fast-growing countries of Southeast Asia, the demand for rolled products in these markets is questionable. The thing is that China, India and Japan are the leaders of the world's ferrous metallurgy. China alone produces more than half of all steel in the world, and the entire region, including South Korea, Indonesia and Vietnam, -more than 70%. Manufacturers from these countries have already successfully divided the European quotas of Russia for the supply of rolled products.

Demand for metal in Russia is declining after the withdrawal of foreign car brands

Unsold export volumes will put pressure on the prices of the domestic metal products market. But at the same time, domestic demand in Russia will decline due to the decline in transport mechanical engineering due to the withdrawal of foreign car brands. The president of the country proposed to support the industry through the growth of infrastructure projects and instructed to adopt a strategy for the development of the industry until 2030. However, it should be understood that this is a deferred decision, since additional costs to maintain demand for steel are not included in the budget of the current year.

NLMK is less being at risk than other steel companies. Neither the company, nor its main owner Vladimir Lisin, who controls 79,3% of the shares, nor the bulk of its products were directly sanctioned. NLMK exports mainly semi-finished products to the EU and the USA — steel slabs, but they are not subject to restrictions. The company produces rolled products closer to consumers, having 23% of its rolling capacity in the EU and 19% in the USA. Thanks to the successful configuration of production assets, NLMK has a good chance to maintain the structure of its exports, while the domestic market of Russia and the CIS accounts for only slightly more than 40% of the company's sales.

Unlike the steel industry, non-ferrous metal producers have not been sanctioned directly, and the probability of this remains small, given the significant share of Russian non-ferrous metals in global markets. There are, however, indirect problems related to logistics and finance due to sanctions against the transport industry and the Russian banking system. Nevertheless, as we can see from the data on the shipment of products, against the background of that the shipment of ferrous metals for export in Russia in April decreased by 6,6% year-on-year, the shipment of non-ferrous metals for export, on the contrary, increased, what is more — by 22,6%.

Industry will remain fairly stable in general

Against this background, the position of Norilsk Nickel looks the most secure. The company ranks first in the world in palladium production, first in nickel production, fourth in platinum and rhodium production, as well as eighth in cobalt production, and 11th in copper production. Providing more than 40% of palladium to the world market, Norilsk Nickel is less at risk of falling under any serious sanctions. Besides, unlike Rusal, which is forced to import most of the raw materials, Norilsk Nickel has all the resources within the country for decades of work. And as the “cherry on the cake”, it is hardly the only industry issuer that has not refused to pay final dividends on its shares for the previous year.

Rusal's position looks not so secure. Although the export of Russian aluminum has minimal chances of being banned, the company has risks in terms of raw materials. In March, Rusal had to stop the work of its Mykolayiv Alumina Plant (Ukraine). Then Australia imposed a ban on the export of its alumina to Russia. This is minus 20% of the needs of Rusal's aluminum plants. To ensure production, the company will have to turn to its Chinese competitors, and it is not yet clear what it will cost.

Thus, we are seeing a rather ambiguous picture in the Russian metallurgical industry, against which the chances of some producers look more and others less preferable.

Nevertheless, the industry will remain quite stable in general, the margin of safety and high profitability of metallurgical production will be enough for companies to close this difficult year at least without losses. State support for the industry in the process of the ongoing transformation of the Russian economy has already been announced, and it will also not be superfluous.

Aleksey Kalachev

The author's opinion may not coincide with the position of the editorial board of Realnoe Vremya.