Mechel: Maybe Now Is The Right Time To Put It High On Your List?

| About: Mechel OAO (MTL)

Summary

Mechel has reached the agreement with its main creditors on debt restructuring.

Sale of a share in the Elga coalfield and start of Universal Rolling Mill has to allow the company to fulfill its obligations in 2016.

Risks of bankruptcy still remain, but the profit/loss ratio looks very attractive.

Restructuring

As of December 10, 2015 the total debt of Mechel constituted $6.18 billion (by currency rate 69.2 RUB/USD). As for now, in the case of a currency rate of 78 RUB/USD, total debt shall become lower than $6 billion.

In general, over the last two years the company was able not only to reduce its net debt by nearly one third, but also to reach fundamental agreement to restructure with the main creditors:

• Sberbank ($1,267million),

• Gazprombank ($1,793million),

• VTB ($1,068million),

• Syndicate of International banks ($1,004million).

Figure 1. Dynamics of a Mechel debts.

(Source: Proprietary)

Generally the terms of agreement look so:

•Tenure

- Repayment extends up to 2017-2022.

• Currency

- Full conversion of the Gazprombank and VTB loans into rubles ;

- Ruble portion of the debt up from 35% to 60%.

• Interest rates

- Rates tied to LIBOR and CBR Key rate instead of highly volatile MosPrime rate ;

- Ruble interest payments down to 8.75% from current 12.5%-14.5% due to partial interest capitalization.

• Penalties and fines

- Banks agree to waive significant portion of accrued penalties and fines.

After restructuring the repayment schedule will look as follows:

Figure 2. New debt repayment schedule.

(Source: mechel.com)

From this presentation remains unclear, whether the debt of VTB and to Gazprombank was already converted in rubles, and if so, at what rate. Therefore in the table below I've calculated annual payments of the company according to the currency rate provided from presentation and from a current data:

Figure 3. New payment schedule of Mechel.

(Source: Proprietary)

There still remains a debt about $900 million from other creditors. However the negotiation process with them will go much easier, so Mechel will be able to restructure these debts too. In general they should add about $200 million a year to the payments calculated by me.

So, Mr. Zyuzin is back on his feet, agreements with the main creditors are reached, the market's got a signal that no one - starting from small shareholders and finishing by creditors and the state - is interested in bankruptcy for Mechel.

And now it's time to find out how the company is going to pay off these debts.

Troubles

The main problem is that the current EBITDA isn't enough to pay debts. According to my table, in 2016 Mechel has to pay $1.1-1.15 billion, $416 million of which should already be received by Sberbank in the first quarter. There is a preliminary agreement that Mechel should sell a share in the Elga coalfield to Gazprombank and VTB. That will allow the company to cover payment to Sberbank.

In other words it turns out that in 2016 Mechel will have to pay $700-730 million

EBITDA of Mechel for the last 4 quarters amounted to $800 million. Due to weakness of ruble and building-up of coal production in the Elga coalfield there is no reason to expect lower EBITDA for 2016.

It all means that this year Mechel, most likely, will be able to make ends meet.

Figure 4. Dynamics: Sales and EBITDA of Mechel

(Source: Proprietary)

In the long run: what to expect in 2017 and farther?

I think that the most possible are following options:

1) Increase of prices for Mechel's production together with devaluation of ruble will allow the company to boost EBITDA and also to raise profitability. As a whole, conditions of restructuring show that creditor banks of Mechel are invested in this scenario. The cash flow from a full capacity of the Elga coalfield (by 2018) and Universal Rolling Mill will become an additional bonus.

2) Continued reduction of prices. In this case it is possible that Mechel will be forced to sell to creditors much larger share in the Elga coalfield and also a rail road to it. It's hard to estimate their cost; however I saw figures in $2-2.5 billion flashing in press. If it's true Mechel's debt will be reduced to $3.5-4 billion under current EBITDA. So chances of paying off this debt will also be quite good.

Conclusion

It is obvious that all shareholders would just as soon save the company. At that point company's condition is in charge of management and market environment.

Of course, if at an extraordinary shareholder meeting the debt restructuring is approved (in whichI have no doubts) it will become the strong catalyst for growth in shares of the company.

The current capitalization of Mechel is $400 million while EV in 6.4 billion dollars. In 2016 I expect that the company will be able to reduce a debt by $50-600 million, i.e. in case of invariable EV there will already be a potential for doubling or trebling of the share price.

Figure 5. EV dynamics of Mechel

(Source: Proprietary)

As for me it is worth buying these shares with an outlook for 5 years minimum. Thus it should be perfectly understandable that though the risks of bankruptcy of the company have decreased, they still remain. If successful, shares of the company have at least tenfold potential of growth, so these risks can be quite justified.

Disclosure: I am/we are long MTL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.