Mechel's CEO Discusses Q3 2012 Results - Earnings Call Transcript

Dec.12.12 | About: Mechel OAO (MTL)


Q3 2012 Earnings Call

December 12, 2012 9:00 am ET


Vladislav Zlenko - Director of Investor Relations

Evgeny Mikhel - Chief Executive Officer

Stanislav Ploschenko - Chief Financial Officer

Oleg Korzhov - Senior Vice-President for Economics and Management


Anton Rumyantsev - Sberbank

Dan Yakub - Citi

Dmitry Glushakov - Credit Suisse

George Buzhenitsa - Deutsche Bank

Vasiliy Kuligin - Renaissance Capital


Welcome to Mechel Reports Nine Months 2012 Financial Results Conference Call.. For duration of the call, you will be on listen-only and at the end of the call you’ll have the opportunity to ask questions. (Operator Instructions)

I'm now handing over to your host, Vladislav Zlenko to begin. Please go ahead, sir.

Vladislav Zlenko

Thank you and good day, everyone. We would like to welcome you to Mechel’s conference call to discuss our nine months 2012 results which were reported today.

With us from management today are Mr. Evgeny Mikhel, Mechel's CEO; Mr. Stanislav Ploschenko, Mechel's CFO; and Mr. Oleg Korzhov, Mechel's Senior Vice President for Economics and Management. After management has made their formal remarks, we will take your questions to the presentation team.

Please note that during this call, management will make forward-looking statements, some of which may have been made in the press release. Some of the information on the conference call may contain projections or other forward-looking statements regarding future events or the future financial performance of Mechel, as defined in the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995.

We wish to caution you that these statements are only predictions and that actual events or results may differ materially. We don’t intend to update these statements. We refer you to the documents Mechel files from time-to-time with the U.S. Securities and Exchange Commission, which contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

In addition, we will be using non-GAAP financial measures, including EBITDA in our discussion today. Reconciliations of non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures are contained in the earnings press release, which is available in our website at

At this point, I’d like to turn the call over to our Mechel's CEO, Mr. Mikhel. Please go ahead.

Evgeny Mikhel

Good afternoon and good morning, ladies and gentlemen. I would like to welcome you to the conference call of the company’s financial results for nine months 2012.

The third quarter proved quite successfully for the company despite the fact that negative trends which could be seen at Mechel’s key markets since early this year developed further. For instance, replacement of our metallurgical coal markets persisted, while a fairly stable situation at domestic markets for steel product was aggravated by a further decrease of prices at key destination primarily Europe.

Nevertheless, thanks to our successful measures on cutting cost and correcting our sales policies appropriate to market parameters and optimizing our cash flow in the third quarter, we practically managed to maintain consolidated EBITDA at the level of the second quarter and improve it for the mining division.

As a whole, the results of nine months of 2012 are as follows: Mechel OAO’s consolidated revenue came up to approximately US$8.8 billion, EBITDA was $1.2 billion and net income was US$173 million.

As I have noted before, in the third quarter, our key mining division was able to improve its operational income. As prices for coal products and iron ore concentrate drove both on domestic and international markets, we focused our efforts on operational costs. As a result, in the third quarter, we managed to cut mining costs at Yakutugol by 15% and by 7% at Southern Kuzbass.

A certain shift of coke and coal sales from China to more profitable markets of Japan and South Korea played its part too. The share of sales to China in our total supplies structure went down by 6% while sales to Japan and South Korea went up by 8% and 3%, accordingly. On the back of a continuing decrease in steel product prices on European markets, in the third quarter, we focused on selling our two divisions’ product specifically on the domestic market where business activity and demand remained stable throughout this period.

As a result, the share of the domestic market of steel product grew in the third quarter from 53% to 60%, which helped the steel divisions to maintain a good EBITDA level despite lower prices and sales.

I would like to say a few words about the foundation that we established during this period for the group's further development. As we have earlier announced, Mechel OAO board of directors approved the company’s new strategy as prepared by its management, focusing on our mining business which is the most profitable and has indisputable competitive advantages both, on the domestic and international markets.

In accordance with this strategy, we decided to completely abandon development of our ferroalloy and power segments as independent business divisions as well as to significantly reduce our steelmaking presence, limiting ourselves to the most profitable market segments and full cycle production integrated into our mining business.

In order to implement this strategy, we have by now largely completed preparation of all non-core assets for divestment, which allows us to say with some confidence that restructuring of our business will be to a large degree complete in the first half of the next year.

Apart from that, we are working on minimizing the impact our loss-making enterprises' negative financial results have on the group's reports. After complete (Inaudible) with possible shutdown to follow, optimizing our production facilities, closing down loss-making enterprises and focusing on our key markets allowed us to increase our EBITDA margin up to 14% in the third quarter despite negative market trends.

The fact that the third quarter demonstrated the best quarter operational cash flow since the second quarter of 2009 is the best testimony to the success of the decisions we made.

Completing our business restructuring will enable us to focus on our mining division and free significant resources for its accelerated development. This primarily concerns the Elga project where we want new successes during the period, for example, launching a seasonal washing plant in September. The washing plant is currently being winterized, so that next year it could function all year around. It will bring the washing plant’s annual capacity up to 3 million tonnes.

As mining at Elga Coal Complex will reach industrial volume levels next year, we'll begin active work on ensuring guaranteed long-term off-take of Elga Coal. In September, we signed a long-term cooperation agreement with RAO Energy System of East OAO, which provides for a greater increase in coal supplies up to total of 60 million tonnes over 15 years.

The Elga project for the development includes construction of new washing facilities with an annual output of over 8 million tonnes of finished product in 2016, and over 21 million tonnes in 2021, most of which will be bound for export. Together with Yakutugol's current coal production, an increased production of coke and coals and PCI at Southern Kuzbass, it will mean over 43 million tonnes of finished product in less than nine years.

It is obvious that with such an output of highly profitable products, it is largely important to have uninterrupted access to all key markets, which can be guaranteed only by controlling transport logistics, including wagon carts and ports with [exit loads out] even now with the current level of coal exports from the Russian Federation. It is also important that all major coal terminals are controlled by our direct competitors, which makes efficient use of third-party capacitors practically impossible. As a result, we induced significant costs due to lack of an efficient market of port facilities.

In 2012, our coal export by sea will total 9.5 million tonnes with only 5.5 million tonnes handled by our own ports. Export to the Asia Pacific will be 3.3 million tonnes with Posiet Port handling only 4.6 million tonnes, which is to say 70%.

To illustrate our problem I can tell you that we are occasionally forced to use Baltic ports to export Kuzbass coal to Southeast Asia. In order to improve the situation, we are upgrading the Posiet Port, which will bring its transshipment capacity up to 9 million tonnes in two years. However, considering average capacities, this will obviously not be enough.

So the second stage of resolving this issue, we plan to construct our own terminal in the Muchka Bay, next to the existing Vanino Port. However, this is a greenfield-type project and is still under preparation. Implementing this project will take three to five years and cost up to RUB20 billion, as it will carry all risks of a greenfield in Russia.

Having weighed all these factors and risks that arise in the nearest future for cashing our stockpiles due to poor deficit in the Far East, we decided to have a consortium of Russian and foreign companies that offer the top price and the tender for privatization of the state-held stock in the existing Vanino sea port. If the tender’s results are approved by the government, this will be the most important acquisition for our company since buying Yakutugol in 2007.

The factors are as follows. First, the port’s strategic location. Port Vanino has access both, to the Trans-Siberian Railway and the Baikal-Amur Mainline, and actually is the Mainline's final destination, which means that the port is one of cargo flow regulators on the trade way with obvious priority status.

This is of enormous importance considering the frequent problem of the Russian railway system’s limited carrying capacity into each direction. Besides, offloading our coals through Vanino will cut the delivery distance from Southern Kuzbass and Yakutugol by some 500 kilometers, saving us $3 a tonne in railway tariffs.

The second factor is the port's current size and development potential. The berths at Vanino Port are four times longer than those at Posiet, while its storage space is six times wider. The port can handle Panamax-sized vessels at berth and Capesize at anchorage, while Posiet will be able to handle Panamaxes only after reconstruction and not earlier than in a year.

Posiet can't handle Capesize vessels. With minimal investment into optimizing the port’s infrastructure, we plan to bring Vanino’s transshipment capacity up to 10 million tonnes in 2013 and up to 15 million tonnes to 20 million tonnes in three to five years. The ability to ship coal to board super-sized ships will not only save us freight costs, but also significantly expand our supply geography, opening markets such as India even with current global prices.

At the same time, owning two ports in the Far East with such storage space gives us unique versatility in planning coal deliveries of the entire coal great range at the same time which greatly extends our offer assortment. Moreover, control over (Inaudible) protects our uninterrupted supply.

The fourth factor is that with the existing Vanino Port, we can greatly save on capital investment by postponing our project of constructing our own terminal at Muchka Bay for a definite period of time.

I'd like to highlight that considering Mechel's high debt leverage ensuring the neutrality of this deal regarding the group's current loan portfolio and the pressure on the group's cash flow was our primarily task when decided to take part in the auction.

We managed to reach an agreement with an investor consortium which will provide non-debt funding for this deal on condition of our administering report, so if the company is the acknowledged winner of this auction this acquisition will have practically no impact on the group's existing debt leverage.

All of these made by the company’s management including those aimed at optimizing our business structure and divisions will, in our view, give significant positive feedback in the nearest future, which will enable Mechel to go through the difficult crisis period caused by the global recession with confidence and lay the foundation for the company’s call to development in the future.

Now, I'd like to give the floor to our Chief Financial Officer, Stanislav Ploschenko, who will give details on the financial results of all of our business segments. Thank you for your attention.

Stanislav Ploschenko

Good morning and good evening, ladies and gentlemen. We will begin the review with the mining segment. The difficult economic headwinds faced by the global mining industry in general and our mining division, in particular, strengthened in the third quarter.

Average FCA pricing for our coking coal, anthracite and PCI and iron ore were down by 6%, 17%, and 22%, respectively. Until recently, pricing on PCI and iron ore had held up relatively better than coking coal prices. With the drop in iron ore prices experienced during the third quarter, the overall price declined since mid-2011 peaks, the rich parity was decline in coking coal prices. Anthracite and PCI prices even with a steep production which we saw in Q3 have still with a 34% reduction from 2011 peak, held up relatively better than prices from other steel-related inputs.

Coke FCA prices were off by just 3% quarter-on-quarter. Peak to trough, they were down roughly in line with the price declines in feedstock. Thermal coal prices including Midlinks on the other hand ticked 1% up due to the increase of export share tonnage-wise in sales from 18% in Q2 to 26% in Q3 as prices on export markets are traditionally higher than on the domestic one.

Generally, they have held up much better than steel-related feedstock prices and are, in fact, down by just 14% from the peak in the first quarter of 2011. The volume dynamics were also different. With softening of the seaborne market and decrease in realized price, we cut production in North America and decreased sales to China from Yakutugol, which is all spot, hardly compensating that with higher sales to Japan and South Korea all that resulting in a 10% reduction in coking coal physical sales volumes.

Sales of other metallurgical coals remained flat as lower demand in Europe was upset by higher sales to Asia, while realization of thermal coal benefiting from higher pricing and the fact that Russian power utilities are restocking for the winter season shot up 16%.

Sales of iron ore also grew by 9% most on behalf of the domestic market. That compensated the negative dynamics in coking coal sales and negative met coal price dynamics to a certain extent, but still led to a 12% drop in the overall third-party revenue in our mining segment to $777 million in the reported period.

Intra-group sales decreased overall by 17% to $172 million with a double increase in iron ore sales volumes and a 5% increase in coke sales volumes to the steel segment offset by 94% decrease in coke sales volumes to the Ferroalloy segment.

Due to the work stoppage at Southern Ural's nickel plant, coke shipment to it ceased altogether. However, we are proud to report that the negative dynamics in sales, volumes and prices were more than compensated by our successful efforts to reduce cash cost almost across the board.

Bluestone was a marginally exceptional with cost per tonne up $1 to $89 per tonne due to cuts in production. As for the rest, the cash costs were down $2 per tonne to $39 for Southern Kuzbass, $4 per tonne to $28 at Yakutugol and $2 per tonne to $43 at Korshunov Mining Plant. That achievement is even more remarkable against the background of growing the ruble-dollar exchange rate and that resulted in the cost of sales down 14% to $490 million, driving the gross margin 1% up to 48%.

Sales and distribution expenses decreased over the quarter by 13%. This reduction was primarily driven by decrease in sales to Ukraine and an increase in the percent of coking coal sold domestically on FCA basis.

As a percent of revenue, SMB expenses were basically flat quarter-on-quarter. Operating and other G&A expenses decreased during the period by 30% due primarily to an $18 million reduction in payroll. For the quarter, the lower revenue was completely offset by our operating cost containment efforts and the lack of variety of one-off charges and accruals which were booked during Q2.

The net result was a $3 million increase in EBITDA quarter-on-quarter to $305 million, pushing the EBITDA margin 4% up to 32% of the revenue.

Net interest expense decreased by $6 million due to an increase in capitalized interest. The appreciating ruble led to an FX gain of $94 million, which can be compared to $198 million loss in the previous quarter.

Profit tax increased by $66 million due to a $14 million deferred tax increase at Bluestone and a $50 million increase in statutory profit tax at our Russian operations due to an FX gain with respect to U.S. denominated debt.

Overall, for the nine months of 2012, the mining segment recorded $3.2 billion of revenue included into segment, down 17% of the same period of last year. The EBITDA fell by 33% to $965 million or 30% of the revenue. The net income fell to $428 million from $631 million in the compared period affected by $2 million FX loss versus a $99 million loss a year ago.

In the steel business, the third quarter continued with robust sales albeit with the gradual slowdown towards the end of the construction season in Russia and the background of weak demand in Europe.

The fact that we had undertaken a massive destocking in the first half of the year, which could not be continued to the same pace in the third one also affected the sales. The sales price was stable with a slight downward pressure coming from the factors just mentioned.

The average sales price changed ranged from 0% for rebar to minus 7% for engineering steel and alloy products on the FCA basis. At the same time, the sales volumes of rebar also remained virtually unchanged as this product is exposed to the stronger domestic market more than the others. The sales of billets and wire rod fell by 31% and 15% in physical terms, respectively. This was due to the fact that for the production in Donetsk plant was reduced and we also decreased purchases of semi-finished steel from Estar for resale in the third quarter on weak export prices.

Sales volumes of flat products including stainless fell by 23% as demand for flat steel especially from Europe continued to weaken unlike the demand for long steel products including stainless. At the same time, we increased sales volumes of high value-added hardware products such as wire and ropes by 3% and 12%, respectively. The combination of these factors resulted in a 10% reduction in segment’s third-party revenue quarter-on-quarter to $1.7 billion.

Intersegment sales fell by 25% largely due to restructuring of the group’s repair and maintenance business, which was previously outsourced by other segments to the steel one. In the third quarter, we put all the maintenance arms back to the respective segments.

The continuing weakness in coal and iron ore prices in the reported period, slightly offset by stronger ruble, resulted in a further decrease in cash costs, which fell to $409 a tonne of billet and $450 a tonne of rebar on average. However, the decline was not enough to compensate for a steeper reduction of revenue, resulting in a 31% decrease in gross profits. That also affected the gross margin, which went to 13% in Q3 down from almost 17% in Q2.

The decline in export sales mostly accounted for by sales of semi-finished and flat steel could not leave sales and distribution expenses unaffected as they fell by 24%, representing only 8% of the revenue versus 9% in the previous quarter. The segment did not incur any impairment of goodwill and long-lived assets in Q3.

Provision of $202 million created in Q2 for debts from related parties which is represented by the loan to Estar was further increased by $75 million in the reported period, reflecting our expectations of recoverability of that loan in the current market for depressed margins.

The provision for other doubtful accounts which was increased by $14 million in Q2 was reversed by $7 million income in Q3 as we cancel the provision for receivables from COGNA following its consolidation in the reported period. No new bad debt provision was created either. These factors resulted in a 17% quarter-on-quarter decrease in the segment's EBITDA to $75 million or 4.3% of the revenue, a slight decline from the previous quarter. Net interest expenses grew by 4% to $96 million reflecting overall increase in cost of debt.

FX loss of $116 million posted in the second quarter reversed to $48 million gain in Q3 due to stronger ruble. In Q2, with positive $32 million income tax gain largely attributable to reduction of deferred tax liability due to an adjustment of tax book value of fixed assets in Chelyabinsk and impairment of long-lived assets in our remaining plants. No such adjustment to impairment took place in Q3.

On the contrary, FX gain on appreciating ruble increased income tax expenses which totaled $13 million in the reported period. As a result, the segment posted $111 million net loss for the period which can be compared to $625 million loss in the previous financial quarter.

Overall for the first nine months, the steel segment posted $5.441 billion of revenue, including intersegment, 7% lower than for the comparable period of 2011. $215 million of EBITDA, a 42% decrease and $752 million net loss compared to $38 million loss in nine months of 2011. $594 million of that loss is accounted for by impairments of goodwill and long-lived assets and bad debt provision for related party loan incurred in 2012.

The price dynamics in the ferroalloy segment continue to be negative for nickel which fell 11% on FCA basis and chrome down 13% as markets continue to be weak in Q3. Only the price for ferrosilicon grew by 6% mainly due to the increase of prices on the Russian markets. The continued softening of the key markets resulted in [M OAO] decision to have production at Tikhvin chrome smelter and idle South Urals nickel plant in Q3 altogether. That decision resulted in a 48% fall in third-party sales of chrome and 36% fall in sales of nickel quarter-on-quarter.

The sales of ferrosilicon, which remains to be the most profitable product of the segment, grew by 39% largely due to more robust domestic market as production continued to grow after the modernization of one of the four furnaces topped up by carryover volumes from the second quarter posted in the reported one.

The growth of ferrosilicon sales however could not compensate for the decline in sales of nickel and chrome which resulted in a 31% drop in the third-party revenue quarter-on-quarter to $91 million.

Intersegment's revenue increased only by 4% to $23 million. Cash cost of all the products remained flat quarter-on-quarter. Thus, cost of sales fell only by the volume of sold products resulting in a reduction of the gross loss by half to only $6.5 million.

Selling and distribution expenses decreased by 23% to $6 million as export sales of nickel and chrome fell. Debt reduction was partly offset by growing share of these expenses per tonne of chrome by high custom clearance charges due to the high number of parties as we were selling smaller volumes of chrome to higher number of customers in order to adapt to weak market.

There was no impairment of goodwill and long-lived assets in Q3. As the result of production volume adjustment, we managed to decrease the segment’s EBITDA loss by 57% quarter-on-quarter to only $3 million in Q3, which is a good result taking into account that all these adjustments will be made towards the end of the quarter.

Net interest expenses changed insignificantly. The second traditionally posted an FX loss on appreciating ruble $15 million versus $22 million gain in Q2. That was due to the fact that most of the liabilities of the segment include an intergroup denominated in ruble whereas the reporting currencies apart from ruble are British pound, U.S. dollar and Kazakh Tenge.

The income tax expense of $3 million in Q2 reversed with a gain of $3.6 million in Q3 as deferred income tax expense for the nickel plant was reduced due to building up tax loss and there was no effect of deferred current income tax expense recognized in the second quarter. All that resulted in a $42 million net loss in Q3, which can be compared to $170 million loss in the previous period.

All in all, the ferroalloy segment generated $421 million revenue, including intersegment in the first nine months of 2012, which is 22% down from the same period of 2011. The present nickel and chrome prices were largely responsible for an $18 million negative EBITDA versus $57 million positive fund for the compared period.

The segment’s net loss of $205 million, nearly half of it coming from impairment of goodwill and long-lived assets plus $42 million negative difference in FX effect can be compared to $32 million loss in the first nine months of 2011.

The third quarter is traditionally the weakest for the power segment due to seasonal factors. The year 2012 was not an exception. The revenue from third parties fell by 16% to $147 million. Intersegment revenue dynamics were less pronounced with only 4% decline to $109 million.

Decrease in sales led to lower variable cost by higher fixed part that resulted in more subdued cost of sales dynamics which dropped only by 6% quarter-on-quarter. The gross income cost sequentially fell by 27% to $45 million or 18% of the revenue versus 22% in Q2.

Selling and distribution expenses declined by 10% to $50 million as a result of lower sales. The almost zero EBITDA of the second quarter turned into a negative $6.6 million in Q3. The net interest expense changed insignificantly. The FX effect was negligible. The result was a $14 million net loss, down from $60 million loss in the previous quarter due to absence of impairment charges on Toplofikatsia Rousse goodwill posted in the Q2.

For the first nine months of the year, the power segment generated $924 million revenue, including intersegment, down 2% period-on-period. The $21 million EBITDA is 37% down for the same period. The zero net result over the first nine months of 2011 turned into a $62 million loss in the reported period, almost all of it coming from the impairment of the Toplofikatsia Rousse.

On the consolidated basis, the revenue declined by 12% quarter-on-quarter to $2,750 billion. The gross profit was 18%, down to $730 million or 27% of the revenue versus 29% in Q2. The consolidated EBITDA was only 3% down quarter-on-quarter to $375 million as positive EBITDA dynamics in the mining and ferroalloy segments offset the downward pace in the steel and power ones.

The relatively robust sales in the mining and steel segments despite the weakening markets which were more than enough to offset negative dynamics in the ferroalloy and power divisions augmented by successful efforts to reduce cash cost and production in loss-making businesses resulted in an improvement in EBITDA margin from 12% to 14% in the reported period.

The net interest expenses remain virtually unchanged despite growing cost of funds are largely due to redemption of high coupon bonds issued in 2009 at the high yield than the current funding we are able to get from the marketplace.

The $292 million currency translation loss in the second quarter reversed to $127 million gain in Q3. The income tax expense posted $69 million versus $36 million gain in the previous period largely due to the absence of one-off tax gains in the steel segment recorded in Q2 due to asset impairment charges as well as high taxable income due to positive FX effect.

For the first nine months of 2012, the consolidated revenue was 9% down versus the same period of 2011 to $8,751 billion, the gross income down 23% to $2,594 billion or 30% of the revenue down from 35% in the first nine months of 2011.

The group's EBITDA of $1.224 billion was 34% down over the same period on a margin of 14% versus 19% a year ago. The $550 million net loss almost a mirror image of the income posted for the first nine months of 2011 was affected by $471 million impairment charges as well as $300 million of provision for doubtful accounts from the related parties.

Let’s now turn to the cash flow statements. I’m proud to say that this is the item where we can claim the biggest achievement in the reported period flagging the success of all our previous and present efforts to adjust the working capital to the present requirements, adapt our business to enhance its profitability and improve the structure of our sales to generate maximum cash flow.

All these efforts that we have been exerting since the beginning of the year materialized in Q3 more than ever increasing cash flow from operations to the record of $458 million despite the fact that the cash flow before changes in working capital decreased by 36% quarter-on-quarter.

Reduction in accounts receivables and divesting inventory alone brought over $90 million, another $93 million came through reduction of our trade position with related parties. As the construction season started to draw to an end, we begin to divest our net receivables from Estar inflated during the high season.

In addition, we received $25 million in dividends from our cost method investments and recorded a $35 million decrease in tax receivable in our major production subsidiaries due to utilization of prepayments for income tax made in previous quarters against the growing income tax accruals of the third quarter.

With that, change in working capital in Q3 summed up to a record of $284 million. At the same time, Q3 saw only $223 million spent on investments less than the working capital released in the same period. Another $195 million were paid in dividend for the year 2011, which combine with the investments still result in less cash outflow than the cash generated by operations, leaving the balance for debt reduction.

Financing activities contributed another $440 million resulted in an increase in cash position by $431 million after $242 million negative effect of the exchange rate changes.

Overall, for the first nine months 2012, our operations generated over $1.1 billion of cash which is record for the last three years. $435 million of that came from working capital adjustments, $997 million were spent on investments and dividend to our shareholders leaving over $100 million, the rest for debt reduction.

Despite superior operating cash flow in the third quarter, net debt increased to $2.6 billion largely as a result of exchange rate fluctuations. The ruble-denominated debt share in the group’s loan portfolio increased from 48% to 54% in third quarter, as foreign debt was being amortized out of long-term credit lines opened with Russian banks. But this exacerbated the effect, the appreciating ruble made on the balance sheet.

For the first nine months, net debt increased by $352 million or 4% despite the fact that the operating cash flow exceeded the expense on CapEx, acquisitions and dividends entirely due to relative ruble appreciation augmented by change in currency structure of the loan portfolio in favor of ruble during the reported period.

Although the group still face significant repayments in 2013, totaling $2.2 billion, we have recently made the first important step in addressing this issue. Four days ago, we completed the restructuring of the $1 billion syndicated facility with international banks. This resulted in an additional 12-month grace period in the facility which previously was in the monthly amortization stage, saving us $600 million in next-year repayments.

The voluntary nature of this restructuring was also a sign of trust to our group continues to enjoy with international banking community proved by the fact that four new institutions entered the facility in the course of syndication. Taking comfort from the fact that after the successful, restructuring around 51% of next year repayments fall on Russian debt, we are convinced that we will be successful in reducing our short-term debt to the targeted $1 billion within the next three months. We expect that will be helped with the divestment of non-strategic businesses which is underway.

To recap presence, ladies and gentlemen, I am proud that our business demonstrated its ability to adapt quickly and generate enough cash to go on with those key investment projects and service debt even in challenging volatile markets.

Despite softening commodity prices in the reported period, we are able not only to deliver a relatively stable performance in terms of the EBITDA, but improve the operating profitability of the business and increased cash flow.

Not the last in this achievement was the right cost for operating adjustments we set on in the beginning of the year and concentration on those parts of our business which we have the biggest competitive advantage.

Obviously, a lot yet has to be done, but being on the right track, I'm convinced that in the next 12 months, we will bring the businesses to the level of profitability and income generation the way it deserves to be.

Thank you for your attention, ladies and gentlemen. We are ready to take your questions.

Vladislav Zlenko

Thank you. We will now take questions. We'd ask that participants please state their name and company before asking their question and allow some time after for translation. When questions are answered in Russian, they will be followed by translation. So you may ask your questions in Russian also and we will translate. Please go ahead.

Question-and-Answer Session


Thank you. (Operator Instructions). .Our first is coming from the line of Anton Rumyantsev, Sberbank. Please go ahead, Anton.

Anton Rumyantsev - Sberbank

Good evening, gentlemen. Thank you for a very detailed presentation. I have two questions on your recent one in acquisition which is actually yet to be completed. But, the first one, actually could you please provide some details on actually what is the reason for this consortium of investors to participate in the view where they will make money.

So, if they will make money on port charges and/or maybe you will provide them with some coal off-take agreement, because it's just so interesting because the price tag for the port is very high and the benefits of this consortium of investors should be also pretty huge.

And the second thing is, that you stated that you will manage the port and that's why the question is, do you plan to consolidate it? And if you are consolidating it, how the investors are participating? Do they receive some stake in Mechel or one of the subsidiaries namely Mechel Mining, and maybe you will just give some more details on how the deal will be structured. Thank you.

Stanislav Ploschenko

Since the results of the tender have not been approved yet and the deals itself has not been closed we cannot provide comments on all the details of the agreement with consortium of investors. Nevertheless, we are ready to provide some comments. As for the consortium of investors, they are going to make money on the ports' economics and the increased value of the port in the future.

The consolidation is planned to be performed through management. And since the port doesn’t have any debt, it will not increase the debt portfolio. We will have an option but not a liability to buy the port and the consortium of investors is not going to get a share or any other participation in the company.

Vladislav Zlenko

Next question, please.


Next question is coming from the line of Dan Yakub from Citi. Please go ahead, Dan.

Dan Yakub - Citi

Thank you, guys. Just probably a follow-up question on buying a port and a couple of other questions related to the cash flow statement and a final question will be on your attempts to divest some of the assets or to find a strategic partner for the development of the Mechel Mining division.

First of all, in terms of buying the port, there was approximately $0.5 billion price tag mentioned for a majority stake in the share capital of port. I just want to try and understand who will actually pay that, whose balance sheet, whose cash flow statement. Does this $0.5 billion will appear on? Is that ever going to appear on your cash flow statement as participation in the share capital of that entity?

Second, in terms of the working capital release, you have seen that close to 63% of the operating cash flow in the third quarter was actually working capital released. Do you think that you have more capacity to release working capital in the fourth quarter? And if you do have more capacity, can you elaborate a little bit on what is the potential for the working capital release in the fourth quarter of this year?

And finally, maybe you can provide some more details, if you have any, on the potential, a start date for the search of a partner to develop Mechel Mining division. You mentioned up to 25% of Mechel Mining division can be divested to a third-party. Just trying to see, maybe you can elaborate a little bit on whether you have had any concrete proposals or when is the start date for that search process?

And on the maybe in the ferroalloy division, maybe you have some understanding in the EAF, some of your EAF investments maybe you have reached any progress in trying to divest some of the assets that you identified as non-core. Thank you.

Vladislav Zlenko

We will start answering from the last question. Evgeny Mikhel will take it.

Stanislav Ploschenko

Evgeny Mikhel will take the final question of the asked ones. So, this question with regards to the possible sell-outs of non-core and some core assets, we are quite active in this domain and we have already distributed teasers and investment memorandums concerning these assets. And all these procedures require time to prepare documents and to settle some in-group streams and this took a bit more time than we had anticipated.

Anyway, in the first half of 2013, we'll be able to close most of the deals indicated and some of the deals are already at a high level of readiness and sure, we have tried to speed up the process to deliver some of the result this year, but we all know that speeding up the selling process makes the buyers willing to reduce the prices. That’s why we take a reasonable approach to the timeframe for the best interest of the company and the shareholders so as to get the best market price for the things we have to sell. Anyway, I’ll say again that in the first half of 2013, there will be ready and closed deals. The results will be available and made public to the investors accordingly.

Vladislav Zlenko

The question on working capital release in the fourth quarter will be answered by Oleg Korzhov.

Oleg Korzhov

As I’ve mentioned, in quarter three, we were able to reveal a big share of our working capital and this procedure have been planned and announced. As for quarter four, we are likely to repeat this thing, because due to some seasonal factors and the way our facilities and distribution parts operate in quarter four.

And as for the production facilities in quarter four, they generate stockpiles for winter to minimize their technical risks while the distribution parts on the contrary increased their stockpiles to minimize the risk weighted to sales needs of the customers, so we have a goal to minimize their working capital outflow for these two events and activities. So, we are not going to have a share of working capital released in quarter four but at the same time the working capital will not decrease due to the seasonal factors.

Vladislav Zlenko

The remaining first and third questions will be answered by Stanislav Ploschenko.

Stanislav Ploschenko

As for the running the port deal, it has been mentioned that it has not been approved yet and we can say anyway that it will not go to our balance or to balance of Mechel or to the cash flow statement of Mechel. We, at the same time, cannot comment on the financial reports and financial documents of our co-investors that’s why we cannot say on whose balance sheet or cash flow statement these funds will go. As for the private placement or the part of Mechel Mining, we can say that the process has been already launched and it enjoys a lot of demand from the investors and we believe that by the first half of 2015, the deal will be closed.

Vladislav Zlenko

Next question please?


Next question is coming from the line of Yuri Yampolsky, Credit Suisse. Please go ahead, Yuri.

Dmitry Glushakov - Credit Suisse

First question regarded the cash cost and it was indicated that for mining it reduced by 13% to 15% in quarter three, and the question is how sustainable this reduction is because quarter two and quarter three are usually the best for Mechel in terms of cost and then the cost usually increase. Could you please comment on this situation?

The second question related to the debt and Dmitry looked at debt maturity schedule and saw that for the 1st of September there was more than U.S.$1 billion in Ural working capital loan and trade finance fund. But for the 1st of December, this figure was lower than $0.5 billion so why this difference?

The third question concerns the Izhstal. Their previous presentation it was said that the debt has been restructured and now Izhstal is to sell asset to pay the debt, so is there any progress in this domain and what are the expectations?

Vladislav Zlenko

The first question will be answered by Oleg Korzhov.

Oleg Korzhov

We don’t expect any miracles to happen, and our company operates and [chromosomes] where seasonal fluctuations are of great importance and this relates to the cost of heat, electricity and winter fuel we are to endure and it has been rightly mentioned historically quarter four has an increase in gas cost. And we believe that it will happen this year as well, but do not think it will be considerable. We expect it to be about 2% to 3% increase of cash cost in quarter four compared to quarter three.

Vladislav Zlenko

Next question will be answered by Stanislav Ploschenko.

Stanislav Ploschenko

The group is continuously restructuring and refinancing as debt would follow and change in the instruments applied and for instance we are shifting from the working capital finance into long-term financing so to shift from short-term to long-term debt and some of the work was done between the 1st of September and the 1st of December illustrated by the graph. And, for instance, we attained a five-year loan from Sberbank worth RUB24 billion, which was used to cover short-term debt including revolvers.

Dmitry Glushakov - Credit Suisse

The follow-up question to Stanislav is as follows, so you are replacing the short-term debt by long-term debt and you have refinanced some of the loans. The question is as follows, what is the average interest rate for the debt? How has it changed compared to the previous figures?

Stanislav Ploschenko

Well, for sure, debt interest is increasing with time and this is largely due to the fact that the cost of funding coming from the Western banks to the Russian banks is also increasing which increases the rates of the Russian banks. So, this happens not to the worse estimates or the risk of the loan taker, but rather due to this funding price.

And, sure, we have done restructuring and refinancing, but at the same time we haven’t seen a considerable increase in the rate. As for an example, for instance, this $1 billion West Bank syndicated loan rate has not increased and we have received a 12-month grace period. And the structure of this loan has been improved, because the rates will be reduced due to the changes in the net debt-to-EBITDA ratio, so this structure is even better than the previous one.

As for the third question, as far as I know, the Estar assets are being sold out and we believe that this will be done by the end of the grace period we provided and to Estar that is by the end of the first half of 2013.

Vladislav Zlenko

Next question, please.


Next question is coming from the line of Alexander (Inaudible), Rosbank. Please go ahead, Alexander.

Unidentified Analyst

Hello. It is Alexander (Inaudible) from Rosbank Bank. I’ve got a number of questions on your coal assets. First one, can you give us the breakdown of your Q3 coking coal sales by subsidiary? Next, what's your coal production plan for 2013 and please provide a breakdown by type of coal and subsidiary?

Next, what was the average realized price of coking coal at Bluestone specifying the delivery basis? And lastly, one small follow-up in your cash flow statement, there is $17 million gain on forgiveness of accounts payable and could you please elaborate on what’s that and where is it included in G&A expenses or anywhere else? Thank you.

Vladislav Zlenko

We'll start answering from the fourth question, Stanislav Ploschenko will answer.

Stanislav Ploschenko

As for the $17 million, this is forgiven receivables from one of our construction department units and we had an agreement with one of the creditors and we also had some questions to them and as we all settle this, settled all these issues. We came to an agreement that we are going to pay $17 million less and this is recognized by the other income line in the P&L statement.

Vladislav Zlenko

The remaining question will be answered by Oleg Korzhov.

Oleg Korzhov

The first question related to the coking coal concentrated shipment, the overall amount was 2.6 million tonnes and the Southern Kuzbass shipped 900,000 tonnes, Bluestone provided 200,000 tonnes and Yakutugol shipped 1.4 million tonnes.

As for the plans for 2013, concerning the coking coal concentrate, we are going to produce 31 million tonne to million 31.5 million-tonne coal and we are going to ship 25.5 million tonne to 26-million tonne coal products.

As for coking coal concentrate, this will amount to 12.5 million tonnes to 15 million-tonne. As for steam coal, this will be 8.5 million-tonne. And as for anthracite and PCI, this will be 4.6 million tonnes to 4.8 million tonnes.

As for the units split, this 25.5 million tonnes to 26 million tonnes, we split the following way. In Kuzbass will ship 12.5 million to 13 million tonnes. Yakutugol will provide 10.5 million to 10.7 million tonnes and this tonne will provide different 2.5 million tonnes.

As for the sales of our used assets, Bluestone, the question asked, that was for quarter four. So, we contracted two types of coal, high coal and low level coal. And as for high level coal, it was U.S$120 for [Northfork] $55 tariff. And as for lower coal, this was $140 to $150 with $55 lower tariff for quarter four.

Vladislav Zlenko

Next question, please.

Unidentified Analyst

Could you please specify the prices for Bluestone quarter three?

Stanislav Ploschenko

For sure we can provide this information. For quarter three, for high volume coal we started with 150 and closer to the end of quarter three it was 120. As for the low level coal, the dynamic was also decreasing. We started with $205 and ended with $140. This is also [Northfork] approach $55.

Vladislav Zlenko

Next question please.


Thank you. Our next question is coming from the line of George Buzhenitsa of the Deutsche Bank. Please go ahead.

George Buzhenitsa - Deutsche Bank

The first part of the question related to the Vanino port and as far as George got the presentation there is a planned increase of the forward throughput which implies some CapEx. So the question is, due to the structural of the deal who is going to finance the CapEx? What is the estimate of the CapEx?

And, another part of the question is that to take part for the bids $100 million worth of bank guarantee was necessary. So the questions is who provided this bank guarantee? Was it Mechel or the investors' consortium? And then another part of the question was that, in the presentation it was mentioned that Mechel would have an option for buying a stake from the investors’ consortium share in this port. And so what type of share would it be? Would it be a controlling stock or not controlling stock?

And will Mechel have share in the Vanino port or not at the initial part of the deal and another question pertains to the universal rolling mill and George would like to know the launch date of their the planned capacity and production output planned for 2014. And another question was concerning the increase of provisions for debt. It is going to happen or not?

Vladislav Zlenko

Stanislav Ploschenko will answer the first question.

Stanislav Ploschenko

As for the increased capacity of the Vanino Port, it will be capable of transshipping up to 10 million tonnes next year and this will require virtually no CapEx. This implies optimization of the warehouses and of the port infrastructure which leads to barely no CapEx. And as for the increase up to 15 million tonnes to 20 million tonnes for the future, we have to just consider this possibility and it’s premature to provide any figures, because we have not weighted the CapEx required for this.

As for the main guarantee question, it was provided to Mechel, and it expires around the deal on purchasing the Vanino Port is closed and the buying party to the agreement is Mechel-Trans which took part in the bid. And as for the further deals with the investment consortium, we wouldn't like to provide any details, because until the results are announced, we are subject to confidentiality agreement. But anyway we can say that Mechel will have a right to obtain a controlling stock over the port.

As for the question concerning the provisions for the Estar loan, this loan underwent the same testing for repayment as goodwill and assets do and this is the testing for impairment. And so these provisions will be determined by the market conditions. The provisions can both, grow and decline and they can decline unlike the impairment in this case and it's premature to talk about the market conditions at the time when we make it go into our reports.

Vladislav Zlenko

And the remaining question will be answered by Oleg Korzhov.

Oleg Korzhov

As for the universal rolling mill, we plan to complete the installment procedures in December, and start the commissioning procedures afterwards. And as for permission procedures, we have already started some of them. For instance, we have done it for the heating furnace which is a big unit of this mill and we are going to complete commissioning in first quarter, and to follow with a hard testing and test production. And by the end of the summer, we are going to produce rails and send them for the Russian railroads for testing.

As for the production figures for 2013, we wouldn’t like to provide any specific numbers because we understand that this universal rail and mill is quite a sophisticated unit which is high tech and quite new to us, so would like to see how it goes and many things will depend on how the results of the test we have and the whole test results and there are many things we have to test together with the (Inaudible) company.

Vladislav Zlenko

Next question please.


Our next question is coming from the line of Vasiliy Kuligin, Renaissance Capital. Please go ahead, Vasiliy.

Vasiliy Kuligin - Renaissance Capital

What is the company's covenant for debt-to-EBITDA, and what's the official figure for quarter four and do you think that you can go beyond this figure due to the reduced EBITDA figures? And the second question pertains to quarter one price for coking coal. Since VHV has contracted this coking coal fiscal quarter one with $5 reduction to the current price. So, do you anticipate a similar reduction in coking coal price for your company?

Vladislav Zlenko

Stanislav Ploschenko will answer the first question.

Stanislav Ploschenko

We agree that under the current market conditions the debt covenants can be exited, but we have already started our preparation for this. And when we have agreed with the western banks for a [restriction] of syndicate and now they are structured syndicate deal goes for Mechel Mining and the ratio there is 3.5 debt-to-EBITDA again the fact that Mechel Mining is the most profitable of our units. We believe that we have already sorted out the issue as for the international syndicate.

There is a risk in this domain remaining for the Russian banks and bilateral post with Western banks. If things like that start, we cannot see any problem, because even if the covenants are exited, we should consider that in the current market conditions which are quite tough we show record-setting cash flow. We are not increasing our debt and these two factors are the most important ones for any banks while it considers a loan taker as for its risk.

Vladislav Zlenko

Next question will be answered by Oleg Korzhov.

Oleg Korzhov

As for the question relating to the third quarter contract prices, Mechel commissioned itself and ships coking coal of K-9 grade to two regions. One is China and the other is Japan and Korea. As for China, we have already contracted for January and February and we have not just reduced the price compared to December figures. There it is, say for $155 with the share for $55 and we hope that close at the end of quarter one the prices are going to show growing dynamics. As for Japan and Korea, we had not contracted our first quarter shipments yet, but we are going to maintain the quarter four prices.

Vladislav Zlenko

Next question, please.


Next question is coming from the line of Maria (Inaudible) BCS Financial Group. Please go ahead, Maria.

Unidentified Analyst

[Maria] have asked a clarification question concerning the covenants for the syndicated deal and she would like to clarify whether these covenants which went to Mechel Mining pertain to the U.S.$1 billion syndicated loan and whether the previous covenants stayed for the new syndicated loan of U.S.$2.7 billion where it was 5.5 debt-to-EBITDA by the end of 2012.

Stanislav Ploschenko

The answer is as follows. As for the first part of the question for the syndicate of U.S.$1 billion, you are right. As for the second syndicate of $2.7 billion, there might be some confusion here because we don’t have this syndicate. If you meant the $2.7 billion to be paid back and as we had indicated as of for the 1st of September and has been reduced to $2.2 billion for these figures, for most of the sum we have the ratio of the covenant of 5.5 which is the Mechel covenant.

Vladislav Zlenko

Next question, please?


We have a follow-up question from the line of Anton Rumyantsev from Sberbank. Please go ahead, Anton.

Anton Rumyantsev - Sberbank

Hey, gentlemen. Thank you. Now, just sort of more of follow-up questions from me. The first one is could you please give us an update if your CapEx plans for 2012 and 2013 have changed somehow, if I remember correct, you plan to spend something like 1.2 billion for 2012 and if this target is still in place? The second question is maybe just in ballpark figures, could you please tell us what average decline of coking coal prices do you expect in the fourth quarter, maybe on FCA basis because there are pretty different types of shipments of the coal?

And the third question is in the third quarter we have seen a quite significant reduction of your sales, general and administrative expenses. Do you think that the amount will reverse in the fourth quarter or you will be able to keep them at their current levels? Thank you very much.

Vladislav Zlenko

Oleg Korzhov will answer the question.

Oleg Korzhov

For 2012 as for the investment figures we had $900 million and $150 million was to be spent on maintaining our facilities on we are building equipment. And $750 million was allocated for the investment projects. For 2013, we initially had a plan of $1.2 billion of investment, but given the market condition and the conditions of our current facilities we decided to review the figure to U.S.$500 million to U.S.$600 million.

And out of this $150 million, $160 million the same as last year would be spent on maintaining the facilities and the remainder of $400 million, $450 million will be earmarked for the investment project. We have two of them remaining one of them is complete in the construction of the universal roll mill and the other one is the Elga development project.

Anton Rumyantsev - Sberbank

Yes. Just to clarify, I’m just interested in the overall trend. So, for example, we expect the prices to decline by 3% or 5% because there were lots of questions asked about some specific prices, but overall trend in the fourth quarter was not mentioned that's why I just decided to clarify it.

Anton Rumyantsev - Sberbank


Evgeny Mikhel

The question was about the fixed price of coal and whether that two major markets again China, Japan and Korea. And for China for quarter four, actually their price was $85 to $100. It starts with $85 and then at the end of quarter four it was $100. As for Japan and Korea, the price was $110 and there’ll we’ll have quarterly contracts. And also in quarter four, we sold to Ukraine and it was U.S.$105.

And as for the overall reduction trends for the coal price for quarter three and four. In Ukraine and Korea, the reduction was about $50. And as for China, the quarter three and quarter four prices were in the same bend. And in quarter three they started a bit higher and a little bit lower, and in quarter four they started a bit lower and ended higher, but overall quarter three and quarter four prices were close.

Vladislav Zlenko

Next question please.


We currently have no questions coming through. (Operator Instructions). We have no further questions coming through. I'll hand you back to your host to wrap up today's call.

Vladislav Zlenko

Ladies and gentlemen, thank you for taking the time to joins Mechel's, the nine-month 2012 financial results conference call today. The replay of the call will be available on Mechel's website. If you have any further questions, please contact the IR office. Thank you again from all the team here. Bye.


Ladies and gentlemen, thank you for joining. You may disconnect your lines.

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