Annual Report 2012
Vladimir Kunitsky
Chief Executive Officer

Chief Executive’s review

"The Group's achievements in 2012 include dynamic operating performance on the back of a favourable environment in the nitrogen and complex fertiliser global market, strong financials, and the successful launch of new apatite concentrate and urea production facilities. These achievements provide further proof of our effective development strategy and sustainable business model."

Operating results

In 2012, the Group's total commercial output reached 5.9 million tonnes, 1% up year-on-year.

In the nitrogen segment, commercial output was up 7% due to an expansion of urea and UAN capacity and improved efficiency at the ammonia units. A lengthy overhaul of the ammonia unit at Dorogobuzh drove down basic indices, but that was offset by higher production at Acron.

Complex fertiliser output was down 1% year-on-year because Acron and Dorogobuzh were forced to suspend NPK operations due to interrupted supplies of phosphates by a counteragent. The 13% increase in complex fertiliser output at Hongri Acron mitigated the drop at the Group's Russian facilities.

The operational highlight of the reporting year was the start of apatite-nepheline ore operations and, since December, of apatite concentrate. As of the end of the year, the Group's Russian facilities have been using raw phosphates for NPK manufacturing from wholly owned sources. The Oleniy Ruchey mine is ramping up and we plan to reach the design capacity of 60,000-65,000 tonnes per month by June, 2013. Once this happens, we will completely cover Acron and Dorogobuzh's input needs.

Financial results

Revenue in 2012 was up 9% to RUB 71.1 billion thanks to higher sales and strong fertiliser prices in the first half of the year. EBITDA dropped 4% to RUB 19.9 billion, primarily due to an increase in the cost of inputs. Prices are up sharply as Russia continues deregulating its raw material market. Since 2011, the price for potash has been calculated based on the export price. The situation in the apatite concentrate market has been similar since 2012. The key task of our vertical integration programme is to cut costs by using our own raw materials. Thus, by launching the Oleniy Ruchey mine on time we will balance the effects of the deregulated phosphate market as early as 2013. As a result, we will keep costs under control and also drive down future expenses.

Net profit in the reporting year was down 27% to RUB 14.9 billion. It is important to note that in 2011 the profit was considerably affected by oneoff sales of securities and exploration permits in Canada. The adjusted net profit excluding those one-off transactions actually increased 12%.

In 2012, capex reached a record high of RUB 16.1 billion. Management is focused on maintaining the Group's financial stability as it implements a challenging investment programme. The Group has kept its net debt below 3 x EBITDA, and in the reporting year it was 1.6.

I would like to point out that we use different approaches for our major investment projects. Total financing of approximately USD 1 billion for the second stage of the Oleniy Ruchey mine and construction of Ammonia-4 unit will come from the Group's own funds and operating cash flow generated by the mine starting in 2013. Construction of the Talitsky mine is a more cost-intensive project to be implemented together with investors and using a loan facility from Vnesheconombank. At this point, we have obtained over USD 400 million from three investors and have agreed on a further USD 1.1 billion as a loan, which will provide 75% of the project's total capex. This approach allows us to secure timely financing for our investment projects over the next few years while maintaining stability.

Investment projects

In 2012, we completed two major investment projects, namely construction of the first stage of the Oleniy Ruchey mine and a new Urea-1000 unit. Importantly, both projects were completed to schedule and within budget.

The Oleniy Ruchey mine is the Group's largest completed investment project. Shipment of the first tonnes of apatite concentrate in December is the result of six years of strenuous work – mine project design and approval, construction of the infrastructure, factory and open pit. In the middle of the reporting year, we completed the main construction work and then, for four month, we fine-tuned the equipment and adjusted the technology to obtain standard quality product. Our main task for the first half of 2013 is to gradually increase output while streamlining operations to reach design performance in terms of consumption indices and commercial concentrate recovery. Construction of the underground mine continued simultaneously with the launch of the mine’s first stage. We plan to start the underground mining in 2017. Total investment since project kick-off has reached USD 500 million.

The Group achieved noteworthy progress in the reporting year on two other major investment projects: construction of the Talitsky mine and a new ammonia unit at Acron. Last autumn we obtained permits to build shafts at the Talitsky mine. This is the most labour- and cost-intensive stage of the potash project. We started ground freezing work and construction of the required infrastructure. In 2013, the Group will begin drilling two shafts. In addition, in 2012 we made extensive preparations for the Ammonia-4 project, including basic design, starting preparation of the construction site and choosing equipment suppliers. We will have to do a huge amount of work over the next few years in order to produce the project's first tonnes of ammonia by 2015.

Market environment

The reporting year was challenging for producers of all types of mineral fertiliser. On the one hand, we capitalised on the favourable environment in the nitrogen fertiliser market in the first half of 2012, when urea and AN prices were close to their local highs. The Group reacted rapidly to the price surge and used this time period to the maximum benefit. On the other hand, in the second half of the year certain factors put significant pressure on the nitrogen market and led to a price adjustment. Despite its volatility, however, the nitrogen fertiliser market was the only one to demonstrate higher sales, while phosphate and potash fertiliser producers faced a considerable drop in demand from their main consumers and had to cut back production. Because nitrogen fertilisers must be applied annually, farmers all over the world have to continue using them even during periods of instability. This advantage of the nitrogen market helps producers maintain high capacity load and efficiently respond to price fluctuations even in the face of natural market cycles.

In light of the instability in all of the single-nutrient fertiliser markets, there was notable stability of demand for our key product – complex fertiliser containing all three nutrients. The NPK market is less subject to volatility than the general global market. This stable demand is maintained primarily due to customer loyalty to this type of fertiliser. The market is being supported by growing demand from traditional consumers, such as China, Thailand and Russia, and from developing markets, such as Brazil and Vietnam.

Prices for nitrogen fertilisers have stabilised since the start of the 2013 spring seeding season. It should be noted that current prices for agricultural products are fairly high, thus encouraging farmers worldwide to apply fertilisers more actively, which makes us believe that the situation in the fertiliser market will remain favourable. As for the prospects of the complex fertiliser market, despite competition from DAP producers that have switched to NPK operations, Acron maintains its competitive edge and leading positions in key markets due to the high quality of our products and our aggressive marketing policy.

Sustainable development

Acron Group has several essential sustainability objectives, which include building a pool of skilled personnel to promote strong workforce potential, enhancing industrial safety to reduce injuries, cutting emissions and ensuring rational use of resources, and supporting development in the regions where it operates production facilities.

Over the past few years, we have been focused on our mining operations. Major endeavours like this need skilled experts, but they also require that we build a good team and put in place a system of social guarantees. In the reporting year, we launched the Oleniy Ruchey mine, which has provided jobs for over 2,000 people in the past few years. North-Western Phosphorous Company is developing a social policy based on the Fair Work programme adopted by Acron and Dorogobuzh. This experience will create a framework for hiring 2,500 employees for Verkhnekamsk Potash Company, which started construction operations at the Talitsky mine, Perm Krai, in the reporting year. Relying on advanced technologies and global experience will help us minimise our environmental impact and enhance safety as early as the construction stage.

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2012 sales by product

(in monetary terms)

 
    %
1 Complex fertilisers 52
2 Nitrogen fertilisers 34
3 Non-organic compounds 6
4 Ammonia 4
5 Organic compounds 4

2012 sales by region

(in monetary terms)

 
    %
1 China 26
2 Russia 19
3 Latin America 15
4 Asia 13
5 Europe 12
6 The US and Canada 8
7 CIS 5
8 Africa and other regions 2