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Annual Report & Accounts 2012

Financial review

Despite the weakening market conditions, the NLMK Group managed to achieve a significant growth in sales, maintaining asset utilization rates at almost 100% as a result of its efficient low-cost steel production and sustainable business model. Our sales grew by 18% to 15.2 mt, thereby partially offsetting the slump in steel prices and driving the Group revenue up by 4% year-on-year to US$ 12.2 billion.

EBITDA was down by 16% to US$ 1.9 billion as a result of the lower prices for steel products. The EBITDA margin was down to 16% (as compared to 19% in 2011), however, it still remained one of the highest in the sector. Net profit was down to US$ 596 million (-56% year-on-year).

As we finalized our large-scale capacity expansion projects, investments in 2012 decreased by 29% to US$ 1.5 billion and in 2013, we expect these to further reduce to US$ 1.0-1.2 billion. NLMK has a selective approach towards capex projects. Today priority is given to those projects that offer a high return on invested capital, aimed at minimizing costs and maximizing business efficiency.

A selective approach to investment and financial discipline provide an opportunity to continue to alleviate the Group’s debt load in the medium term. In 2013, we are not planning on growing our absolute debt levels; borrowings will be used mostly to further improve the structure of our credit portfolio in terms of debt maturities and currency.

Grigory Fedorishin

Vice President for Finance and NLMK CFO

Key factors for 2012

In 2012, the global market situation was characterized by a high degree of instability, with growth slowing down in China, the debt crisis in the Eurozone and relatively low business activity in the USA. The growth rate of the world economy declined from 2.7% in 2011 to 2.3% in 2012. World industrial production growth slowed from 4.7% to 2.5%. With the weakening world economy, the demand for the products of the steel sector fell, causing a drop in steel prices. As a result, the global price in 2012 was lower than in 2011: world prices for hot-rolled coils, for example, declined by an average of about 15%.

NLMK wins IR Global Rankings’ “Best Financial Disclosure” award

NLMK has won the “Best Financial Disclosure” category in a Europe-wide evaluation by IR Global Rankings (IRGR), a comprehensive technical ranking system for IR websites, corporate governance practices and financial disclosure procedures of public companies. The ranking was compiled by IRGR in conjunction with leading global consulting and audit companies, including KPMG. The evaluations were executed by a team of experienced investor relations professionals and reviewed by independent audit and legal experts. More than a hundred international companies from a wide range of sectors participated in the ranking.

 

Consolidated financial results

Key highlights

US$ million

2012

2011

Change (%)

Revenue

12,157

11,729

+4%

Operating profit

1,133

1,666

-32%

EBITDA

1,900

2,254

-16%

EBITDA margin (%)

16%

19%

Net profit

596

1,358

-56%

Net debt

3,574

3,355

+7%

Net debt/EBITDA

1.88

1.49

Revenue

During 12M 2012, sales revenues were US$ 12.157 billion, an increase of 4% year-on-year. Despite the significant deterioration in market conditions, the Group was able to offset the decline in steel prices by an 18% increase in sales, the redirection of sales into the more attractive price-wise Russian market and increased sales of high value added products.

The largest share of consolidated revenue came from the Steel Segment, at 58.8% in 2012 (down 10 p.p. year-on-year). The decline of the Steel Segment share in the revenue structure, in comparison with previous periods, was due to increased activity of the Foreign Rolled Products Segment following the acquisition of foreign rolling assets.

The revenue structure includes a significant proportion of high value added products: 41% in 2012 (up 1 p.p. year-on-year). This increase was due to the consolidation of foreign rolling assets into the Group and sales growth at the Lipetsk site. In 2012, slabs and hot-rolled steel accounted for 18% and 28%, respectively.

To maximize sales in a highly volatile global steel market, the Group reoriented its supplies towards more attractive markets, namely, the traditionally more premium Russian market (36.2% of total revenues in 2012) and the Asian market (11.2%). North America became another area of increased sales revenue (13.5%). Although the European market remains one of the most strategically important areas for the Group’s sales, the problems in the Eurozone led to reduced demand and, consequently, to falling steel prices, which reduced the share of revenue from sales of steel products in that region (down 3 p.p. year-on-year).

Production costs

Production costs (excluding amortization) in 2012 increased by 9% to US$ 8.494 billion due to the increase in sales (+18% over 2011), which was partially offset by lower prices for purchased raw materials and the programme initiated in the second half of 2012 to optimize production and operating costs.

In 2012, slab cash cost at Novolipetsk was US$ 388 per tonne (down 2% year-on-year). This was primarily a result of falling prices for coking coal (approximately 25% lower than in 2011) and pellets (down around 20%). With scrap prices also falling, billet production cost at NSMMZ fell (from US$ 504 per tonne in 2011 to US$ 460 per tonne in 2012); slab production cost at NLMK Indiana also fell.

Efficient control over steel cash costs

NLMK’s main competitive advantage – its low-cost steel production – allows the Group to post a consistently strong financial performance. Its competitive edge is based upon a vertically integrated business model, efficient processes and technologies, skilled staff, and advanced production equipment. NLMK controls the entire value chain, from mining the ore to the final delivery of finished products to consumers. The consolidated cash cost of a tonne of steel at Novolipetsk in 2012 was US$ 388, which is one of the lowest in the global steel industry.

Currently, NLMK is implementing a number of projects to further enhance the vertical integration, to reduce the Group’s dependence on the third-party supply of raw materials to and optimize production costs. This will strengthen NLMK’s status as one of the most efficient steel producers in the industry.

Selling, general, and administrative expenses

During the 12M 2012, operating expenses increased by 4% to US$ 1.762 billion. However, general and administrative expenses decreased by 19% to US$ 448  million due to the continuing optimization measures, as well as a changed approach to the recognition of allowances for doubtful accounts receivable. The 18% increase in selling expenses is mainly due to the increase in sales and a change in the geography of sales.

Interest expenses

In 2012, a portion of the interest payments was capitalized in accordance with US GAAP standards. Interest payments amounting to US$ 68 million were recognized in the profit and loss statement of 12M 2012. Total interest payments (including capitalized interest expenses) for 2012 were about US$ 266 million.

Operating profit and EBITDA

Operating profit for 2012 was US$ 1.133 billion, down 32% year-on-year. In 2012, the Group’s EBITDA amounted to US$ 1.900 billion (a 16% drop compared to 2011); the EBITDA margin was 16% (down 3 p.p.). The slump in the steel market in the second half of 2012 affected profit figures, but was partially offset by the decrease in production costs.

Net profit

For 2012, NLMK’s net profit was US$ 596 million, a 56% drop year-on-year. This was due to reduced operating profits and a one-off accrual of reserves in Q4 2012.

Debt portfolio management

In 2012, financial liabilities in the amount of US$ 1.725 billion were repaid, including two issues of three-year bonds (BO-01 and BO-05), which were repaid in October and December 2012, at a total of about RUB 15 billion. As a result, NLMK Group’s total debt at the end of 2012 was US$ 4.632 billion, of which 39% is in short-term loans and credit lines. The Group’s financial liabilities consist mainly of bonded loans and financial debt of the acquired foreign rolling assets.

At the end of 2012, the Net Debt/12M EBITDA ratio was 1.88.

In September 2012, NLMK placed RUB 5 billion in BO-04 series bonds with a maturity of three years, as well as RUB 5 billion in 07 series classic bonds (NLMK-07) with a maturity of ten years.

This was followed on 4 December, by another issue of Russian series 08 bonds (NLMK-08) for a sum of RUB 10 billion with a maturity of ten years, an offering period of three years, and a coupon rate of 8.4%.

Also, in September 2012, the Group placed a debut issue of Eurobonds totalling US$ 500 million, with a 4.95% interest rate – the lowest coupon rate ever achieved among Russia’s non-state-owned companies – and a seven-year maturity. Steel Funding Limited (Ireland) was the issuer.

Funds received from the placement of the Russian bonds and from the debut issue of Eurobonds (US$ 500 million issue with a 4.95% interest rate and a seven-year maturity), allowed the Group to significantly restructure its financial obligations. The weighted average maturity of outstanding debt at the end of 2012 increased to 3.1 years.

In addition, a new bond programme was organized in December 2012, with a maturity of three years. The programme amounted to a total of RUB 50 billion.

On 20 February 2013, the Group placed an issue of five-year Eurobonds worth US$ 800 million, with a coupon rate of 4.45%.

For more information on our net debt to EBITDA ratio dynamics

Eurobond placement at record low rates

In September 2012, the NLMK Group placed its debut issue of seven-year Eurobonds, totalling US$ 500 million. The coupon rate was 4.95% which, at the time, was the lowest ever rate for a Eurobond issue among Russia’s non-state-owned companies. The Group spent the funds from the issue on general business needs, including the refinancing of current liabilities.

The low rate of the debut Eurobond issue confirms investor confidence in NLMK, which has been achieved through a sustainable development strategy, attractive financial performance, high credit ratings and operational transparency.

Credit ratings

The ratings agencies Moody’s and S&P gave NLMK’s prospects a positive assessment, confirming the Group’s investment grade rating in February 2013. NLMK’s investment grade ratings from the three top world agencies reflect its leading position.

Consolidated balance sheet

On 31 December 2012, the assets of the Group totalled US$ 18.458 billion (up 7% since the beginning of the year). Asset growth was related primarily to the increase in the cost of fixed assets on the balance sheet (up 11% since the beginning of 2012) due to capital investments.

The structure of the Group’s liabilities has seen an increase in the proportion of current liabilities because of the increase in short-term loans and credit lines (up 39% since the beginning of 2012), due to the maturity in 2013 of previously issued rouble bonds. It is worth noting here the reduction in accounts payable (down 10%), due to the repayment of a part of debt for SIF S.A. shares.

Due to the decline in the NLMK Group’s financial results in a weak steel market, the profitability of the Group’s assets and equity fell. In 2012, the return on assets was 3% (down 5 p.p. year-on-year); the return on equity was 6% (down 8 p.p.).

For more information on our consolidated financial statements

Cash flow

Cash flow from operations

In 2012, the cash flow from operations was US$ 1.825 billion, up 1% from 2011. Lower profits in 2012 were largely offset by the optimization of working capital, including a reduction of inventory by US$ 170 million and of accounts receivable by US$ 167 million. Significant cash flow from operations made possible substantial capital investments, payment of dividends and other payments without increasing the Company’s net debt.

Cash flow from investment activities

The completion of construction on the main production facilities at Novolipetsk, including Blast Furnace # 7 and a new Basic Oxygen Furnace, allowed us to reduce capital investments in 2012 by 29% to US$ 1.453 billion.

Cash flow from financial activities

Net cash outflow from financial activities in 2012 was US$ 119 million, due to net external financing of US$ 21 million, as well as payment of US$ 117 million in dividends.

Cash and cash equivalents at the end of 2012 totalled US$ 951 million. Including short-term financial investments, the Group’s highly liquid assets at the end of 2012 totalled US$ 1.058 billion.

NLMK has passed the capital-intensive stage

The second stage of the Technical Upgrade Programme was completed during 2012. Its main purpose was to grow low-cost steel production in Russia and to ensure that further processing takes place in close proximity to major customers and, to this end, a number of large-scale projects requiring significant capital investment were completed successfully. Following the completion of this expansion phase, NLMK focused on improving efficiency. At the end of 2012, capital expenditure totalled US$ 1.5 billion, 29% lower than in 2011. In the past year, the modernization of steelmaking facilities at the Lipetsk site has continued, including the installation of secondary metallurgy equipment. New rolling equipment was installed at NLMK DanSteel and VIZ-Steel. Construction of the NLMK Kaluga mini mill has also continued. In the near future, we expect to be able to further reduce capital expenses.