At the end of 2018, the metallurgy and production sector lost the growth rate of revenue to the oil and gas sector. This was caused by the correction of world prices for metals. However, the depreciation of the ruble in 2019 allowed Russian steel companies to increase operating profit by 47%, revenue growth rate by 28% and net profit by 40%.

The profitability of the sector

Over the past 6 years, the industry index of the metallurgical sector has increased by 100%, second only to the oil and gas sector. Due to the high volatility in the metal market, this sector is often in the lead or outsiders at the end of a particular year: 4 times this industry was in the Top 2 for the best yield, 2 times – in the list of the two worst sectors. In 2019, the profitability of the metallurgical industry lags behind the market due to stagnation in the metal market and the strengthening of the ruble.

According to forecasts, metal prices in 2019 will continue to decline due to the slowdown in economic growth in China, caused by the aggravation of the trade war with the United States and the deterioration of economic indicators of leading European economies. Nevertheless, the weakening of the ruble, expected in the second half of 2019, will help steel companies to maintain successful financial performance in 2018.

Indicators of the sector of metallurgy and mining, trillion rubles.

The sector of metallurgy and mining contains a large number of cheap multiplier companies, which is explained by the negative opinion of investors about the long-term growth in prices for the products of this industry.

It is important to note that the excess profits that have been received by the companies of the industry over the past few years, due to the fall of the ruble, were used to reduce the debt burden. Therefore, 6 companies in the industry have a net debt/EBITDA ratio of 1 and below. This allows all free cash flow to be directed to dividends. In the near future, the largest companies in the sector plan to increase investment, which may force the company to revise its dividend policy.

Evaluation of companies at multiples

Companies in the metals and mining sector have heterogeneous estimates for multipliers. The highest multipliers from manufacturers of precious metals: Polymetal and pole. Low values – from coal producers. "Kuzbass fuel company" and "Raspadskaya" - one of the cheapest companies in the Russian market. However, the long-term growth potential of these companies ' shares is questionable due to the non-transparent dividend policy.

The largest representatives of the sector are of the greatest interest for the dividend strategy:

• Severstal;

• Norilsk nickel;

• MMK;

• NLMK.

Companies

Norilsk nickel

In 2018, the company showed excellent financial results, which was facilitated by the growth of prices for non-ferrous metals and the weakening of the ruble. Palladium prices, which account for about 40% of the company's total revenue, increased by 23% in 2018, while copper and Nickel prices fell by 15%.

The growth of share prices led to an increase in multipliers, which reduced the investment attractiveness of Norilsk Nickel shares.

As for dividend yield, investors are interested in shares, but risks should be taken into account. The management of the company claims an increase in capital expenditures, which will require a reduction in dividend payments. However, RUSAL, which is one of the major shareholders of the company (it owns about 27% of the shares), opposes such a decision. If you agree a reduction of dividends does not work, then Norilsk Nickel will have to wait for 2023, when the validity period of the shareholders ' agreement. In the short term, the amount of dividends is likely to remain unchanged. Plans for the development of the company should have a positive impact on the company's shares.

NLMK

NLMK is one of the world's leading manufacturers of high-quality steel products. The previous year was also successful for the company. Profit and profitability reached record levels. This is due to high steel prices and the weakening of the ruble. At the end of 2018, the company's revenue in dollar terms increased by 20%, operating profit – by 35%, net profit – by 54%.

In terms of EV/EBITDA, the company is at the average level. The debt load is low, which allows the company to let almost all the free cash flow for dividends. The company plans to increase capital expenditures to $1-1 this year.1 billion, which can lead to a reduction in free cash flow by 20-30% and a decrease in dividends. But even in this case, the yield will be at an acceptable level.

Severstal

The value of the metric EV/EBIT indicates that the company is slightly undervalued by the market, at the same time, the profitability of the capital of the company displays it in the 10% most efficient companies in Russia.

In 2019, the company plans to increase capital expenditures by 2 times to $1.4 million, while the company's management assures that this decision will not affect the dividend payments, which will be calculated on the normalized cash flow.

The high stability coefficient of dividend payments and the high expected dividend yield signal the need to keep the company's shares in the portfolio.

MMK

Magnitogorsk iron and steel works is one of the largest steel producers in the world. At the end of 2018, the company showed strong financial results due to high steel prices and the weakening of the ruble. All the key indicators show a positive trend, updating the historical highs.

The company is slightly underestimated by the market and has a high return on capital, net debt / EBITDA at the end of 2018 was close to zero, which allows the company to continue to direct all free cash flow to dividends – these factors allow investors to include it in their portfolio in the long term.

ALROSA

In terms of EV/EBIT, ALROSA is at the average market level. However, the return on equity above the market average, dividend yield of 10% and high stability of dividend payments help the company's shares to be interesting to investors.

VSMPO-AVISMA

According to EV/EBIT multiplier (7.9), the company is considered to be overrated. Return on equity is the lowest in the industry. However, the high stability of dividend payments and dividend yield above the average market attract investors to the share.

The growth potential of the company is high, as VSMPO-AVISMA is the largest supplier of titanium semi-finished products to the world market, as well as a partner of the world's major aviation companies (Airbus and Boeing), which support the high demand for the company's products.

Raspadskaya

At the end of 2018, Raspadskaya showed expected good results. Rising coal prices, increased production and the weakening of the ruble helped to improve the company's performance. For fundamental multipliers, Raspadskaya is inexpensive and has the best return on capital in the industry. However, after the change in dividend policy (in March 2019), investors ' interest in the company decreased. According to the new dividend policy, the company plans to pay dividends of at least $50 million, which is a very low value with a free cash flow of $300 million.

KTK

The growth in coal prices and export sales in 2018 helped the company to show good financial results. Kuzbass fuel company has increased all financial indicators several times, net income / EBITDA is below 1, the fundamental indicator EV/EBIT is 3.8 and high return on capital – all this is of interest to investors. However, the non-transparent dividend policy raises concerns.

Mechel-p

The company pays 20% of IFRS profit on preferred shares, which may be one of the highest dividend yields on the Russian market by the end of 2018. However, due to the high risks for investors, it is not recommended to keep the company's shares in the portfolio in the long term.

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