Mechel Inks Supply Pact with RAO

Leading Russian miner Mechel OAO ( MTL - Analyst Report ) has forged a supply contract with RAO Energy Systems of East, an energy holding company operating in the Far East Federal District. Under the pact, Mechel will supply RAO Energy Systems with coal from the Elga Coal Complex.

The agreement, which was signed during the Business Summit of the Asia Pacific Economic Cooperation (APEC), provides RAO Energy Systems with the access to the high quality coal of the Elga deposit. Initially, Mechel will supply probes of coals from the deposit to RAO Energy Systems’ subsidiary “DTE”. If the test burning results comes positive, the company may increase the supply to up to 60 million tons over 15 years.

The agreement builds on a long-standing collaboration between Mechel and DTE. The company has been supplying DTE with steam coal from the Neryungri open pit, which is a part of its mining subsidiary, Yakutugol.

Mechel, which competes with ArcelorMittal ( MT - Analyst Report ) among others, 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 continues the development of the Elga mine. It has also constructed a seasonal washing plant at the site for accelerating the production and sales of coking coal concentrate.

Mechel’s large capital-spending program, high debt and substantial interest burden are matters of concern. However, we are encouraged by the opportunities stemming from the Elga mine which is expected to reinforce the company’s position as a metallurgical coal producer through capacity expansion.

Mechel currently carries a Zacks #3 Rank, which translates into a short-term (1 to 3 months) Hold rating. We have a long-term Neutral recommendation on the stock.