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Russian metals producers forge ahead

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The start of construction of blast furnace 3 at Severstal’s sprawling Cherepovets plant will signify more than just strong business optimism at the Russian steelmaker. It will feel like throwing off a decade-long hoodoo.

First announced in 2008, only to be postponed and cancelled as the global financial crisis and then the 2014 commodity crash whipsawed across the industry’s balance sheets, the Rbs28bn ($500m) project is one of a number of capital expenditure projects by Russian metals and mining companies forging ahead with renewed confidence.

Despite the threat of new western sanctions against the country and US tariffs on aluminium and steel, Russian metal executives have a spring in their step, as commodity prices continue to rise, borrowing costs come down and painful debt restructurings and strategy shifts over the past five years begin to bear fruit.

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“Higher profits and, very importantly, lower interest rates result in better optimism and lower costs of financing for the projects,” said Kirill Chyuko, head of research at BCS Global Markets in Moscow. “Thus companies are more comfortable to restart projects and invest in the new ones.”

Initial work on blast furnace 3 — Severstal’s fifth furnace at Cherepovets — is part of a flurry of investments in new mines, plants and renovated facilities across the country’s metals industry.

Russia’s six largest listed metal companies all forecast stronger spending this year, with combined capex estimated at $5.68bn, 52 per cent higher than in 2015.

That, alongside increased dividend payments, is a positive trend for Russian metals producers, which are second only to oil and gas in terms of importance to the economy and the country’s fiscal health.

Over the past two years, steel and nickel prices have risen roughly 60 per cent, while aluminium is up 40 per cent. Gold has risen around 12 per cent. Over the same period, Russia’s key interest rate has fallen from 11 per cent to 7.5 per cent.

That boom, and rising demand, carried Vladimir Lisin, owner of NLMK, Russia’s largest steelmaker, to the top of the Forbes 2018 Russian rich list, just ahead of Alexei Mordashov, Severstal’s owner. Two other metal tycoons were in the top ten, alongside the country’s oil and gas barons.

“In 2017, steel consumption in Russia increased by 5 per cent,” said Alexander Shevelev, Severstal’s chief executive, who expects 3 per cent to 4 per cent growth this year. “Strong market conditions and internal efficiency programmes” allowed the company to record what Mr Shevelev said was an industry leading and company record ebitda margin of 32.8 per cent.

“Back in 2015, the market environment was completely different from what we see today,” adds Rusal, Russia’s largest aluminium producer.

“In 2017, alongside a positive macro backdrop, [we] delivered robust results. We also significantly improved our debt profile by actively pursuing capital markets opportunities and engaging with our strategic financial partners. Overall, the company is in good shape for 2018.”

Rusal was forced to restructure $17bn worth of debt in 2009 — Russia’s largest corporate restructuring in what became a symbol of the industry’s woes. It has spent the years since shutting down inefficient production capacity, cutting costs and making further tweaks to its repayment schedule. It increased dividends by 20 per cent in 2017, and is ramping up spending on new projects this year.

It is a similar story at Polyus and Polymetal, the country’s top gold producers. Polyus late last year began drilling at its new Sukhoi Log project, one of the world’s largest undeveloped gold deposits, while Polymetal will start production from its flagship Kyzyl mine later this year.

Norilsk Nickel, one of the world’s largest nickel producers and the top palladium miner, plans to spend $2bn on capex this year and as much as $2.5bn in 2020 on modernising its Soviet-era smelters and a new platinum venture.

“A favourable long-term outlook for our metals is underpinned by the increased adoption of electric vehicles, strong economic growth and higher environmental standards globally,” said Sergei Malyshev, the company’s chief financial officer.

“We are investing throughout our value chain, from new high-margin mining projects to cleaner and more efficient downstream facilities.”

But there are threats lurking. Domestically, a slowly strengthening rouble has steadily increased costs for the industry, which typically earns in dollars but pays out in local currency — and imports a large amount of its most expensive new technology and machinery.

On top of that, rising political tension with the UK in recent weeks over the attack on the Russian double agent Sergei Skripal has raised the threat of new sanctions against Moscow, even as Washington considers whether to impose tougher restrictions on leading oligarchs.

The main owners of Norilsk, Rusal, Polyus, Polymetal, Severstal and NLMK were all on the so-called Kremlin List released by the White House in January that officials say could form the basis of a roster of individuals to be targeted in future.

US President Donald Trump has also announced tariffs on imported steel and aluminium, a move that analysts said could affect market sentiment but will only marginally affect Russian producers.

Executives across the industry say they have learnt lessons from the 2008 and 2014 crashes, and will be more circumspect in terms of borrowing, and steer clear of big ticket acquisitions, especially those outside of Russia.

“All companies lived through the recent lows when profitability was very thin and, at the all-time lowest levels, this was painful. Thus, companies will focus on organic growth only. M&A is the key risk here,” said BCS Global Markets’ Mr Chyuko.

“Heavy borrowing and spending by the Russian companies didn’t cause the commodity crash — they were just unlucky. [For] all Russian metal and mining companies, M&A that they did in 2005 onwards was value destroying and very lossmaking. They have learnt the lesson.”

Battle of the tycoons

Amid the general optimism in Russia’s metals and mining industry, one potential faultline has re-emerged for investors: the return of a long-running battle between two of the country’s most powerful tycoons.

Vladimir Potanin, chief executive of Norilsk Nickel, and Oleg Deripaska, owner of Rusal, first fought for control of the $30bn nickel producer a decade ago, and the expiration of a 2012 peace deal between the two billionaire oligarchs has restarted the tussle between them.

Under the terms of that deal, brokered by the Kremlin, Mr Potanin controlled 30.8 per cent of the company and the chief executive’s office. Mr Deripaska, through his aluminium company Rusal, controlled 27.8 per cent.

Roman Abramovich, who was brought in as a peacemaker, took control of around 6 per cent through holding companies.

But that truce collapsed last month when Mr Potanin announced he had struck a deal to buy shares from Mr Abramovich, sparking a legal challenge from Rusal in London and spooking shareholders in both companies.

Rusal then upped the ante, suggesting that it could trigger a so-called “shoot out”, essentially a forced auction that would see one of the two oligarchs buy out the other’s entire stake — dubbed a game of billionaire’s Russian roulette by local analysts and newspapers.

That might not come to pass. In a sign that the feud may well simmer down again, Mr Abramovich this month struck an agreement to sell part of his holding — 2.1 per cent to Mr Potanin and 2 per cent to Mr Deripaska’s Rusal.

If the London court rules in May in favour of Rusal, those sales could be reserved and the shootout could be back on the table. That winner-takes-all gamble could mean a $15bn bill for the victor — and a massive slice of debt that investors would likely balk at, rising metal prices or not.

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