We are upgrading our recommendation on Russian miner
Mechel OAO
(
MTL
) to Neutral factoring in the healthy prospects for its Elga mine.
The company's profit slipped 29.5% year over year to $218 million
in first-quarter 2012. Revenues rose modestly to $3 billion.
Despite a weak pricing environment, revenues from the mining
segment increased year over year in the quarter on the back of
higher coal product sales volume and increased iron ore concentrate
revenues. However, steel market dynamics were not favorable and
Mechel had to deal with lower demand for steel products.
Mechel, which competes with
ArcelorMittal
(
MT
) and others, 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 and is mainly focusing on growth and
cost-cutting measures.
The company owns and controls essential infrastructure, including
ports, rolling stock and power plants, which provide access to the
export markets. It is capable of internally sourcing most of its
raw materials.
We are encouraged by the incremental opportunities stemming from
the Elga mine which is expected to reinforce Mechel's position as a
metallurgical coal producer through capacity expansion.
The company continues the development of the Elga mine. It has also
constructed a seasonal washing plant at the site for accelerating
the production and sales of coking coal concentrate. In addition,
Mechel is also making progress in building a second line at the
Sibirginskaya mine in the Southern Kuzbass, which is expected to
double its production capacity to 2.4 million tons of coking coal a
year.
However, Mechel's high debt load represents a serious concern. The
company had total debt of $9.6 billion sitting on its books at the
end of the first quarter, roughly four times of its market
capitalization. Mechel could be handicapped because of its high
leverage and interest burden and may not be able to keep up with
its huge capital spending program.
In addition, Mechel's cost advantage is in danger of being wiped
out as the company has seen costs rising at a fast clip over the
last three years. Increase in electricity costs, railway
transportation, natural gas and labor coupled with effects of
inflation could drive Mechel's costs further north and diminish its
earnings power.
There are several more established players in the steel and mining
space who have more resources than Mechel. This could ignite a
price war in emerging regions where Mechel has interests, forcing
it to reduce price in order to compete and taking a hit on its
margins in the process.
Our recommendation on the stock is backed by a Zacks #3 Rank, which
translates into a short-term (1 to 3 months) Hold rating.
ARCELOR MITTAL (MT): Free Stock Analysis Report
MECHEL OAO ADS (MTL): Free Stock Analysis
Report
To read this article on Zacks.com click here.
Zacks Investment
Research