Mechel's Earnings Strong, but the Long-Term Matters More

| About: Mechel OAO (MTL)

Let me preface this post by saying, I don't really care too much about the quarterly earning reports for some of the companies I hold, Mechel (MTL) is much like Petrobras (PBR) and Vale (NYSE:RIO).

Mechel reported yesterday - it will be part of the portfolio for a very long time; in fact when we launch for real it will be one of the first buys. One day when the potential for global recession hits the market's conscience. I expect a very large sell-off, and that's going to be one of those times to buy this sort of name in large scale, along with those other handful of "tuck under pillow for half a decade" names - IF you are a believer in a world of shortages and that we are nowhere near the end of a very long uptrend in commodities. While demand for such things might dissipate temporarily (a few quarters to a year and a half) as the world slows, the long term won't change one iota.

While I realize the lemmings in the market will overreact one way or the other as if the world is ending or mermaids and unicorns have arrived based on a few cents here or there every 90 days, I am indifferent. These are very long term plays, and my positioning in them has more to do with technical patterns at any moment rather than any earnings hit or miss or any 90 day period.

With that said, let's look at the numbers just so we have a historic record in the blog when people are talking about Mechel as a great investment on CNBC circa 2009 or 2010. Note this is a full year result (2007) not a quarterly report. Last time around they reported the first 9 months together [Dec 12: Mechel Reports Earnings, Considers Mining IPO], so if you were inclined, you'd take this report, and subtract out the numbers from the last report to get "quarterly" results. Since I could care less about a 90 day period, I won't.

  • Net revenue in 2007 rose by 52.0% to $6.7 billion from $4.4 billion in 2006. Operating income rose 92.6% to $1.4 billion, or 20.9% of net revenue in 2007, compared to operating income of $725.7 million, or 16.5% of net revenue in 2006.
  • Mechel reported consolidated net income of $913.1 million, or $2.19 per ADR / diluted share, an increase of 51.4% over consolidated net income of $603.2 million, or $1.48 per ADR / diluted share, in 2006.
Mining Business
  • Mining segment revenue for 2007 totaled $1.8 billion, or 28% of consolidated net revenue, an increase of 41.3% over segment revenue of $1.3 billion, or 30% of consolidated net revenue in the 2006. The increase in revenue reflects production growth at our principal coal producer Southern Kuzbass, production growth at Yakutugol, and the acquisition of the remaining assets of Yakutugol, the largest Russian coking coal producer. These factors resulted in strengthened market position and increased sales of mining products to third parties for the year.
CEO Comments on mining segment
  • "Mechel's mining segment experienced a breakthrough year in 2007. As demand and the pricing environment continued to improve significantly, Mechel increased production, successfully raising coal production by 25% and nickel production by 19%. With the acquisition of strategic assets, such as Yakutugol and Elgaugol, we have strengthened Mechel as global company with significant growth potential. As a result of favorable pricing and increased production, net income for 2007 increased 3 times compared to 2006. Profitability in the mining segment was also positively affected by cost control efforts and successful execution of the technical upgrade program for segment's mining plants technical upgrade program.
Steel Business
  • Revenue from Mechel's steel segment increased by 42.5% in 2007 to $4.3 billion, or 65% of consolidated net revenue, from $3.0 billion, or 69% of consolidated net revenue, in 2006. Operating income in the steel segment increased by 37.3% to $558.2 million.
CEO Comments on Steel Segment
  • "Although we successfully executed our plans to increase production capacity, the pricing environment for metallurgical products especially in the second half of the year remained challenging. With higher transportation costs and steadily growing prices for raw materials, scrap, electric power and gas, our steel products prices were flat to down. Record high nickel prices also affected profitability in Mechel's steels segment, which is Russia's largest stainless flat products producer. In addition, rebar market overstocking led to decreased pricing in the latter half of 2007, which put pressure on our profitability as we have a significant market share for long steel products.
  • As a primary objective for the steel segment, we are continuing to concentrate on increasing output of high value-added products and achieving earnings growth through modernizing production facilities and controlling costs. Despite the ongoing high materials costs, we continue to see an improving economic environment for our products, which makes us optimistic regarding improved financial performance in the steel segment."
The smaller Power business which is newer
  • Revenue in Mechel's power segment from sales to 3rd parties totaled $503.3 million, or 8% of consolidated net revenue, an increase of 917.6% over revenue from sales to the third parties of $49.5 million or 1% of consolidated net revenue in the 2006.
CEO Comments on Power business
  • Mechel began to develop its power business in 2007 and the acquisition of the coal- fired Southern Kuzbass Power Plant and Kuzbass Power Sales Company made Mechel one of the main players in the energy market in the Kemerovo region, Russia's principal coal mining area. In 2007, Mechel also developed its power segment abroad by acquiring a 49% share of Toplofikatsia Rousse JSC, located in Bulgaria to extend its presence into new steam coal markets. Our power assets will require significant efforts to modernize the production facilities and integrate them into the Group's production chain.
  • The segment's profitability in 2007 was primarily affected by interest payments of "in-group" loans obtained to make the strategic acquisitions during the year. Looking forward, we are very optimistic about the prospects for power generating facilities in Russia, where many regions lack energy. We expect that the forthcoming deregulation of the electricity market will drive the development of the Russian power industry and benefit Mechel. Based on these factors, we plan to continue developing Mechel's power segment, which will increase the Group's stability, decrease costs due to the generation of our own electric energy and build value for the shareholders of the company."

There is a lot more in the earnings report as the company spreads its wings into Eastern Europe - Bulgaria, Romania etc etc [Apr 9: Mechel Continues to Acquire Most of Eastern Europe]. If this company were in a "free market", I could see Mittal (NYSE:MT), or one of the 3 major mining giants buying it. But since it is not, we'll just have to enjoy years of growth ahead, although a global recession will hurt steel prices to some degree - but unless you're a "world will not need steel for the next 30 years" type of person, the story here is still very young. Below is the chart since November 2007 when we began this position; keep in mind its effectively split 3:1.

Disclosure: Long Mechel in fund and personal account