Mechel Mines Mighty Impressive Earnings

| About: Mechel OAO (MTL)

Russian mining company Mechel OAO (NYSE:MTL) recorded a net income of $657.2 million in full year 2010, comprehensively beating last year’s consolidated net income of $73.7 million, a jump of 791.2% year over year. Revenues in the year 2010 soared 69.4% year over year to $9.7 billion based on the company’s relentless efforts to increase production; and were above the Zacks Consensus Estimate of $9.3 billion.

Throughout 2010, the company made concerted efforts to enhance the coal production volumes by modernizing production facilities, perfecting the marketing structure, developing new high value-added products and lastly, by implementing strategic investment projects, which strengthened its market position.

Operating profits in 2010 climbed more than six times 2009’s profit and amounted to $1.5 billion, compared with the operating income of $245.6 million in 2009. Operating margin was 15.72% in 2010 versus 4.27% in 2009.

Segment Performance

Mining Segment: The segment’s revenue from external customers in 2010 totaled $3.1 billion, an increase of 78.1% over $1.7 billion in 2009. The segment’s operating margin was 30.75% versus 9.72% a year ago.

Although the segment underwent certain ups and downs in 2010, management quite successfully averted the crisis. Several thickeners at the Nerungrinsk washing plant collapsed in the end of 2010. The company took prompt measures to bring the plant in operational mode.

Mechel also implemented various investment projects such as the construction of the Elga coal complex and the related rail branch line. In addition, the favorable market and environmental conditions also helped in maintaining the production level of the segment.

Because of the Australian floods, there has been an upward trend both in demand and prices for coking coal and its products as well as for iron ore. Moreover, the persistent shortage in supply of coking coal in the world market is encouraging for the group's mining segment in 2011.

Steel Mining Segment: Revenues from the Steel Mining segment made up 57.3% of total revenue, soaring 77.7% year over year to $5.6 billion. The segment reported operating income of $297.6 million reversing its prior year loss of $18.5 million. Low costs in the second half of 2010 also contributed to the increase in production.

The segment’s sales division, Mechel Service Global, also adopted various measures and expanded its network of warehouses and service centers. This division successfully penetrated new European markets whole of last year.

These efforts increased the sales 3 million tonnes of finished product by the end of 2010. The segment upgraded its existing plants and expects that in 2012, the division's enterprises will be working on qualitatively new technological level.

Ferroalloy Segment: Ferroalloy segment sales totaled $455.2 million, up 25.2% from the year-ago level. The segment constituted 4.7% of consolidated revenue. The segment recorded operating income of $23.0 million in 2010 against operating losses of $27.6 million in 2009.

Despite facing difficulties in chrome ore production at the beginning of the year, the company managed to increase production by making efforts of lowering costs. The demand for the segment’s products also increased due to improved market conditions, which led to an increase in production.

The segment is also upgrading its facilities such that all the plants may be self sufficient and be using their own raw materials resulting in significant cost reduction, increase in production volumes and improvement of compliance with environmental standards.

Power Segment: The Power segment generated about 6.7% of revenues, which totaled $653.7 million, up 22.4% year over year. Operating income for the segment in 2010 increased 14.8% to $46.7 million. Mechel's power segment keeps growing and developing.

At the end of 2010 it acquired 51% of Toplofikatsia Rousse, a power plant located in the Republic of Bulgaria which consumes coal from its assets, thus increasing its stake in its authorized capital stock up to 100%. In 2011, the segment expects to increase the power division's efficiency which will enable it to improve its performance in the future.

Financial Position

Mechel has a large capital-spending program. Capital expenditure for 2010 amounted to $990.1 million, of which $621.9 million was invested in the mining segment, $315.2 million in the steel segment, $41.7 million in the ferroalloy segment and $11.2 million in the power segment. Total debt was about $7.3 billion, while cash and cash equivalents stood at $340.8 million as of 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. It is focusing on growth and cost-cutting measures.

Mechel has also entered into various agreements to supply its rail products to large Russian metal mining companies. We are positive on the company’s favorable business profile with a high degree of backward integration and low-cost structure. Mechel’s key assets are located close to the major steel consuming markets.

In addition, the company owns and controls essential infrastructure, including ports, rolling stock and power plants, which provide access to export markets. However, Mechel’s large capital-spending program, high debt and substantial interest burden are matters of concern

Zacks Recommendation

Currently, Mechel has a short-term (one to three months) Zacks #2 Buy rating and a long-term (6 months) Neutral recommendation.


Mechel faces stiff competition from Arcelor Mittal (NYSE:MT) and Norilsk Nickel Mining and Metallurgical Co. (OTCPK:NILSY).