Mechel Posts Strong Growth in FY11

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Russian mining company Mechel OAO (MTL) recorded consolidated net income of $727.9 million in 2011, up 10.8% from the previous year’s consolidated net income of $657.2 million. For the fourth quarter, net income (as reported), grew nearly eight-fold sequentially to $201.2 million.

Revenues for the year came in at $12.5 billion, 28.7% higher than $9.7 billion posted in 2010. The jump in revenues was a result of Mechel’s competitive lead in the market, its geographical diversity, and a wide array of products sold by its branches. For the fourth quarter, revenues slid roughly 9% sequentially to $2.93 billion.

Operating income climbed 19.5% year-over-year to $1.8 billion in the reported year. However, operating margin slid slightly to 14.6% in 2011 from 15.72% in 2010.

Segment Performance

Mining: The segment’s revenues from external customers in the year were $4.1 billion, an increase of 35.7% over $3.1 billion in 2010. Operating income was $1.7 billion, 42.6% higher than $1.2 billion posted in 2010. The adjusted earnings before interest, taxes, depreciation and amortization (:EBITDA) of the mining segment jumped 37.9% year-over-year to $2 billion in 2011.

The company did well to increase the performance of its mining segment despite facing production problems in the first half of 2011 and unfavorable market conditions in the latter half. Mechel managed to improve sales of coal products and also employed a number of large-scale strategic moves to improve production capabilities and its resource base.

The company put its Elga open pit into operation earlier than expected, thereby accelerating the development of the important Elga coking coal deposit. Mechel also increased its offering of high value-adding products and strengthened its position in the PCI export market. It also entered into a joint venture for selling coal in India and opened a representative office in Singapore, expanding its global sales network.  

Steel Mining: Revenues from the Steel Mining segment made up 57% of total revenues, increasing 28.1% from the last year to $7.2 billion. The segment reported an operating income of $191.7 million versus last year’s operating income of $297.6 million, a massive drop of 35.6%.

The company faced weakness in the steel market in the fourth quarter, creating pressure on demand and pricing, resulting in a decline in earnings from the segment. However, the softness in the steel markets was covered to some extent by the Mechel Service Global sales network, which has shown rapid growth over the last 3 years.

Ferroalloy: Ferroalloy segment sales totaled $475.3 million, up 4.4% from 2010. The segment constituted 3.8% of consolidated revenues. The segment recorded an operating loss of $44.9 million in the year as against an operating loss of $23 million in 2010.

The company said it faced uncertain trends in the fourth quarter which affected the segment’s overall performance. Although the company managed to keep nickel costs and ferrochrome production costs stable, pricing pressures dragged down the results of this segment.

Power: The Power segment generated about 6.2% of revenues, totaling $776.7 million in the year, a year-over-year jump of 18.8%. The segment’s operating income almost halved to $23.8 million in 2011 from $46.7 million in 2010. The loss would have been greater but an improved performance in the fourth quarter of 2011 driven by the heating season and improvement in capacity utilization arrested the slide.

Financial Position

Mechel has a large capital-spending program. Capital expenditure in 2011 amounted to $1.8 billion, of which $1.2 billion was spent in the mining segment, $539 million in the steel segment, $62.1 million in the ferroalloy segment and $18.7 million in the power segment. Total debt was around $9.9 billion, while cash and cash equivalents stood at $643.4 million as on December 31, 2011, up from $340.8 million as on December 31, 2010.

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), 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’s large capital-spending program, high debt and substantial interest burden are matters with which the company contends frequently.

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

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