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Edited Transcript of CHMF.MZ earnings conference call or presentation 20-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Severstal' PAO Earnings Call (IFRS)

Moscow Apr 22, 2017 (Thomson StreetEvents) -- Edited Transcript of Severstal' PAO earnings conference call or presentation Thursday, April 20, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexey Gennadyevich Kulichenko

PAO Severstal - CFO and Executive Director

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Conference Call Participants

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* Alex Collins

* Carsten Riek

UBS Investment Bank, Research Division - Executive Director, Head of European Steel Research, and Equity Analyst, European Steel Research

* George Buzhenitsa

Deutsche Bank AG, Research Division - Research Analyst

* Nikolay Sosnovskiy

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Presentation

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Operator [1]

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Good day, and welcome to the Q1 2017 financial results for Investors and Analysts' Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Alexey Kulichenko, Chief Financial Officer. Please go ahead.

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [2]

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Good afternoon, everyone. Thank you for joining our Q1 2017 financial results call. I'm Alexey Kulichenko, the CFO of Severstal. Over the next 15 minutes, I will briefly take you through our presentation, which is available on our website, before opening the call for your questions.

Before I start, as usual, as regulation requires, let me remind you that our presentation contains projections and other forward-looking statements regarding future events and future financial performance of our company. These statements are based on numerous assumptions regarding the future operational environment, our business strategies, and we do not intend to update these statements to reflect events and circumstances occurring in the future.

I will start the presentation with Slide 4, which summarizes Severstal's performance for the first quarter of 2017.

In Q1, favorable price environment (inaudible) all Severstal assets and company maintained a steady performance despite seasonal headwinds. High commodity prices supported export and domestic steel prices. Company replenished inventory to normalized levels to accumulate finished goods for subsequent realization during coming quarters (inaudible) of construction activity.

Group revenues increased by 7% to $1.5 billion, while Severstal EBITDA increased by 10% quarter-on-quarter to $578 million, while EBITDA margin remained one of the highest among global steel peers total of 33%.

Seasonal growth of net working capital led to a decline in free cash flow, which totaled $70 million. We expect improvement in free cash flow generation in the upcoming quarters.

Cash CapEx of $138 million was down 17% quarter-on-quarter. In February, we announced CAPEX program, which sets an annual estimated target of RUB 43 billion across the total businesses. The company continues to invest in safety across all assets, downstream, IT development projects as well as other maintenance projects.

Whilst maintaining a low debt level, Severstal is committed to returning value to its shareholders. Our net debt ratio to EBITDA remains 0.4x at the end of Q1 2017. As a result, Board of Directors recommend a dividend of RUB 24.4 per share for Q1 2017.

On Slide 5, you can see that revenues for the first quarter increased 7% quarter-on-quarter to $1.5 billion. That reflects higher selling prices despite decline in sales volumes at both Russian Steel and Severstal Resources divisions.

On Slide 6, you can see our EBITDA performance. Group EBITDA increased by 10% to $578 million on, on the back of the revenue growth.

Now let's move to divisional review. On Slide 8, we start as usual with Russian steel. Steel products decreased by 9% quarter-on-quarter to 2.5 million tonnes, driven by weaker domestic demand, low activity from local traders and the fact that company built up finished goods for further sales and the (inaudible).

The share of high value-added products in the sales mix improved to 44% in Q1 2017, partly supported by 14% increase in cold-rolled coil sales after modernization and expansion of the cold rolling mill.

Export sales increased to 42%, reflecting all of the above-mentioned factors. Revenue increased by 8% quarter-on-quarter and remained at $1.6 billion. With the positive impact of higher top line being offset by high input costs. EBITDA was almost flat at $409 million. EBITDA margin decreased by 2 percent points to almost 25%.

On Slide 9, you can see dynamics of our slab cash costs. At Cherepovets Steel Mill, total nonintegrated cash cost of slab production in Q1 increased by $73 per tonne quarter-on-quarter to $323 per tonne as a result of higher hard coking coal and iron ore prices, as well as the Russian currency appreciation. Integrated cash cost of slab in Q1 increased by $46 per tonne to $240.

Now let's move to Severstal Resources on Page 10. In Q1, coking coal concentrate from Vorkutaugol declined further by 11% to almost 710,000 tonnes, impacted by scheduled long-wall repositionings at Vorkutinskaya and Komsomolskaya mines. We expect volume returning to normal levels in the coming quarters, supported by a recent uptick in hard coking coal and iron ore benchmarks, which positively influenced Russian selling prices, revenue increased by 22% quarter-to-quarter to $424 million and EBITDA surged 47% to $214 million. And while EBITDA margin [ reached ] to a record level of 51%, expanding 9 percentage points. Given the fixed nature of mining business, lower processing volumes at Vorkutaugol dragged total cash costs higher to $83 per tonne. At the same time, total cash cost at Karelsky Okatysh increased to $28 per tonne, influenced by growth in distribution and energy expenses, and Olcon increased to $34 per tonne, also partly reflecting a decline in sales volumes.

Let's now move to financial section of our presentation on Slide 12. You can see our cash flow, free cash flow was $70 million positive, resulting from significant increase of net working capital, which was mainly valued growth driven who have higher costs for all components and higher rates but also partly due to seasonal inventory build-up.

CapEx for the first quarter totaled $138 million, decreased by 17% quarter-on-quarter.

And on Page 13 and 14, you can see our liquidity and debt highlight. Severstal's gross debt in dollar terms increased 36%, in total at $2.7 billion. At the same time, at the end of first quarter, cash and cash equivalents increased to $1.9 billion, which primarily reflects our new bond issuance as well as free cash flow generation. Liquidity position remains strong. We have as usual unused credit committed lines of $675 million. Net debt declined to $788 million at the end of Q1, reflecting gross debt increase and growth in carried balances.

Net debt-to-EBITDA ratio remained at level 0.4x at the end of the quarter, that is partly the timing shared as dividend for Q4 and Q1 will be paid all in June. And we expect that this ratio will return to closer to 0.5x as the normalized bottom level of our own threshold on net debt.

And finally, let's move to Slide 15, which summarizes our view on the market. Global steel demand is expected to increase by approximately 1% in 2017. At the same time, global demand may be supported by supply restrictions for environmental reasons and policy of capacity closures in China.

In Russia, we think that after decrease of the market of 4% in '16, we could expect recovery up 2% in '17, back on the growing demand and normalization of macroeconomic conditions in Russia.

The board is confident that company's vertically integrated business model and focus on efficiency puts Severstal in good position relative both to local and global peers.

With this, I want to hand on back to operator to receive your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Carsten Riek from UBS.

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Carsten Riek, UBS Investment Bank, Research Division - Executive Director, Head of European Steel Research, and Equity Analyst, European Steel Research [2]

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I have 2 questions, if I may. The first one is on the net working capital build-up. It was again quite a substantial one. I hoped it would be less because you were one of the few companies which predicted that the steel prices, which we have seen at the beginning of the year, were not sustainable. So therefore, I thought there would be less net working capital. So my question here, was there -- apart from the usual seasonality, was there any net working capital build-up out of -- I wouldn't say speculative elements, but more than usual? That's the first part. The second part is on the dividend. The RUB 24.4 per share translate pretty much in 100% payout ratio. Your balance sheet is rock-solid, so you could actually afford it. Cash flow was not that great. Could we expect going forward, that from the dividend policy, as long as you can afford it, you could go closer to the 100% payout?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [3]

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Okay, thank you for your questions. Let me start with the working capital one. On one hand, if we -- there are 2 components in the number, which you see. And the one component is the inventory growth itself. But first of all, yes, we saw declining trend in pricing and actually compared to our own plans, we decided not build inventory for the usual season as we normally do. And our increase in tonnage was quite moderate. I can tell you that in physical value, we increased work in progress and finished goods only by 150,000 tonnes, which is pretty, I'd say, low amount and partly also to replenish work in progress across all divisions of Russian steel. And that's for me more like the normalized demand and partly also, because we are allocating volumes partly to export, it just require longer supply chain. So from that standpoint, our increase of inventory is very moderate. Where I really think is significant -- the main portion of increased income, is from value components, because each tonne which we have on the balance sheet, both the raw materials and steel cost more and that comes together with the stronger ruble. And obviously, the main component of this increase is just (inaudible). So growth of working capital comes together with revenue growth and pricing growth. So that's something we cannot afford. So it's more like the -- I would say, the price trend issue rather than the volume increase in our inventory. In terms of net debt-to-EBITDA, and in terms of our dividends, actually, as you see, we are now much lower than even our lowest threshold, and there is a certain timing in free cash flow generation and seasonally, usually we have -- sometimes seasonal negative free cash flow for the first quarter, but making decision on dividends, we're more like -- (inaudible) metric at the level of net debt, which we'll have after the payment. And if we assume our forecasts to the end of Q2, because there were not reasons of annual shareholder meeting for (inaudible) Q4 and now to Q1, we think that after the statement, we will more likely be on the 0.5 level, which is low level of our own threshold and that's what basically the key driver of dividend payment. So as I said, like as long as our net debt is at 0.5, we are paying free cash flow. And today, decision is more of a adjustment to catch up as well. That's why holistically it looks a bit high compared to free cash flow generation, specifically for the quarter. And also, we said like we could pay not less than 50%, but it's not restricting us actually in paying more. So it's more like the driver is more the net debt level at the moment.

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Operator [4]

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We will now take our next question from Alex Collins from Barclays.

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Alex Collins, [5]

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I have a follow-up on the working capital question. So you mentioned that partly it was an inventory build-up, which makes sense. And the other part was a sort of revaluation. Is that captured in the -- because the biggest line in the cash flow statement is net other changes in operating assets and liabilities? Is that where it's captured? Or is that something else? That's my first question.

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [6]

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No. Yes, and other changes usually -- yes, there are other elements which influence and support the advances in prepayments for us and for our customers, usually we have by year-end higher level of prepayments and more, I would say, adjusted to normal level up to Q1. So those are, I would say, temporary elements -- partly we are repaying our bonuses which reducing accounts receivable, which is also another -- accounts payable, sorry, to employees and that kind of thing. So its -- I would say, speaking for inventory, is where the value component is, and for others is just usual creation of elements of net working capital.

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Alex Collins, [7]

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And right now, is your net working capital level -- is this a comfortable level or do you expect a change, either a further build or release from here?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [8]

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No, we do not expect -- from the inventory standpoint, we do not expect further build. I don't think Q2 will be a quarter of significant relief, but more or less we'll stay on these levels and maybe we will have (inaudible) lower value, we could see some [ things ] in that element. And I expect more release usually coming in Q3. Yes, something like that, I would say. And usually, estimate -- how we estimate the normalized level, we think that level between 10% and 12% of revenue is a good level of working capital. Sometimes we -- when we're moving to 9%, it's more like the one of seasonal to the year-end. But I think, it's already a bit too aggressive and today, we are slightly above 13%, and part of that is also within the specific impact of the currency, because our revenue is calculated at average level of last quarter and a rate at specific date of the quarter end represents the strongest ruble at this moment. So there are a few data coming just from that exercise. So I would say it's also one of -- it's just also because of value creation in working capital.

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Alex Collins, [9]

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I've actually got 2 follow-up questions. So I was wondering if you -- you touched on it at the end of the presentation, but I was wondering if you could give the outlook for steel prices within Russia for Q2 and perhaps Q3 and Q4? And then my final question is CapEx, just an update on the CapEx guidance for 2017, if possible.

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [10]

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Well, we just announced recently CapEx size. We do not intend to give any change to that. It will come in the range of RUB 43 billion, whatever rate you want to apply to it to the year-end. Another -- speaking about pricing, of course, it will be subject to the trend of the world pricing benchmarks. We see that already, like Q1 from the standpoint was a good quarter, and by the way, taking into account the discount (inaudible) our steels mills a certain part of that will be reflecting in Q2 results. But also, we definitely are still declining. We are declining on the world markets, including China. And yes, from that standpoint, we definitely will see also pressure to local pricing in rubles. I think we will see on average from the order taking standpoint, already it's like a weaker quarter. It (inaudible) standpoint, which we're going to be still okay, and I would say might be a little bit better than Q1. But from that, I think -- I don't think that the current level of pricing is sustainable, so we expect moderate declining of prices in certain (inaudible) year.

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Operator [11]

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(Operator Instructions) We will now take our next question from Nikolay Sosnovskiy from Prosperity Capital Management.

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Nikolay Sosnovskiy, [12]

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Actually, I have 2 questions. One is on working capital obviously, just 1 small follow-up. In first quarter inventories, which you report in balance sheet increased from like $867 million in fourth quarter to almost $1.1 billion, which is plus $225 million. And if we take your first quarter average realized price $573 x 150 kilo tonnes of additional inventory volume, you just mentioned that's only like $85 million, but inventories have increased by more than $200 million. So can you please explain this difference in inventories. That's my first question.

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [13]

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Okay, I've tried already two times, but let me try this time. The main value -- the main component of the growth in inventory is value. Both of each tonne, both of raw materials and finished good and work in progress now on our balance sheet at different value because of the price increase, which came through Q1 compared to what we had it on the beginning of the year. And that comes together with also better rate in terms of the ruble. So each ruble in our balance sheet now has cost more dollars than it was in the beginning of the year, and those 2 components are the main drivers, which you rightly mentioned of almost 150 million. So that's the components. It has nothing to do with the physical growth of the inventory.

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Nikolay Sosnovskiy, [14]

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I was just trying to understand that the [ BBMPs ], the potential increase in steel you mentioned, 150 million -- 150 kilo tonnes at that prices -- $80 million, that seems a bit low. I mean, the question is, whether maybe your inventories of produced but unused coking coal and iron ore concentrates have increased?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [15]

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I don't know, it's again -- I mean, the main increased gain from different value of each tonne and the increase of physical tonnage is relatively low here, only 85. That does -- I mean, you took 150 at a dollar average cost, right?

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Nikolay Sosnovskiy, [16]

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Average selling price.

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [17]

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Well, I mean, it's not a selling price, it's at the cost level, so...

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Nikolay Sosnovskiy, [18]

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Okay. Then it should be even lower?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [19]

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Yes. Yes. Yes, you're right. But I mean, just take it at -- take the rate difference, it will give you biggest demand and the rest is just in the price itself.

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Nikolay Sosnovskiy, [20]

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Okay. And then the second question is on market situation basically, some of your competitors mentioning that trader is quite packed with inventories, and inventory level is already quite high. So restocking -- usual seasonal restocking [ prepare summer ] is not actually taking place. Do you see something like that, traders that trade with you, they are buying normally or they refuse to buy? Do you see their inventories?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [21]

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I think, I could only confirm that yes, we see quite high level of inventories, and as a result, we do not see (inaudible) the seasonal activity. And I think that will be the reason of -- in terms of stock prepayments that we will see shift of normal (inaudible) in April or May, but maybe also in June, July. Yes, that's exactly the case, that's quite high inventory at high price, so that's...

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Nikolay Sosnovskiy, [22]

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But the question here is actually, do they have enough end user demand? Or they just all concerned about the sustainability of domestic high premiums and they're just waiting them to come down? Or they don't have final demand in tonnages for the steel?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [23]

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I think, it's more about eventual demand. We do not see it that strong yet, so we will see how it will work within the start of this season. But I think, definitely higher prices will not stimulate (inaudible) product for that area. So yes, we definitely do not see yet strong activity of this season.

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Operator [24]

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(Operator Instructions) We will now take a follow-up question from Carsten Riek from UBS.

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Carsten Riek, UBS Investment Bank, Research Division - Executive Director, Head of European Steel Research, and Equity Analyst, European Steel Research [25]

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Very quickly on the FX. Because it was quite evident that the stronger ruble hurt you a bit. We still haven't seen any weakness in the ruble. Could that have a negative impact on your export strategy going forward? Or do you think at the moment, it's not yet at the level where it hurts?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [26]

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Well, it's very easy to -- the short answer is no, we don't see. The reason for that is two things. First of all, level of our cash cost, which you can see also on Page 9, check them in my presentation and compare that to cash cost or to the price of slabs, which we have on the market today. You see that even with this level of costs, we are able to be competitive on the slab market. And of course, which you'll see more than that (inaudible) and going forward, it depends. And you will see more or less situation around these levels. That's you will see further price decline and no weakening of ruble, this margin will go down to definitely or completely unique $80 to $90, I think, of further decrease of profitability. I don't see that this is the possible scenario. And yes, vice versa, we could not see certain weakening of ruble, it could help. And do we expect potential further strengthening of ruble. I think -- we also do not see it as a main scenario, as we can see a lot of rhetorics around strength of the ruble also from its usual, so we think that we will see moderate weakening going forward. But yes, all in all, at the moment, the rate and price levels are quite balanced to make us -- keep us profitable on all markets.

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Operator [27]

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We will now take a follow-up question from Nikolay Sosnovskiy from Prosperity Capital Management.

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Nikolay Sosnovskiy, [28]

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Just a small follow-up on FX and actually CapEx. You've reiterated in your press release, $43 billion (sic) [ RUB 43 billion ] CapEx for this year, but is there any kind of feeling in terms of level, if for example, ruble goes much stronger, around 50? But that would mean that CapEx, you will use dollars, and certainly be higher than $750 million, maybe. So did you have any kind of internal -- your dollar-based guidance assuming -- which you don't want to close?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [29]

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Well, the short answer is no, we don't. Usually, our CapEx program is the list of the projects which we decided to implement for a reason. And they are either good projects on economical standpoint and/or, I'd say, viable maintenance programs and it doesn't matter if we still believe that we are sustainable and in terms of fluctuation of the rate, we will continue to stop them. So from that standpoint, our -- at least our program for the year is quite stable. So we don't intend to revise it. Of course, if we will see certain crush or collapse of the markets, economy or rates or whatever, which will completely change the landscape and level of our profitability and (inaudible) generation, we could see and that was the case in 2009 -- 2008, sorry was the time when it was such situation. So in this case, of course, we can react, but if situation is just assessment of creation of ruble to dollar (inaudible) years and I don't think we will short term action as a result of this (inaudible).

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Nikolay Sosnovskiy, [30]

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No, I'm not talking about the consolation, but maybe, you know, slowing down expenditures to be, some particular projects, being for some equipment to be placed or when ruble presumably gets weaker. No such thinking?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [31]

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No, we don't. Our net debt is low. Our free cash flow generation is very strong. Our margins are definitely at record level. And also not just to ourselves, but among the peers. So there is no reason basically for that, because it doesn't mean that we could -- I mean, we're quite okay with our sustainability. And from that standpoint, if we think that this project needs to be accomplished, we will do it. I mean, all of our covenants (inaudible) we don't really have a subject basically to worry, so like -- I think, free cash flow generation dividend yield is also comfortable for the shareholders. I don't see weak to basically cutting or slowing down the CapEx to temporary situation. Again, if it's needed to be done, you can do it when needed, if that's benefiting in terms of the result. That's how we can approach.

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Operator [32]

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(Operator Instructions) We will now take our next question from George Buzhenitsa from Deutsche Bank.

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George Buzhenitsa, Deutsche Bank AG, Research Division - Research Analyst [33]

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I have 2 questions, just staying with FX, can you please tell us -- well, given that ruble has been strengthening since the beginning of the year, can you see any significant inputs coming into Russia? And do you think that could undermine the current level of domestic market premiums in the second quarter, at least? And the second question is on inventory. I'm sorry, just to wrap it up, as far as I understand, you carry inventory at cost in your balance sheet. So my question is, you mentioned one of the reasons for an increase in inventories was higher prices, can you please reconcile the fact that you carried it at cost and the fact that you mentioned higher price as a reason for an increase in the value of inventories in your balance sheet?

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [34]

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Okay. Okay. Thank you for the question. Let's start with products. Can you remind me what the question on products...

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George Buzhenitsa, Deutsche Bank AG, Research Division - Research Analyst [35]

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It was about inputs and the fact that the (inaudible)

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [36]

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Yes, okay. Yes. First of all, obviously, you're right. I mean, having such strengthening of ruble, level of pricing and local premium as a result, market became attractive for other players. In Q1, as a result, we see quite significant increase of volumes coming from Kazakhstan, from Ukraine as well compared to the last quarter, more than doubled. And definitely reflection to the high premium and that is one of the driver of the softening of the prices as a result of that. So that's exactly that. And sequences and as I mentioned earlier, we do not expect that we could afford that level of prices sustain a bit further and we definitely expect that we will see softening of that going forward. In terms of inventory, let's take Slide 9. Our cash costs at nonintegrated, but you can see of slabs. Obviously, that relates to all other products as well. We're speaking of costs at the moment, yes, because I mean, when I said price of each tonne, I mean at what price we have it on the balance sheet, of course, meaning that we carried the cost. So our price increase of $250 to $323 per tonne. So that's just by itself, the $70 increase of each tonne. And you apply it to the inventory which we have, so we receive the increase of the value component on the balance sheet. And then, yes, that basically comes together with -- itself both elements increase of costs as the result of high raw materials and also increase in dollar as a result of that high amount of dollars from the same ruble basically.

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George Buzhenitsa, Deutsche Bank AG, Research Division - Research Analyst [37]

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I thought you mentioned sales price increase as a reason, you know...

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [38]

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Hold on, I mean, price over -- speaking of pricing, at what value we have this inventory. It's not about how the cost of that element will impact.

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Operator [39]

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(Operator Instructions) There appears to be no further questions at this time. I'd like to turn it back to yourself for any additional or closing remarks.

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Alexey Gennadyevich Kulichenko, PAO Severstal - CFO and Executive Director [40]

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Thank you very much everybody for your questions. I think, when price is going that much up together with strengthening of ruble, we have this growth of working capital, which is not always clear, but I think it's inevitable consequences of the price growth on the market and we have opposite story when prices are going down. And we're quite comfortable that today, on one hand, we have a good situation on the market from the pricing standpoint, yet it is under pressure because nothing stays good forever. But we think we are well positioned basically to still have a good result on the market which we expect for the rest of the year. Let's have next discussion after Q2 results and thank you for your attention.

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Operator [41]

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This concludes today's call. Thank you for your participation. You may now disconnect.