Alexey Mordashov: Russian Economic Prospects

lexey Mordashov, CEO of Severstal, President of “Russian Steel” partnership

Key takeaways:
Russian economy has dramatically transformed over the last few years, but there is still much to be done
Russian steel has structural advantages, it is a profitable and internationally competitive business
Russian steel sector is open and supports global free trade
Our response to the sectorial and domestic challenges is focusing our efforts on efficiency, cost-cutting, capital discipline and attractive return to shareholders

Steel lies in the heart of Russian economic development. Historically, major economic breakthroughs, such as the reforms of Peter the Great in 18th century or mass industrialization in 1930s were associated with the development of modern steel mills and reaching out to our wealth of steel-related raw materials.
Today Russian steel industry remains one of the key drivers of the Russian economy and a highly competitive global business.
Russian steel employs half a million people, it makes up 8% of industrial production and 6% of Russian exports
Russia is the world’s 5th-largest steel producer and 6th largest steel consumer
What is much more important for us, Russian steel producers consistently rank among the world’s lowest-cost and highest-margin steelmakers. You can find all four major Russian steelmakers within the world’s TOP-10 producers by EBITDA margin, an unrivaled achievement globally
Based on its competitive advantages, Russian steel industry has become an important supplier to international markets. However, as Russian economy and steel demand developed over time, domestic market has become our top priority. Last year, Russia ranked as only №7 among the world’s largest exporters. In fact, South Korea and Germany, which have no domestic raw materials or energy resources, exported more steel than Russia.
Given our rising orientation towards the domestic market, Russian economic outlook is critical for the future of the steel industry. Russian steel has seen its ups and downs together with our country, and transformed itself together with the country.

It is worth reminding just how radically Russian economy has changed over the last 10-15 years:
Over the latest 10 years Russian GDP has grown by 1.7 trn US dollars
Russia is now a $2 trln economy which makes it one of the world’s largest markets
Russian middle class has grown from 30% to 60% since the start of the century. This year Worldbank for the first time in history classified Russia as a high-income economy
The Russian automotive market is now second-largest in Europe

The story of Russian growth is just beginning, Russia is hungry for growth
Despite its successes in the past decade, Russia significantly lags behind developed countries. For example, Russian per capita GDP represents only a half of German one
Housing stock per capita is only about 50% of what it is in Europe. About a half of housing stock was built more than 25 years ago and needs to be replaced by modern and comfortable houses
And of course there are huge unfulfilled infrastructure requirements in Russia. As the largest country in the world by landmass, Russia needs a lot of transport infrastructure. Partly because of lack of modern infrastructure, logistics costs reach 20% of GDP, which is almost twice as high as the world average.
In order to eliminate the infrastructure and housing gap, a share of fixed capital investments in Russia should increase from 20-22% of GDP to ideally 30%. It means that investments should grow faster than GDP. As a result, steel consumption driven by investments should also grow faster than GDP
From the macroeconomic perspective, Russia has great advantages to deliver this growth
Very healthy public finances – the government debt at minimum levels and world’s third-largest foreign currency reserves
Fairly moderate taxes, just to give you two examples - 13% flat personal income tax and 20% corporate tax
Open economy - Russian economy is well-integrated in the world. Share of trade in GDP is around 50% of GDP and growing. For comparison, at USA it is only about 30%. Russia proved its adherence to free trade by its recent WTO access, so tariffs will keep going down in the forthcoming years
Open capital markets – we have no capital controls and, as events of 2008 crisis and the last couple of quarters have shown, Russia remains committed to keeping free flow of capital even in times of emergency and panic at the capital markets
Russian steel industry also works in an open global competitive environment. Even before the accession to WTO we did not have significant tariffs for most of the key product categories. Level of tariffs in specific products where they exist is much lower than in other major steelmaking emerging countries

Russian economy and steel industry need to meet new challenges Slower demand. Before the global financial crisis steel demand in Russia grew with impressive 10% per year. Global financial crisis caused a 38% fall in steel consumption. It took, however, only two years to return to the pre-crisis level. But now demand has slowed again.

Steel consumption is highly sensitive to the current economic problems in Russia. Fixed capital investments are expected to contract this year, as well as machinery production and non-residential construction. Currently the lifesavers for Russian demand are residential construction and infrastructure projects.

Steel consumption forecasts are being revised downwards:
Current level of steel consumption is about 43 mn tonnes which is in line with projections made in the Worldsteel “Russia-2020 project” prepared in 2010
However, future looks less optimistic than as it was in 2010.

Current industry demand growth consensus is not more than 2-3% annually till 2020 which is lower than 8-10% assumed in “Russia-2020”
The main negative factor is lower than expected investment activity in the Russian economy Russia is not a low-cost country anymore.

Electricity price is comparable to US and many European countries, skilled labour is in shortage and inflation remains persistently high, threatening our global cost position
Russian steel is ready to meet these challenges Industry went through a difficult period of restructuring and closure of inefficient capacities in the aftermath of the collapse of Soviet Union – the industry capacities were cut by more than 30%.

However, today steel is one of the most modernized industries in Russia: fixed asset investments in 2000-2013 amounted to US$54bn. Russia is one of the very few few regions which are self-sufficient in all key steel-making raw materials: iron ore, coking coal, scrap, natural gas Our priorities in the current environment are to control our costs, maintain capital discipline and improve customer service and returns to shareholders Global overcapacity is a common problem for everybody.

Given the ever-rising margin pressure, cost control remains our number one priority. Leading companies in Russia have already achieved significant progress in productivity improvement, cutting overheads and streamlining the organizational structures.

According to global analysts, the rate of cost reduction over the last few years was as high or higher than with the world’s major metals and mining houses Russian steel industry has invested a lot, for many years being a net recipient of funds from the financial markets. It is highly important for us to secure adequate returns to our investors.

Current market environment stipulates the need to reward investors in steel industry, it is a harvest period. Our industry leaders are focused on prudent capital management, implementing a disciplined dividend and debt repayment policy.