Annual Report & Accounts 2012

Management Q&A

Oleg Bagrin

President (Chairman of the Management Board), Member of the Board of Directors

Q. How does steelmaking overcapacity in the world impact the Group’s strategy?

A. Overcapacity in the global steel industry has become one of the consequences of the economic crisis that began in 2008 and continues to this day. According to preliminary estimates, overcapacity in steel production is around 500 million tonnes, which represents more than a quarter of the world’s total capacity. This situation has a negative impact on the prices for steel products and, ultimately, it leads to a fall in profitability for many companies around the world. Given these conditions, the basic principles of the Group’s strategy, including maintaining its stability and searching for ways to improve its efficiency, are particularly relevant.

At the same time, changing market conditions have led to an evolution of the Group’s strategic priorities. While, in previous years, the Group has actively increased its capacity almost doubling it during the past five years, today we are focusing on maximizing the efficiency of the business, balancing elements in the production chain and optimizing business processes. NLMK will continue to focus on improving product quality and developing the production of high value added and niche products.

Q. What are the Group’s main medium term strategic priorities? What key investment projects is the Group planning to implement in the short and medium term?

A. The key project for 2013 is the launch of the NLMK-Kaluga mini mill. This project will enable NLMK Group to increase its production capacity for high quality long products by 70%.

The programme to develop transformer steel production is in its final stage: manufacture of high-permeability transformer steel will begin at Novolipetsk in 2013.

Recently, special emphasis has been placed on programmes to reduce costs at all levels of production: including through increasing energy efficiency, by cutting expenditure and by the use of less expensive raw materials without lowering the quality of the products manufactured.

In the medium-term, one of our strategic goals is to enhance vertical integration of raw materials. The key investment projects in this area are the construction of our own pellet production facilities and an increase in the production of iron ore concentrate at Stoilensky. These projects will allow us to attain 100% self-sufficiency in iron ore. We also intend to implement several projects to develop our own scrap processing network.

For more information on our strategy

Horacio Malfatto

President (CEO) of NLMK Europe

Q. What is NLMK Europe’s strategy for the next 5 years?

A. The key strategic priorities for the development of NLMK Europe over the next few years are improved operating efficiency and advances in the production of high value added steels, primarily niche products. Among these, the expansion of our production and distribution network for plates and NLMK’s deeper penetration into the European automotive market rank amongst the most important. To this end, we have implemented a number of important capex projects to upgrade the Division’s rolling equipment: we’ve commissioned a new mill at NLMK DanSteel and have launched brand new rolling facilities at NLMK Clabecq. These measures have allowed us to expand the product mix and to improve the quality of our products.

In the future, we plan to direct investments towards debottlenecking initiatives in our flat steel operations. This will enable us to reduce significantly our working capital and, most important, to attract new clients. We are convinced that the Division’s further integration within the Group’s Russian assets will create further opportunities for continuous efficiency improvements throughout the value chain.

For more information on NLMK Europe division

Alexander Saprykin

Vice President, Strategic Raw Materials Division

Q. Please describe the situation in the raw material markets in 2012.
What changes are expected in 2013?

A. In 2012, the world faced a global steel overproduction crisis and this imbalance of supply and demand was also evident on the commodity markets. According to experts, 2013 will be quite a difficult year for steelmakers, which, of course, will affect the markets for coal and iron ore.

The imbalance on the coal market and the sharp decline in prices for steel products led to a correction in coking coal prices in the second half of 2012. On the Russian market, the price of coking coal in 2012, to some extent, reflected the trends on foreign markets but with a certain time lag. Russia produces about 80 mt/y of coking coal, of which it consumes 65%. In 2013, we expect a gradual increase in the supply of coal with a stable level of consumption by steel companies. However, demand in the export markets remains poor and this will continue to put pressure on domestic prices.

In 2012, the global iron ore market was unstable and prices were volatile. The main factors behind this were high inventory levels of iron ore fines in Chinese ports coupled with an increase in supply from major ore manufacturers. Although a reduction is possible in 2013, it is expected that iron ore prices will remain at moderately high levels. On the whole, the mining industry in Russia experienced an upturn in 2012, where domestic companies increased production by 0.6% year-on-year to 105.2 mt. It is expected that the price dynamics of the Russian iron ore market will depend on developments in global markets.

Grigory Fedorishin

Vice President, Finance

Q. What is the optimal debt leverage for the Group? Will NLMK’s financial policy change in the medium-term?

A. NLMK traditionally follows a conservative financial policy.

The growth of debt in recent years has been due to an Upgrade and Development Programme at NLMK, which has included investment projects requiring substantial capital expenditures together with the acquisition of new assets. Nevertheless, at the close of 2012, the ratio of net debt to EBITDA remains one of the lowest in the industry at 1.88.

Today, the most capital-intensive phase of this development has been completed and, since 2011, investment has fallen by 25–30% per year. The decrease in capital intensity in the Company’s future development will enable us to put in place a flexible financial strategy and to reduce the debt burden; in the medium term, we are focused on a target ratio of net debt to EBITDA of 1.0. We also adhere to a balanced dividend policy, which envisages a dividend of between 20% and 30% of net income, depending on the results for the year.

For more information on our financial position

Q. Should we expect any changes to the Dividend Policy in the near future?

A. There have been no significant changes to NLMK’s Dividend Policy since it was adopted in 2005. The aim of the Dividend Policy is to provide stable dividend payments to the Group’s shareholders, taking into account profit levels and the funds needed to further develop NLMK.

Provided that dividend payments do not negatively affect the Group’s financial position or hinder its growth potential, NLMK pays out a minimum of 20% of its consolidated net income. Moreover, NLMK aims to pay out an average of at least 30% of consolidated net income as dividend payments over a five-year period.

NLMK’s current Dividend Policy is well balanced and it is unlikely to be significantly amended in the near future.

For more information on our Dividend Policy

Konstantin Arshakuni

Director for Strategy and Business Development

Q. What are the Company’s plans for the Usinsky-3, Zhernovskoye-1
and Zhernovski Gluboki coal deposits?

A. Work to assess the development prospects for the Zhernovskoye-1 and Usinsky-3 coal deposits is currently being carried out under licence agreements. Since the development of these fields is a capital-intensive process, the schedule for further investment depends to a large extent on how the industry develops. Because difficulties on the raw materials and steel markets are expected to continue, a higher priority for the Company are projects to reduce the consumption of valuable grades of coal and coke in the blast furnace. With a much lower capital cost compared to developing our own coalfields, these techniques produce a significant operational benefit, allowing the Group to remain one of the lowest-cost producers on the world steel market.

Nevertheless, the cost-effective vertical integration of our main raw material remains one of the Company’s key strategic objectives in the medium term.

For more information on our projects to maximize cost-efficient upstream integration into key resources

Alexander Burayev

Director for Long Products and Metalware

Q. When will NLMK Kaluga be launched? What products will it produce?
Who will be its key consumers?

A. NLMK Kaluga is a mini mill equipped with an electric arc furnace with a capacity of 1.5 mt/y of steel and an integrated rolling mill for the production of a wide range of rebar and structural shapes. Hot testing is expected to begin in May 2013. By the end of 2012, cumulative capex for this project totalled about RUB 30 billion.

The plant is located in central Russia, close to major consumers and key raw material suppliers and its commissioning will strengthen NLMK’s position on the growing Russian market for long products, with a 23% share of the rebar market and a 12% share of the market for structural shapes. The Group will have a 33% share of the market for rolled steel used in construction in Central Russia.

NLMK Kaluga incorporates the latest technical and technological developments, thereby ensuring the production of the highest-quality products and improved technical and economic performance. An SAP ERP management system will be introduced at the plant.

For more information on NLMK Kaluga project

Anton Bazulev

Director of External Relations

Q. How will Russia’s accession to the WTO impact the steel sector
and the Company’s business?

A. Russia’s accession to the World Trade Organisation (WTO) will have both positive and negative consequences for the steel industry. The import duty rates for the majority of steel product types will remain unchanged at 5%, therefore we do not expect a significant increase in competition from international suppliers in the Russian market. Moreover, Russian exporters will now have a mechanism to contest discriminatory decisions through WTO arbitration and the automatic dissolution of the quota agreement between Russia and the EU will allow Russian producers to increase their supplies of steel products to the European market.

In fact, as far as NLMK is concerned, there will be very little change, since the company has held a stable share of the European market for many years and has long-term partnerships with customers in the region.

On the other hand, WTO membership brings a range of risks for the Russian steel industry. WTO accession increases the risk of anti-dumping tariffs being introduced with regard to Russian steel producers. In addition, increased competition in the Russian machine and equipment markets could have a negative impact on steel product consumption.

In any case, we do not expect WTO membership to resolve all issues. The effect will be all-encompassing and will be determined for the most part by how Russia moves forward along the path to development, increased investment and economic growth.

Yury Larin

Vice President, Technology Development & Operational Efficiency

Q. Would you qualify the key CR trends as positive (CO2 emissions, water consumption, waste recycling, etc.)?

A.As a socially responsible company, NLMK is committed to continually reducing its negative impact on the environment.

Over the last five years, environmental investments have totalled around US$ 650 million. Significant investments have enabled the introduction of new, environmentally friendly equipment and a number of new environmental technologies and the increase in the degree of processing of by-products and previously unused waste.

As a consequence, NLMK has achieved impressive results. With a substantial increase in production at the main site, over a five-year period specific air emissions have reduced by more than a quarter and specific water consumption has decreased to a level that is superior to the best available technology in the industry. We have also eliminated completely the discharging of pollutants into watercourses. We attach great importance to industrial waste processing and, in 2012, the recycling rate at Novolipetsk was 93%.

The Company will continue to adhere to the principle of sustainable development, while minimizing negative effects on the environment in the regions where it operates.

For more information on our environmental protection initiatives

Stanislav Tsyrlin

Vice President, HR & Management System

Q. What is the amount of funds allocated by NLMK Group towards financing
social programmes in 2012? What are the key projects implemented in the reporting period? How does the Group support its employees?

A. NLMK has made improvements in the quality of life of its employees and the development of regions where the Group’s assets are located a key priority and achieves this, in part, by offering assistance to local residents.

We ensure that our employees receive high-quality medical care under voluntary health insurance schemes, that they participate in additional pension arrangements and that they have the opportunity to improve their living conditions. The Group has a number of recuperation and recreation programmes for employees and their families and also provides social support for veterans and pensioners.

For more information on our employees

The Group focuses particularly on the development of local communities: we are implementing programmes to improve the social environment, to provide financial assistance to educational, cultural and sports institutions and to help vulnerable people. For example, in 2012 we have continued the infrastructure improvement assistance programme for local residents that we began in 2010. NLMK has provided prompt assistance to residents of the Lipetsk Region to help them manage the consequences of a natural disaster.

In 2012, we continued to work on promoting a healthy lifestyle and supporting sport among the Group’s employees and local residents, as well as undertaking efforts to provide young people with career counselling. In total, the Group spent approximately RUB 1.5 billion (US$ 48 million) on social programmes in Lipetsk in 2012.

For more information on our community engagement