Mechel's Profit Dips Sharply

Russian miner Mechel OAO (MTL - Analyst Report) recorded consolidated net income of $218 million in the first quarter of 2012, down 29.5% from last year’s $309.2 million. Revenues in the quarter came in at $3 billion, up modestly from $2.9 billion posted in the year-ago period.

The company’s margins took a sharp hit as operating income dropped 30% from last year to $314 million and adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) declined 18.2% to $463.4 million in the quarter.

Segment Performance

Mining: The segment’s revenues from external customers in the quarter were $932.7 million, an increase of 12.6% over $828.1 million reported in the year-ago period. Operating income was $275.6 million, 5.6% lower than $292.1 million posted the first quarter last year. The adjusted EBITDA of the mining segment dropped 0.9% year over year to $358.1 million in the quarter.

The mining segment remained pressured in the quarter as it faced difficult economic conditions. The company had to briefly close several mines in Southern Kuzbass and this contributed to depressed margins. However, Mechel was able to maintain its coal product sales at high levels along with improving the sales of iron ore concentrate.

The company continued the development of the Elga mine and laid rail tracks towards the deposit. It is now constructing a seasonal washing plant at the site for accelerating the production and sales of coking coal concentrate. The plant is scheduled for completion this summer and Mechel expects to ship out its first load of coking coal concentrate from the mine once construction is complete.

Steel Mining: Revenues from the Steel Mining segment, which made up 56% of total revenues, decreased 6.1% from the last year to $1.6 billion. The segment reported an operating income of $10.7 million versus last year’s operating income of $125.6 million, a massive drop of 91.5%.

Ferroalloy: Ferroalloy segment sales totaled $124.7 million in the quarter, up 0.5% from last year, and constituted 4% of consolidated revenues. The segment recorded an operating loss of $33.8 million in the quarter as against an operating income of $11.9 million last year.

Power: The Power segment generated about 8% of revenues, totaling $243.4 million in the quarter, a year-over-year jump of 8.1%. The segment’s operating income dropped 25.8% to $24.9 million in the quarter from $33.5 million last year. The segment’s revenues jumped due to the heating season and improvement in capacity utilization. However, an increase in the cost of electricity and other commercial costs led to a fall in margins.

Financial Position

Capital expenditure in the quarter amounted to $276.2 million, of which $147.8 million was spent in the mining segment, $114.4 million in the steel segment, $11.8 million in the ferroalloy segment and $2.2 million in the power segment. Total debt was around $9.6 billion, while cash and cash equivalents stood at $439.7 million at the end of the quarter. The company’s position is precarious as far as debt is concerned, since the debt on its books is almost four times its market capitalization.

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. Mechel competes with ArcelorMittal (MT - Analyst Report), among others.

The company owns and controls essential infrastructure, including ports, rolling stock and power plants, which provide access to the export markets. However, as mentioned earlier, Mechel could be handicapped because of its high debt and interest burden, and might not be able to keep up with its huge capital spending program.

We currently have a long-term Underperform recommendation on Mechel, which is in agreement with a short-term Zacks #5 Rank (Strong Sell).