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Disappointing 3Q for Mechel

MT MTL

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Russian mining company Mechel OAO (MTL - Analyst Report) recorded a net income of $25.7 million in the third quarter of 2011, down 86.6% from the previous quarter’s consolidated net income of $191.9 million.

Revenues in the third quarter decreased 7.6% sequentially to $3.2 billion.

Operating income in the reported quarter climbed 11.2% sequentially to $529.5 million. Operating margin was 16.49% in the third quarter of 2011 versus 13.72% in the second quarter of 2011.

Segment Performance

Mining Segment: The segment’s revenue from external customers in the quarter totaled $1.15 billion, an increase of 3.9% over $1.1 billion in the sequential quarter. The segment’s operating margin was 37.3% versus 43.0% in the previous quarter. The adjusted EBITDA in the mining segment in reported quarter went down by 8.3% and amounted to $511.8 million compared with the segment's adjusted EBITDA of $558.0 million in the previous quarter.

In spite of a deteriorating pricing environment in the third quarter, the mining segment managed to show a revenue increase as compared with the second-quarter results. This was possible due to capacity restoration and development work in previous periods that enabled production and sales growth of almost all products in the third quarter. Production growth and cost control measures positively resulted in a decrease of production cash costs at all Russian coal mining subsidiaries.

Steel Mining Segment: Revenues from the Steel Mining segment made up 56.3% of total revenue, decreasing 12.8% sequentially to $1.8 billion. The segment reported an operating income of $115.6 million versus its prior quarter operating income of $36.8 million.

The segment's results in the third quarter noticeably outperformed those of the previous quarter. Despite a decline in revenue, attributable to a temporary reduction in sales to third parties, Mechel demonstated an increase in production volumes of the majority of product types and stronger financial results. Improved production results were achieved due to re-starting Blast furnace No. 5 after its recent repair and replacement of Converter No. 2 at the Chelyabinsk Metallurgical Plant, as well as modernization of rolling mills at Izhstal.

Ferroalloy Segment: Ferroalloy segment sales totaled $103.7 million, down 21.1% from second quarter of 2011. The segment constituted 3.2% of consolidated revenue. The segment recorded an operating loss of $19.8 million in the third quarter of 2011 against an operating loss of $1.1 million in the second quarter of 2011.

The ferroalloys division continues to show good results. Nickel production volumes were maintained at a stable level. A slight decrease in ferrosilicon production, caused by reconstruction of furnace #4, was anticipated.  Currently, the furnace is being prepared for launch and will be operational in the first quarter of the next year. Further, increases will be supported by the chrome bales workshop.

Power Segment: The Power segment generated about 5.1% of revenues, totaling $164.1 million, down 7.2% versus the second quarter of 2011. Operating loss for the segment in the reported quarter decreased drastically by 5745.5% sequentially to $10.3 million due to the seasonal decrease of generating and selling heat and electricity, which had its effects on financial results. The reported quarter’s adjusted EBITDA in the power segment went down by 237.5%, resulting in a loss of $7.0 million compared with the adjusted EBITDA profit of $5.1 million in the second quarter of 2011.

Financial Position

Mechel has a large capital-spending program. Capital expenditure for the nine months of 2011 amounted to $1.4 billion, of which $929.8 million was invested in the mining segment, $404.4 million in the steel segment, $46.0 million in the ferroalloy segment and $13.1 million in the power segment. Total debt was roughly $9.5 billion, while cash and cash equivalents stood at $518.1 million as of September 30, 2011.

Our Take

Mechel is a leading domestic steel and coal producer with a strong position in key businesses, including production of specialty steel and alloys. The company has the largest coal reserve base in Russia and is mainly focusing on growth and cost-cutting measures.

The company owns and controls essential infrastructure, including ports, rolling stock and power plants, which provide access to the export markets. However, Mechel’s large capital-spending program, high debt and substantial interest burden are matters of concern.

Zacks Recommendation

Currently, Mechel has a short-term (1 to 3 months) Zacks #5 Strong Sell rating and a long-term (6 months) Neutral recommendation.

Competitors

Mechel faces stiff competition from Arcelor Mittal (MT - Analyst Report) and Norilsk Nickel Mining and Metallurgical Co.

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