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Edited Transcript of CHMF.MZ earnings conference call or presentation 19-Jul-19 9:30am GMT

Q2 2019 Severstal' PAO Earnings Call (IFRS)

Moscow Jul 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Severstal' PAO earnings conference call or presentation Friday, July 19, 2019 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alexey Gennadievich Kulichenko

PAO Severstal - CFO of AO Severstal Management & Director

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Conference Call Participants

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* Andrew Ian Jones

Wood & Company Financial Services, a.s., Research Division - Equity Analyst

* Anna Antonova

JP Morgan Chase & Co, Research Division - Analyst

* Boris Sinitsyn

VTB Capital, Research Division - Equities Analyst

* Daniel Harry David Shaw

Morgan Stanley, Research Division - Research Analyst

* Kabelo Moshesha

Renaissance Capital, Research Division - Junior Research Analyst

* Nina Dergunova

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Timothy William Riminton

Barclays Bank PLC, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the conference call on the second quarter 2019 results for investors and analysts, hosted by Alexey Kulichenko, CFO. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Alexey Kulichenko, CFO, please go ahead.

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [2]

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Good afternoon, everyone. Thank you for joining Severstal's Q2 2019 Financial Results Call. I'm Alexey Kulichenko, CFO of Severstal, and over the next 10 minutes, I will briefly take you through our presentation, which is available on our website. And then we'll open the line for your questions.

And before I start, I want to remind you that this call may contain projections and other forward-looking statements, which reflects our view on the company performance and markets at the moment. If these projections change with time, we do not take responsibility for immediate update on the call's participants on those shifts.

Now let's start with Slide 4 of the presentation, which summarizes Severstal's performance for the second quarter of 2019. Our revenues increased 7% to almost $2.2 billion, mainly due to positive selling price [tenants]. Our group EBITDA increased 14% to $753 million, reflecting higher revenues and that largely reflect to maintain its EBITDA margin high at almost 35%.

In Q2 2019, Severstal increased domestic share of steel sales to 70%, due to increased attractiveness of domestic sales positively impacted by local consumption growth in construction sector. Share of high value-added steel sales increased to 46%. This benefits our flexible sales approach and proximity to export routes, allowing us to decide each quarter where to sell better and take action.

Our free cash flow declined to $263 million, affected by growth of CapEx and restocking of net working capital compared to the restocking of Q1. Cash CapEx totaled $267 million. However, the recommended dividend payment is RUB 26.72 per share.

For Q2 2019, we shifted our free cash flow for Q2, given current ForEx. That also reflects our commitment to pay 100% or more free cash flow in the form of dividends, given our leverage is below 1x. You can see that based on Q2 results, our net debt to EBITDA is 0.49, which exactly almost in line with the lowest level of our threshold.

And on Slide 5, I will draw your attention to bottom chart showing EBITDA dynamics quarter-on-quarter. You see that in Q2 2019, we recorded negative $60 million of intersegment EBITDA, which mainly a result of the reversal of profit of the pellets on stock of Russian steel who are the seller of these pellets to the final consumers. And that basically means that $60 million of EBITDA is already reduced in form of the pellets but kept on stock, as we plan to ship it and to get this EBITDA back in Q3. And since 2019, we switched to new scheme of our iron ore products distribution and service products, as I already mentioned, through our steel sale structures.

And on Slides 6 and 7, we summarized our performance for the first 6 months of 2019. You could see that our revenue is lower due to adverse market factors. However, on Page 7, we show EBITDA drivers. In the first half of 2019, additional improvements were $85 million and mainly driven by positive market shifts and macro environment, which we have on the steel side. Decline in steel volumes of 1% and increased stock of exported pellets, which led to negative impact of $52 million. However, as I already mentioned, we expect this factor to reverse in next quarter.

Smart procurement, operational performance drivers generally were 0, and that is the summary of -- on one hand, positive dynamics in number of our activities but which were offset by high salary, repairs and impairment costs, which we have compared to last year.

Let's now move to give you some overview starting from Slide 9 of Russian steel. We see that steel product sales remained flat, which is combination of higher steel prices, delivered revenue growth at almost 9%. Russian Steel division EBITDA, however, remained almost unchanged at $397 million, with EBITDA margin below 20%, reflecting higher cost of raw materials.

On Slide 10, you can see dynamics of our slab cost of Cherepovets Steel Mill. Total nonintegrated cost of slab production at Cherepovets increased to $355 per tonne, mainly due to higher raw material costs and stronger ruble. And then in the same time, integrated cash cost of our slab was $197 as a result of cost improvement on resource division and general EBITDA growth of our mining companies.

And now let's turn to Severstal Resources on Page 11. In Q2, the Resources division sales volumes of coking coal concentrate declined 7% due to short-term maintenance works at beneficiation plants. Sales of iron ore pellets and iron ore concentrate increased 2% and 10%, respectively, due to seasonal factors and iron ore volumes growth and higher selling price, resulting Resources revenue uptick by 27%. EBITDA increased 41% quarter-on-quarter and total to $416 million, and EBITDA margin reached 64%.

And let's move to financial section of our presentation. Slide 13 summarizes our cash flow. I already noted that free cash flow was $263 million negatively affected by restocking of inventories in Q3 compared to a restocking of Q1. And also we have growth quarter-on-quarter on our CapEx spend according to our strategy.

And now please turn to Slide 14 where you see summary of our liquidity and debt highlights. Public debt of the company includes outstanding loan participation notes and convertible bonds. In April, we'd made 2 issues of local bonds of RUB 15 billion for 7 years and RUB 10 billion for 5 years with 8.6% coupon for both issues. Our net debt-to-EBITDA ratio was 0.5x in Q2, which reflects cash balances reduction and dividend payments which we did during Q2 -- both for Q4 and Q1 that allows recommending dividend exceeding generating free cash flow for the quarter.

And let's move to Slide 15. Finally, we've summarized our view on the market. We see that following supply disruptions in Brazil and Australia in first half and due to growth of steel output in China, and we see a high level of prices in iron ore. And we see that it still stays at the record level and still across various scenarios of their further direction, though ex-China steel demand side, we see stagnation due to weakness auto and machinery sectors in Europe, economic slowdown in Turkey and current cost of raw material basket is giving a certain level of support to steel prices limiting the downside potential.

In Russia, steel demand showed an impressive 10% year-over-year growth in first half, driven by massive restocking activity in local construction sector. Hence, we can expect some deceleration of steel demand in second half of the result of restocking which will take place. However, Severstal's proximity to export routes continue to be major competitive advantage, and given the flexibility to quickly distribute shipments between best performing markets. Despite a number of potential headwinds from both export and domestic markets, Board remains confident on the resilience of Severstal's integrated business model relative to its local and global peers.

With that, I want to conclude my introduction and move to Q&A part and open the line for the questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Dan Shaw from Morgan Stanley.

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Daniel Harry David Shaw, Morgan Stanley, Research Division - Research Analyst [2]

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Just 2 questions for me. First one on CapEx, the run rate in the first half is quite low relative to the guidance. Can you just confirm that you reiterate the guidance and that you expect a pickup in the second half? Or do you think that the guidance perhaps is a bit higher than where you're going to come in? And then the second question on the domestic market because the conditions there look pretty good and the premium looks quite high relative to history. Can you just talk about what your expectations are for that going forward and if you sort of expect there to be some normalization of the premium, I guess, at the end of this quarter and going into kind of the quiet construction season or whether you think that the premium can be sustained at current levels?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [3]

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Okay. Thank you for the questions. First of all, we confirm our guidance on CapEx at $1.4 billion, so we expect main portion of it to be spent in second half of the year according to our schedule. And in terms of domestic markets, we see that, first of all, it remains relatively good in terms of premium level, mostly driven in Q1 by -- in the first half by significant restocking and also as a result of maintenance of number of local players. And we think that situation with strong premium will continue at least through this season. And after that, of course, we should expect some softening as a result of season end and production supply increase, and after maintenance of the campaigns would be completed.

And also I want to say that in terms of the market itself, we think that this massive -- the restocking, which took place in the first half will, of course, cause a certain deceleration going into second half. And as a result of that, we could expect lower volumes because we do not of course see at the moment the 10% driver growth of [preventions] in consumption. So we think it will be a certain softening of the local markets in the second half of the year.

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Operator [4]

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The next question comes from Boris Sinitsyn from VTB Capital.

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Boris Sinitsyn, VTB Capital, Research Division - Equities Analyst [5]

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The same 2 questions from our side. But firstly, on your operational efficiency program, so you have the target of $350 million of EBITDA savings for this year while you achieved so far $85 million. So do you expect to reach $350 million target for this year? And if yes, what are the key initiatives which would help you to catch up with the plan? The second question is probably on domestic demand as well, but your view on domestic premiums for HRC, as far as we understand, they're quite high at the moment versus historical level. Do you think -- what's your, firstly, outlook for the coming month? Do you expect domestic prices to be maintained? And what is your outlook on premium maybe by the year-end given your expectations so far a little bit softer demand in the second half?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [6]

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Okay. Thank you. I thought I answered the second one, but I will repeat. And let me start with that. I will repeat that we expect to see good premium on the local market as long as we have number of supplies moving into maintenance of their facilities on the local players. After that, we should expect to -- also together with end of the season, we could expect certain softening of situation. I cannot precisely predict and which month specifically. But I think situation for next 2 months I think will remain relatively good. In terms of volumes, again, I think that we will see softening of volumes on a base of restocking, which should take place taking a big restocking of the first half.

Speaking of operational efficiency, as -- again, to mention, at least 65% -- $65 million of EBITDA is just moving from Q2 into Q3 by simply shipping the pellet stock, which we already produced. And we are currently in the ship -- process of shipment from our warehouses, and we expect that to be completed in Q3. For most of it, EBITDA will be in -- from stocks to -- move from stock to P&L. And we also have a number of other activities. But we think that we will deliver more than $300 million improvements year-on-year according to our targets. And main drivers will be also, except for pellets, which I mentioned, improvements which we expect to have in our upstream operations, including better volumes and -- of Vorkuta and a number of improvements, which we expect to have on our mining assets compared to the half first of the year.

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Operator [7]

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The next question comes from Nina Dergunova from Goldman Sachs.

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Nina Dergunova, Goldman Sachs Group Inc., Research Division - Equity Analyst [8]

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Most of my questions have been answered already. So I wanted just to double-check, firstly, on your outlook for the third quarter, if you could provide some -- more indication about net working capital. Shall we expect some release in the net working capital in third Q and that if we will see volumes decrease already in third Q or it will be skewed towards 4Q in your view? And the second question is about Balakovo Mini-Mill sale. When do you expect this transaction to be closed?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [9]

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Okay. On working capital, we think that we will see some release in Q3, but it will be relatively moderate. Yes, we expect to see decrease in pellets stock, which we currently have but from cost standpoint, it's not that weak in terms of working capital side. Yes, weak in terms of EBITDA delivery, but it will not be, I would say, a big reduction in the working capital itself. And in terms of -- yes, from that -- on steel, I think it will be more or less flat. I think our -- maybe moderate restocking and subject, of course, to strength of the markets in Q3 compared to Q2. In terms of Balakovo, we expect to close this deal in July or relatively soon.

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Operator [10]

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The next question comes from Timothy Riminton from Barclays.

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Timothy William Riminton, Barclays Bank PLC, Research Division - Research Analyst [11]

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So 2 questions for me. Firstly, you highlight that some of your peers have reduced volumes this year and that's helped support the domestic market. Do you expect any volumes in Severstal to be -- to drop off for -- have low growth due to the increased CapEx spending and investment you're doing in the second half of the year? And secondly, your cash position now is relatively small given your ongoing dividends and spending requirements. Have you considered any financing options to cover that shortfall?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [12]

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Well, on second question, the first answer is yes. We consider financing options, taking into account that we will pay high dividends than free cash flow adjusted for our higher CapEx, which we announced in our updated policy. Can you iterate the first one? To be honest, I'm not sure I get it right.

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Timothy William Riminton, Barclays Bank PLC, Research Division - Research Analyst [13]

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The first question was just on your own volumes. So some of your peers have reduced volumes due to their CapEx plans and blast furnace overhauls, and your spending and investment is due to pick up in H2. So my question is, do you expect volume growth at Severstal to be lower than it would otherwise?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [14]

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But I -- yes, I understood exactly how I heard the question, but I don't understand the link between our CapEx and maintenance works and volumes of our peers. So that -- maybe I'm still a bit confused. Yes, first of all -- I mean, of course, we see that we have lower supply from our peers. And obviously, we have relatively good balance as the result of that -- better balance as a result of that on the local market. And CapEx plans are -- our CapEx plans, we do not have any direct links in the short term speaking for H2. So I -- maybe that's what the elements where I'm confused.

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Timothy William Riminton, Barclays Bank PLC, Research Division - Research Analyst [15]

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All right. I guess then in terms of maintenance, do you expect the higher CapEx spending to mean more maintenance time on your current assets, which would lead then to lower steel volumes...

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [16]

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No. No, our maintenance is not linked to our CapEx. Our CapEx program, we have the precise projects, which we in detail described during our strategy update. And you can see -- and we continue all of them according to the schedule. We do not want any extra maintenance as the result of -- maintenance of others or situation with the market. It goes according to our operational plans, and we do not plan to change them anyhow, and again our CapEx program is more long-term oriented than continuous according to our plans. So there is no any link of those 2 elements in second half of the year.

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Operator [17]

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(Operator Instructions) The next question comes from Anna Antonova from JPMorgan.

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Anna Antonova, JP Morgan Chase & Co, Research Division - Analyst [18]

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Actually, all my questions have been answered. Just a quick follow-up on Balakovo. Could you please remind us what cash proceeds do you expect to receive from the deal when it is closed as you have mentioned in July?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [19]

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We expect to have $215 million of cash proceeds as the result of the deal.

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Operator [20]

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The next question comes from Andrew Jones from Wood & Co.

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Andrew Ian Jones, Wood & Company Financial Services, a.s., Research Division - Equity Analyst [21]

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Few questions for me just in terms of volumes. You were talking about growth to about 2.2 million tonnes at Yakovlevskiy this year. In the first half, how much did you achieve? And are you still expecting to get to that sort of 2.2 million tonne target? And also just on the coal, given the output was down in the second quarter, I mean are you still expecting to get to something like 4.1 million tonnes this year? Or could you be slightly light of that? That's the first question. I'll follow up in a minute.

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [22]

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So first one was about Balakovo. On Balakovo, we had some...

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Andrew Ian Jones, Wood & Company Financial Services, a.s., Research Division - Equity Analyst [23]

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No. Yakovlevskiy.

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [24]

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Relief on the preparation works, so I think it will have a lower result as the result of this year. At the moment, I feel like around -- more realistic numbers, around 1.8 million. So I don't think it will make a major change to our results, but we see that it goes not as fast as we were expecting. But we believe we will fix all the issues related to our [impact], and we will be able to proceed further and catch up next year. In terms of -- can you repeat the second part of the question in terms of 4 million?

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Andrew Ian Jones, Wood & Company Financial Services, a.s., Research Division - Equity Analyst [25]

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Yes. On the coal volumes in Vorkuta.

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [26]

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Yes. The coal volumes, we will realign with our plans. Yes, most of the volumes ramp-up will happen second half of the year. And as a result also, we expect significant improvements of our coal cash costs, volumes and annual results of Vorkuta.

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Andrew Ian Jones, Wood & Company Financial Services, a.s., Research Division - Equity Analyst [27]

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Okay. And just on the steel side, I mean you were sort of suggesting that maybe a reduction in volumes in the second half of the year. Were you talking about in general in terms of Russian demand or in terms of your volumes? Because I noticed in the first half, I mean, the volumes weren't higher year-on-year. And things such as galvanized steel and color coated steel, given your new capacity, as I would have expected those to potentially be higher given the strong domestic environment. Could you give us some more precise guidance maybe in terms of volumes for Severstal in the third quarter and the second half and how the product mix might change?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [28]

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Okay. Thank you for the question. First of all, volumes of Severstal is not really linked to the volumes of the local market because we're a fully utilized company with all the selling remaining volumes to export market. Yes, we see strong performance of local market and as result, [relocation] of more volumes. And if we will see softening of market as a result of restocking, we will see higher volumes for export. From that standpoint, I believe that we will have strong volumes, and I would expect a small increase compared to the first half as we have a certain cumulative stock on our balance sheet. And that will just mean that if local markets will behave weaker as the result of restocking, we will sell higher share [to it].

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Andrew Ian Jones, Wood & Company Financial Services, a.s., Research Division - Equity Analyst [29]

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And on the next -- I mean given the extra capacity as you now have in galvanized and coated steel, can you ramp those up further in the second half? Or is it just a case of demand is about where the level -- I mean is it just demand constrained at the moment?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [30]

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No. I think we're quite well utilized. The only thing I mentioned, which is very specific for second half of this year, as one of our pickling lines is now under reconstruction. That means that we have a temporary bottleneck in the -- and in amount of cold rolled coil, and we will see of course as a result what is more beneficial to sell in the form of cold rolled specifically or in galvanized or color coated format. And that is again -- [year] specific. And it could happen that in couple -- some reasons it works for us, selling in the cold rolled format just taking into account it will be shorter with -- for this period of time for the reconstruction of the pickling line. Other than that, we are pretty well utilized in our coated and galvanized capacities, and you can see that also from the first half year results.

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Operator [31]

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The next question comes from Kabelo Moshesha from Renaissance Capital.

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Kabelo Moshesha, Renaissance Capital, Research Division - Junior Research Analyst [32]

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I just wanted to find out on Vorkuta. When are the works or maintenance, the repairs going to be completed? And what sort of normalized volumes should we be modeling? And then in terms of costs, which had been rising quite significantly recently, where do you see costs normalizing? What should we be using in the long term?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [33]

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I can give you a simple guidance for costs. More than -- like close to 90% of Vorkuta costs are fixed. So you can take first half of this year and that will be more or less the same cost for next half of the year but as well as we expect higher volumes, and volumes ramp-up will mean that this cost will be allocated to higher volumes and we will have full cost reduction per tonne as the result of this volume ramp-up. And I already mentioned that we are in line with our guidance for Vorkuta, and most of the work plan we have completed already during Q2. And starting from end of Q2 and Q3 and onwards, we will have higher volumes of production and as a result, a significant improvement of our cash cost per tonne.

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Operator [34]

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There are no further questions from the phone. (Operator Instructions) We'll now take a follow-up from Timothy Riminton from Barclays.

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Timothy William Riminton, Barclays Bank PLC, Research Division - Research Analyst [35]

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Just a follow-up on my second question regarding financing. Do you have any thoughts about the Eurobond market versus local ruble market, which you tapped earlier this year and looking for financing in the rest of the year?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [36]

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Yes. We definitely see that Eurobond market is at the moment in a very attractive condition, and we definitely consider it as one of the options for us to proceed with further borrowings. Of course we will see how it will behave further, but at the moment, it looks quite good.

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Operator [37]

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As there are no further question signals, I'll now turn the call back to your host for any additional or closing remarks. Would you like to close the call?

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [38]

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No more questions, right?

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Operator [39]

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No further questions.

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Alexey Gennadievich Kulichenko, PAO Severstal - CFO of AO Severstal Management & Director [40]

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Okay. Yes, okay. Thank you, everybody, for your participation and your questions. And see you later during our next results announcement. Bye.

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Operator [41]

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That will conclude today's call. Thank you for your participation. You may now disconnect.