Mechel OAO (NYSE:MTL) Q3 2014 Earnings Conference Call December 9, 2014 10:00 AM ET
Alexey Lukashov - Deputy Director, IR
Oleg Korzhov - CEO
Andrey Slivchenko - CFO
Dmitry Glushakov - Alfa Bank
Irina Trygub - Raiffeisen Bank
Alexander Sychev - Société Générale
Nitesh Agarwal - Citigroup
Thank you and good day everyone. I would like to welcome you to Mechel’s Conference Call to discuss our Nine-Month 2014 Results which were reported today. With us from management today are Mr. Oleg Korzhov, Mechel’s CEO; and Mr. Andrey Slivchenko, Mechel’s CFO. 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 this 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 do not 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. Reconciliation of non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures are contained in the earning press release, which is available on our website at www.mechel.com.
At this point, I would like to turn the call over to Mechel's CEO. Mr. Korzhov, please go ahead.
Good afternoon and good morning dear ladies and gentlemen. We’re very happy to welcome you at this conference call by the Company covering the results of nine months of 2014. Our consolidated revenue was US$5 billion. The consolidated EBITDA was US$470 million. The overall market environment, which changed since last year, has strong decline in prices for our coal products makes me try and pay more attention to the third quarter rather than the nine months of the year. And looking at the results of the quarter, the Group showed a slight decline in terms of revenue, but the efficiency of our operations have improved. The adjusted operational profit in third quarter grew by 161%, EBITDA by 28%, profitability and EBITDA throughout the whole Group improved by 4%, reaching 14% overall.
A considerable contribution into the quarter results came from the steel makers. The division shot up having grown the EBITDA by 80% quarter-on-quarter having shown the maximum level of profitability throughout its history. The operational profit grew almost threefold and of course a major contribution came from the declining prices for inputs and the favorable environment in the steel product market. Nevertheless, it would not be correct to explain these dynamics certainly through the external factors. Considerable contribution into the results of the steel division came from the steps undertaken to optimize its activities as a part of the corporate strategy development which was endorsed by the Board of Directors in May 2012.
Amongst the measures undertaken, we took out the division structure ineffective operations. We gave up inefficient sales of the products from third party produces, introduced the changes into the system of planning and sales and marketing, expanded this year the products with high added value. Specifically this year we’ve already sold in excess of 100,000 tonnes of the rail products from the Chelyabinsk rail steel mill. And the fact that we are moving in the right direction is being confirmed by the good financial performance of the division.
The mining division didn’t show the kind of growth that the steel making division did, but even against the current market and the minimum price, it was able to maintain profitability and EBITDA at a stable level quarter-on-quarter. The division continues to remain core export operator trying to cover the amounts of output which went down after the Bluestone was put on hold through an active expansion of production at the Elga deposit. Considering the year-end results, this mine will produce about 1.2 million tonnes of coal. Its processing currently will be a continuous one throughout the full year after a successful completion of winterization of the benefaction plant. And it is necessary to note that through the achieved amounts of output, the Elga mine has already demonstrated the cost per tonne of product at the level of the Yakutugol or Yakut coal.
The global market of the steel coal in third quarter showed stabilization. The equivalent benchmark state after level of their previous quarter at about US$120 FOB Australia for the hard coking coal of premium quality, the prices in domestic market effectively stayed unchanged, the prices in the global market for the iron ore product continued to fall down under the burden of the excessive supply and the slowdown of the Chinese economic development, which is the main consumable to iron ore product. By the end of the quarter, they reached minimum levels after the global prices of 2009 as the level of $7 to $8 per the iron ore product CIF China.
[Audio Gap] and was brought about by the growing demand on the part of the builders, investments in the main capital and the growing mortgage financing during the previous quarter. As a result of the growing consumption of the market, we're watching the positive price environment despite the competition becoming stronger through the new projects being developed for the production of the assorted steel for construction purposes which were launched into operation last year, which enabled our steel division to load up its capacity to the maximum and produce the product which is most sought after in the market.
Despite all the positive achievements, the operations within the Company do feel the shortage of working capital, encountering the problem of a shortage of funding. Thanks to the ruble devaluation, our debt went down by 9% during Q3. However, servicing this debt is still a problem for the Company even despite the bankrupt of a better financial performance. So this is in short what happened in the Company during the past period.
And I would like to pass them microphone over to our Finance VP, Andrey Slivchenko, who will tell us more about the Company’s financial performance in between these segments of our business. And thank you very much for your attention.
Ladies and gentlemen, good evening, good afternoon and good morning. Thank you for joining us today. There have been a few developments in the third quarter of this year I’d like to draw your attention to.
First, we’ve seen further increase in the profitability in the third quarter. The EBITDA reached US$220 million, which accounted to a 28% increase from the previous quarter, regardless of the decrease in revenues by 9%, and exceeded average 2013 level by about 22%. Out of $1.6 billion in revenues in third quarter, 33% came from exports with more than 70% contributed by the mining segment.
The steel segment started to contribute more in 2014 to the Group’s EBITDA 46% and nine months of 2014 compared to 29% in nine months of 2013. EBITDA margin doubled from the third quarter -- from the second quarter, reaching 14%. Sales volumes in Q3 dropped both in steel and mining segments which was the major factor for process decrease in the mining sector and did not allow the steel segment to having higher results. Despite low prices on coal and efficient financing of both segments, it led to reduced shipments and sales.
Consolidated EBITDA for nine months of 2014 amounted to US$470 million, with the EBITDA margin up to 9.3% from 8.9% a year ago. Gross margin increased to 37% in the third quarter. For the nine months of 2014, it grew from 30.5% to 35% year-on-year basis as a result of higher marginal products in the steel segment and decreased cost of [raws] (ph) across the product range. Further, we saw additional effect on the currency devaluation on the cost which will be more of an issue in the fourth quarter.
The Group realized operating income of $79 million for nine months of 2014, up from a loss of 596 million for nine months of 2013. If release of accruals for doubtful accounts allowances on tax provisions for previous years adjusted, operated income would amount to $124 million versus $216 million last year.
Net loss for the nine months of 2014 amounted to 1.2 billion, a decrease of almost 46% as compared to the same period last year. The major pressure on the Group’s income was from the revaluation of dollar and euro denominated debt which contributed $734 million for the nine months, of which more than 550 million emerged in the third quarter. Adjusted net loss less non-cash accruals attributable to the previous years would amount to 321 million versus 329 million last year. Net debt as of the end of the third quarter amounted to 8.1 billion, down 9% over the quarter. It further decreased to 7.3 billion as of the beginning of December due to the devaluation of the Russian ruble. In the second quarter of 2014, we approached our major lenders with restructuring request and afterwards we requested other lenders to suspend the current repayments of principal and decrease the payments of interest until a global agreement or restructuring is reached between the Company and its creditors. So no repayments of principal have been made since the midyear except for servicing of the public debt. Thus, the decrease in the debt position was mainly due to the current depreciation. The reduced financial activities help the Company improve its cash standing and decrease its trade working capital only by another 175 million, resulting in minus 120 of trade working capital by the end of the period.
Thank you for your attention and welcome with your questions.
Thank you. We will now take questions. We would ask the participants, please state their name and the company before asking their question and allow some time after for translation.
(Operator Instructions) And our first question comes from Dmitry Glushakov of Alfa Bank.
The question is about the costs. And so respectively, how you calculated what was the way that the ruble devaluation may have affected or will affect the general Group or the separate divisions of the Group during the fourth quarter?
Thank you. The question will be answered by Oleg Korzhov.
So as far as the revenue and expenses are concerned, I shall explain in terms of the way the U.S. dollar exchange rate affects us. So the revenue of the Company in dollar denomination by a month is about US$110 million, US$120 million. This is the amount of our export revenue from the sale of our products. Now if we take a look at the costs, then the Company doesn’t have too many of the costs which are denominated in U.S. dollars. Primarily this is the interest which we are paying to the banks that amounts to about $110 million a month. For about US$15 million, this is the input raw materials, primarily the iron ore coming from the Sivaglinskoye supplies and approximately RUB11 million that we are paying for fighting. So there is still some additional cost for others which is also correlating to the U.S. dollar exchange rate of no material value. So in totality, again, the US$120 million in terms of revenue, we've got about 40 million, 45 million of costs denominated in U.S. dollars. So if we take that apart, all the rest should be considered as the additional revenue for the Company coming from the devaluation of the ruble depending upon the currency rate you may estimate what is the profitability of the Company out of the exchange rate fluctuation.
Our next question comes from Irina Trygub of Raiffeisen Bank.
So several questions. The first one is naturally about the companies, that looking at Slide #15 which is amongst the pages of your presentation. You’re showing quite a big, in excess of 2 billion of debt outstanding. Could you please tell us what is the plan that the Company has to refinance this debt and when Mechel can be expected to reach some sort of an agreement with its lender banks? So this was the first question.
Now the second question. Could you prompt us and tell what is the level of CapEx that you’re planning to have by the end of 2014 and specifically for Q4? And if possible also give us the figures for your 2015 capital expenditures.
And the third question. Does Mechel intend to sell any additional assets and what it's going to do with its Ukrainian assets, which is the Donetsk Electrometallurgical Plant, the Bluestone and any possible divestitures that you’re planning for 2015?
And the last question. How much Mechel is planning to produce from its new rail manufacturing facility in 2015?
First question will be answered by Andrey Slivchenko.
As we mentioned recently, we are reaching agreements with smaller lenders about the restructuring of our debt. We have restructured our debt in leasing operations with the VTB Leasing. We reached an agreement in the recent past with the Uralsib Bank. We are in the process of reaching the final agreements with the Moscow Credit Bank and the Bank of China.
And as far as the banks are concerned, which are part of the pre-export finance syndicate, we have put together a working group. The banks are meeting us halfway. We haven’t yet achieved a final preliminary agreement. However, we’ve initiated a dialog about restructuring our debt within this syndicated instrument.
The key element in this restructuring process is undoubtedly the agreement that we reached with the banks with the government participation in them. Almost one of these days we’ve been able to arrive with Gazprom Bank at a compromise option for restructuring our debt and we submitted this agreement to drop this agreement, the draft of this agreement to Sberbank and VTB for their subsequent clearance.
At this point in time, it is difficult to be precise about the exact timing. But I do feel that in some near future, we’ll be able to achieve an agreement about restructuring with all of the banks mentioned.
Next question will be answered by Oleg Korzhov.
And I will start by the order of appearance and first is about our cost for capital construction and investing into capital construction. So if we take apart our Elga project, which as you know is being funded under the project finance arrangement, then the cost to maintain our investments in 2014 would amount to approximately US$100 million, approximately 25 million every quarter. A similar situation we envisage to be in Q4 with a plan that the cost would amount to about US$25 million.
As we used to mention previously, we have practically put on hold all of the investment project and all of the allocations except the ones which are intended to maintain the operations and the acquisition of the equipment which is intended to substitute the worn and torn one, as well as the ability to bring down the cable.
Now in terms of the similar plans for next year, we’re not planning any considerable increase. As we used to in say in the past, we have minimized all of the cost related to our investment activity. So we shall just remain the cost to maintain our operational position. And depending upon the kind of cash flow that we will have next year and the budget that we endorse, these levels will remain in range of US$100 million to US$150 million a year.
Answering the second question which is about the universal rolling mill, in 2014 we plan that the amount of production would amount to 125,000 tonnes, out of which approximately 100,000 and 115,000, maybe even 120,000 tonnes will be the construction steel and about 10,000 to 11,000 tonnes will be rail's. For next year, we are planning to significantly increase the amount of production at this facility and so I think that the overall output would amount to approximately 350,000 tonnes next year.
We currently are undertaking a very serious effort together with Danieli Company to expand our construction steel at the mill. And as of April next year, we’re planning to considerably expand the offering and through that considerably expand the amount of production.
Now as far as the certification of our rail products are concerned, we are doing this work according to the pre-planned schedule. Right now we have already done the preliminary tests, laboratory tests in the Railroad Research Institute. So the first shipment of rail was already installed as a experimental rail link. And so the tests again will start which should amount to about 150 million gross kilometers which is the requirement of the railroad company. And so the plan is to complete it by the end of the second quarter next year. And after the tests are completed, we are expecting that the certificate will be issued to our [third] (ph) shipment. And as of that period, we will be planning to start shipping our rails to the Russian Railroad Company on a regular basis.
And now as far as the third question about the sale of our assets is concerned, as we have previously stated, second stage of our divestiture program is where we are looking at the possibility of selling the following assets, Kuzbass Marketing and Sales Company, the American Bluestone Company, Donetsk Electrometallurgical Plant and Moskoks, which are the facilities which are currently being actively considered and discussed and we have an understanding and we have various bids that we received so far. The most advanced in terms of the sale is Bratsk feroalloy plant and Kuzbass Marketing and Sales Company which have almost reached the home stretch in terms of the sale. As far as Bluestone is concerned, we have done a lot of preparatory work. And as of today, we have a number of commercial bids for the acquisition of these assets from third parties. We are in active discussions with these potential buyers. And as far as the price and the settlement principles are concerned, so we are planning that in the near future we will be also reaching a certain home stretch frame.
As far as the Donetsk Electrometallurgical Plant is concerned, the situation is not a straightforward one. You know that we have stopped this operation because of the economics. And so to speak today about relaunching its operation again is a bit of a problem and is wrought with challenges because of economic considerations and the sale of this asset is also meeting with the difficulties. Unfortunately the economic and political environment there doesn’t make it possible for us to bring in a buyer either to start working at that facility or continue looking simplify for a potential acquirer for this asset.
Next question comes from Alexander Sychev of Société Générale.
Several questions in this one. The first is what is the volume of reserves that you were able to sell during this quarter. The second is about the South Kuzbass. And specifically the production of coal at South Kuzbass reached the minimal during the past three years. What is the reason behind it? And what are the plans that you’re having for this year in 2015?
The third question is about Elga. How much coal you sold during Q3 and what was the mix in between the coking coal and steam coal? And the average sale price, what was it?
And the last question. Could you explain why in one of the slides in your presentation for a second quarter in a row the average coking coal sale price is not less than the PCA anthracite coal price?
A - Alexey Lukashov
The question will be answered by Oleg Korzhov.
Well, sorry if I’m going to miss some of the bits of your questions and I would be asking to kindly repeat if something I missed in making from my side. So as far as the amount of production and shipping from the South Kuzbass coals in Q4, we are planning that the volume of production of shipment in the fourth quarter would equal the third quarter. Principally, there are not going to be any changes.
Now if we compare the volumes of production in between 2014 and 2013, it is true that as far as the shipments are concerned, there is a bit of a decline. Last year we shipped to our consumers 22.7 million tonnes of product. This year we’re planning to reach the level of 21 some million tonnes. The deviation of 1.6 million from several factors, the first was Bluestone about 1.7 million tonnes of shipments that we didn’t do this year. We added Elga in our overall shipments for about 800,000 tonnes to 1 million tonnes for the year, but we also have the negative of 600,000 tonnes in South Kuzbass, whereby Yakutugol continues to maintain the same level as last year.
As far as the South Kuzbass is concerned, there are several reasons as to why the shipment volumes went down. One of the basic reasons is because [indiscernible] mine this year had to go through the reassembly of the [indiscernible] and so we didn’t do any work there. On top of it, I should say that the funding issues we’re financing the operation of our mining division because of the working capital difficulties, they do affect our overall operation efficiency and in fact basically were the reasons of the H1 where we had to keep up with all of our financial obligations with the bank. And so we had to bring working capital sufficiently down. So that is the reflection of the situation whereby the number of assets where we had to incur maximum expenses because of the stripping that we have to do, we had to go through this problematic period.
But as far as 2015 is concerned, we've planned that the volumes of output will be at the level of 2014. We do not envisage any prerequisites for them to go down. In April we are planning to relaunch the [indiscernible] mine and that would give us an additional volume of production. Additionally, we also plan to grow our output from Elga as well as add its volumes to the overall shipments.
And as far as the question is concerned about the changes in the reserve statistics that we would bring into our operations during Q3, as far as the stock of steel products in our warehouses, the station didn’t change. We basically entered into the third quarter and exited from it with the same level of stock as far as the coal produce are concerned in terms of the soft levels maintained at the warehouses, they went out by approximately 700,000 tonnes.
And now we'll try and answer the question about Elga. And as far as I was able to note it down, the volumes of production at Elga during Q3 were 528,000 tonnes, the shipment volumes, bearing in mind the volumes processed by the plant 317,000 tonnes and the 105,000 tonnes coking G grade concentrate and the balance was the energy and steam coals.
And as far as the price for the Elga coal is concerned, the coking concentrate we sold during Q3 at the price of approximately $70 to $75 VCA, FCA. The energy coals we sold approximate at the price of $20, $25 on the same basis.
Now this is the repeat of the question which was seemingly missed in the overall responses. So the question was about the fact that in Slide #5 shows that during the second quarter and the current quarter the coking coal prices were lower than the anthracite and the brown coal prices. The question is, why is that so?
Sorry for this slight delay. We now found exactly the slide that you are referring to. So let me explain that in Q3, and let me begin by saying that the coking coal concentrate prices haven’t really changed. In Q3 they were effectively the same as during the second quarter. Now the price changes as far as the anthracite and the PCI grade coals are concerned happened because of the shipments we did during the third quarter to Ukraine and that is -- I mean during the third quarter the prices considerably went up, as a result of which the average price became higher than the coking concentrated prices.
(Operator Instructions) Our next question comes from Nitesh Agarwal of Citigroup.
This is Nitesh from Citi. I just wanted to confirm on your net debt situation at the billing of December. What was the approximate net debt including financial lease liabilities at the beginning of December?
Could you please repeat the question? The connection is not very good.
My question is, what was the approximate net debt including financial lease liabilities at the beginning of December?
The question will be answered by Andrey Slivchenko.
The net debt amount is US$7.3 billion, which is figure that we are registering in the beginning of December.
We have no more questions. (Operator Instructions) There are no questions in the queue.
Ladies and gentlemen, thank you for taking the time to join Mechel's nine months 2014 financial results conference call today. The replay of this call will be available on Mechel’s website. If you have any further questions, please contact the Investor Relations office. Thank you again from all the team here.
That will conclude today’s conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.
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