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Russian miner Mechel OAO (MTL - Analyst Report) posted consolidated net income of $54.9 million in the third quarter of 2012 compared with a net income of $25.7 million in the year-ago quarter, representing a roughly 114% surge. Revenues for the quarter came in at roughly $2.71 billion, down 15.4% from $3.21 billion in the year-ago period.

The company registered an operating income of $126.7 million in the third quarter compared with an operating income of $529.5 million a year ago, leading to a contraction in operating margin. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) declined 44.7% year over year to $374.8 million in the quarter.

Mechel remains focused on improving its core divisions such as mining and full-cycle steelmaking and has adopted several measures to cut costs and increase sales. Its cost containment initiatives contributed to a marked improvement in its bottom line in the third quarter.

Segment Performance

Mining: The segment’s revenues from external customers in the third quarter were $777.2 million, down 32.2% from $1,146.6 million in the year-ago period. Operating income was $200.3 million, 53.2% lower than $427.5 million posted in the third quarter of 2011. The adjusted EBITDA of the mining segment declined 40.4% year over year to $305.2 million in the quarter.

The company mainly focused on increasing production and shipment volumes as Southern Kuzbass's production capacities were restored. The company also made efforts to minimize costs by limiting operational and administrative expenses, acquiring third-party supplies for lower prices, selling inventories and planned reductions of production at several assets.

The company completed the construction of the Elga Coal Complex. It also signed a long-term deal with RAO Energy Systems of East OAO, which offers gradual increase in coal supplies up to a total of 60 million tons over 15 years, thus ensuring a long-term off-take for Elga’s steam coal.

Steel Mining: Revenues from the Steel Mining segment, which constituted 63% of revenues, decreased 5.4% year over year to $1.7 billion. The segment reported an operating loss of $42.9 million versus last year’s operating income of $115.6 million.

Ferroalloy: Ferroalloy segment sales totaled $91 million in the quarter, down 12.3% from last year, and constituted 3% of consolidated revenues. The segment recorded an operating loss of $24.5 million in the quarter as against an operating loss of $19.8 million last year.

Power: The Power segment generated about 5% of revenues, totaling $147.1 million in the quarter, a year-over-year decline of 10.4%. The segment’s operating loss was $10.9 million in the quarter versus a loss of $10.3 million last year.

Financial Position

Capital expenditure amounted to $847.3 million as of September 30, 2012, of which $509.8 million was invested in the mining segment, $296.2 million in the steel segment, $32 million in the ferroalloy segment and $9.3 million in the power segment. As of September 30, 2012, total debt was at $9.7 billion while cash and cash equivalents amounted to $582 million. The company has secured a syndicated loan of $1 billion to further improve its liquidity.

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, 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.

Mechel retains a short-term Zacks #3 Rank (Hold). We currently have a long-term (more than 6 months) Neutral recommendation on its shares.
 

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