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Buy Alrosa 10 August 2012 Coverage Change Emerging Europe Russian Federation Price at 9 Aug 2012 (RUB) 25.15 Metals & Mining Price Target (RUB) 40.00

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Buy Alrosa 10 August 2012 Coverage Change Emerging Europe Russian Federation Price at 9 Aug 2012 (RUB) 25.15 Metals & Mining Price Target (RUB) 40.00 Deutsche Bank Markets Research Rating Company Date Buy Alrosa 10 August 2012 Coverage Change Emerging Europe Russian Federation Price at 9 Aug 2012 (RUB) 25.15 Metals & Mining Price Target (RUB) 40.00 Reuters Bloomberg Exchange Ticker 52-week range (RUB) 76.44 - 22.40 ALRS.MM ALRS RX MSE ALRS A diamond in the rough; initiating Erik Danemar Research Analyst with a Buy (+7) 495 933 92 19 [email protected] Pureplay leverage to diamond market; initiating with a Buy We initiate coverage on Alrosa with a Buy recommendation and a George Buzhenitsa RUR40/share target price, offering almost 60% upside potential. We see Alrosa Research Analyst trading at 0.63x our DCF estimate or 4.4x and 5.5x our 2012F EV/EBITDA and (+7) 495 933-9221 P/E, implying a 17%/40%/35% discount to diversified miners/gold/diamond [email protected] companies. Alrosa boasted 47% EBITDA margin in 2011 with an improved financial position and paid a 28% dividend on its IFRS results. With an optimistic outlook on diamond prices, we believe Alrosa can deliver further Price/price relative improvements. While the stock may retain a meaningful liquidity discount until IPO plans are clarified, we believe there is upside for the patient investor. 90 75 Carat: the world’s biggest producer (by vol) with the world’s biggest reserves 60 With 34.5mnct or about 25% of global output in 2011, Alrosa is the world’s 45 largest diamond miner (by vol). Over 2011-21F, Alrosa plans to further expand 30 production by 18% to 40mctpa. In 2011, Alrosa disclosed reserves at 1.2bnct, 15 or about 33% of global reserves, to back up its current production for at least 12/11 6/12 35 years, while it spends ~3.5% of sales in exploration to maintain its resource Alrosa position over the next 10 years. As the global diamond industry struggles to Russian RTS Index (Rebased) find new deposits and open pits mature, and Asian diamond consumption Performance (%) 1m 3m 12m grows at multiples of GDP, we expect diamond prices to rise and Alrosa to be Absolute 1.0 -10.9 – a prime beneficiary. Having struggled with a heavy debt burden through the Russian RTS Index 7.0 -2.3 -10.1 crisis, net debt/EBITDA has come down from 6x to 1.5x, giving Alrosa more financial flexibility. While a heavy capex program (~20% of sales) will consume much cash flow, we still forecast FCF yield of 6% in 2013 and we believe Alrosa may continue to share yield when diamond prices are strong. Cut: reducing non-core assets and social obligations; cutting the inclusions Vertically integrated by legacy and (modestly) diversified by choice, Alrosa has started to transfer its social assets. On our forecasts, Alrosa’s 2012F mining EBITDA margin is 5pp above its blended margin, with social expenditure diluting cash flows. In 2H12, Alrosa plans to divest its gas assets as well as its Timir iron ore project. Cash flows from these sales should further strengthen Alrosa’s near-term cash flows and streamline Alrosa’s asset profile. Clarity and colour: transparency at industry, company and mine may improve Like other diamond companies, details on Alrosa’s assets remain scarce. The results of a reserve audit are likely in 4Q12 and could bring details on asset quality. Alrosa has cleared the administrative hurdles, but signals on a potential IPO are mixed as a possible 7+7% sale has been put on hold. As a government company in a strategic sector, social and political utility functions could conflict with the profit objective. On the industry level, pricing and structure are unclear after De Beers relented power, complicating forecasts. Price: we value Alrosa on DCF with a 12.7% WACC and 2.5% TGR; risks Our RUR40/share target price implies 6.1x/5.3x EV/EBITDA 2012/13F multiples. Risks include diamond prices, rouble appreciation, execution and taxation. ________________________________________________________________________________________________________________ Deutsche Bank AG/London All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 072/04/2012. 10 August 2012 Metals & Mining Alrosa Model updated:09 August 2012 Fiscal year end 31-Dec 2009 2010 2011 2012E 2013E 2014E Running the numbers Financial Summary Emerging Europe DB EPS (USD) 0.01 0.04 0.16 0.14 0.16 0.17 Reported EPS (USD) 0.01 0.05 0.12 0.15 0.16 0.17 Russian Federation DPS (USD) 0.00 0.01 0.03 0.02 0.02 0.02 Metals & Mining BVPS (USD) 0.4 0.4 0.5 0.7 0.8 1.0 Weighted average shares (m) 7,365 7,365 7,216 7,216 7,216 7,216 Alrosa Average market cap (USDm) na na 8,630 5,732 5,732 5,732 Enterprise value (USDm) na na 11,124 8,759 8,476 7,940 Reuters: ALRS.MM Bloomberg: ALRS RX Valuation Metrics Buy P/E (DB) (x) na na 7.3 5.5 5.1 4.8 P/E (Reported) (x) na na 9.6 5.2 5.1 4.8 Price (9 Aug 12) RUB 25.15 P/BV (x) 0.00 0.00 1.97 1.16 0.97 0.82 Target Price RUB 40.00 FCF Yield (%) na na 8.9 12.3 6.2 10.7 Dividend Yield (%) na na 2.9 1.9 2.0 2.1 52 Week range RUB 22.40 - 76.44 EV/Sales (x) nm nm 2.4 1.9 1.7 1.5 Market Cap (m) RUBm 181,482 EV/EBITDA (x) nm nm 5.3 4.4 3.8 3.4 USDm 5,732 EV/EBIT (x) nm nm 6.9 5.5 4.9 4.4 Company Profile Income Statement (USDm) OJSC Alrosa explores, mines, processes, and sells rough Sales revenue 2,456 3,734 4,687 4,607 4,949 5,229 diamonds through a global distribution network. On Gross profit 1,348 1,927 3,116 3,053 3,330 3,523 34.5mn ct production in 2011, Alrosa was the world's EBITDA 567 1,183 2,110 2,009 2,2302,339 biggest rough diamond mining company by volume and Depreciation 269 290 335 486 513548 second by value. The group's main operations are located Amortisation -438 0 166 -66 00 in Yakutia, in northeastern Siberia, near the cities of Mirny, EBIT 737 894 1,608 1,588 1,7171,791 Udachny, Nyurba, Aikhal and Anabar. With 1.2bn ct at Net interest income(expense) -544 -402 -347 -169 -292 -264 0.90ct/t in reserves, Alrosa also enjoys a world leading Associates/affiliates 18 34 42 47 4849 resource position that can support current production Exceptionals/extraordinaries 0 0 0 0 00 levels for at least 35 years. Other pre-tax income/(expense) 0 0 0 0 0 0 Price Performance Profit before tax 210 526 1,304 1,467 1,473 1,576 Income tax expense 101 138 397 359 339 363 90 Minorities 1 3 6 14 910 75 Other post-tax income/(expense) 0 0 0 0 0 0 60 Net profit 108 385 901 1,094 1,125 1,204 45 DB adjustments (including dilution) -40 -84 276 -57 0 0 30 DB Net profit 69 301 1,177 1,037 1,125 1,204 15 Dec 11 Jun 12 Cash Flow (USDm) Cash flow from operations -202 935 1,423 1,653 1,394 1,696 Alrosa Russian RTS Index (Rebased) Net Capex -347 -369 -658 -946 -1,038 -1,082 Free cash flow -550 566 766 707 356 614 Margin Trends Equity raised/(bought back) -3 -2 -112 0 0 0 48 Dividends paid -60 -14 -73 -85 -113 -121 44 Net inc/(dec) in borrowings -442 -622 -346 322 -224 -465 40 Other investing/financing cash flows 334 -258 -216 -1,358 -292 -264 36 Net cash flow -721 -330 18 -414 -274 -236 32 Change in working capital 74 397 -128 292 -202 -14 28 24 Balance Sheet (USDm) 20 09 10 11 12E 13E 14E Cash and other liquid assets 168 135 373 270 290 321 Tangible fixed assets 5,553 5,502 5,266 7,464 7,989 8,523 EBITDA Margin EBIT Margin Goodwill/intangible assets 48 47 45 49 49 49 Associates/investments 64 70 78 127 175225 Growth & Profitability Other assets 1,978 1,529 1,723 1,598 1,835 1,874 60 30 Total assets 7,812 7,284 7,484 9,508 10,339 10,991 50 25 Interest bearing debt 3,901 3,339 2,968 3,435 3,211 2,746 40 20 Other liabilities 1,242 912 1,004 1,160 1,195 1,219 30 15 Total liabilities 5,143 4,251 3,972 4,596 4,406 3,965 20 10 Shareholders' equity 2,708 3,042 3,535 4,923 5,935 7,018 10 Minorities -39 -9 -22 -11 -28 0 5 Total shareholders' equity 2,669 3,033 3,513 4,913 5,933 7,026 -10 0 09 10 11 12E 13E 14E Net debt 3,732 3,204 2,595 3,166 2,921 2,425 Sales growth (LHS) ROE (RHS) Key Company Metrics Sales growth (%) nm 52.0 25.5 -1.7 7.4 5.7 Solvency DB EPS growth (%) na 338.5 298.9 -11.9 8.5 7.0 150 10 EBITDA Margin (%) 23.1 31.7 45.0 43.6 45.1 44.7 EBIT Margin (%) 30.0 23.9 34.3 34.5 34.7 34.3 8 Payout ratio (%) 6.4 15.8 27.5 10.1 10.1 10.1 100 6 ROE (%) 4.0 13.4 27.4 25.9 20.7 18.6 4 Capex/sales (%) 16.1 10.6 15.6 21.1 21.0 20.7 50 2 Capex/depreciation (x) -2.3 1.4 1.5 2.3 2.0 2.0 Net debt/equity (%) 139.8 105.6 73.9 64.4 49.2 34.5 0 0 Net interest cover (x) 1.4 2.2 4.6 9.4 5.9 6.8 09 10 11 12E 13E 14E Source: Company data, Deutsche Bank estimates Net debt/equity (LHS) Net interest cover (RHS) Erik Danemar +7 495 933 92 19 [email protected] Page 2 Deutsche Bank AG/London 10 August 2012 Metals & Mining Alrosa Investment thesis Outlook OJSC Alrosa explores, mines, processes and sells rough diamonds through a global distribution network.
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