(MTL) Mechel OAO 2011 First Quarter Earnings Soar

Russian mining company Mechel OAO (MTL) recorded a net income of $309.1 million in first quarter 2011 comprehensively beating last year’s consolidated net income of $82.6 million, a jump of 274.3% year over year.

Revenues in the first quarter 2011 soared 54.4% year over year to $2.9 billion based on the company’s relentless efforts to increase production.

Throughout the quarter 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 the reported quarter climbed more than three times the first quarter profit in 2010 and amounted to $448.4 million, compared with the operating income of $147.6 million in the first quarter of 2010. Operating margin was 15.28% in the first quarter of 2011 versus 7.77% in the first quarter of 2010.

Segment Performance

Mining Segment: The segment’s revenue from external customers in the quarter totaled $828.1 million, an increase of 57.2% over $526.8 million in the comparable year quarter. The segment’s operating margin was 33.19% versus 25.33% a year ago.

Although the segment underwent certain ups and downs in 2010, management quite successfully averted the crisis. The Neryunrginskaya washing plant was temporarily halted in the quarter and so there was a decrease in end product output at Yakutugol. The company took prompt measures to bring the plant into operation.

Also there was an increase in demand of coal from China, South Korea and Japan. The company is positive about the segment and expects good financial results in 2011.

Steel Mining Segment: Revenues from the Steel Mining segment made up 59.9% of total revenue, soaring 60.7% year over year to $1.8 billion. The segment reported an operating income of $125.6 million versus its prior year operating income of $23.5 million.

The company continued developing high value added products as well as maintaining a high workload for its facilities and also increased the production of many of its products leading to stable operations of the segment. Due to the expansion of its Mechel Service Global sales network, the volume of steel products sales increased at priority rates.

The segment implemented cost control measures and also an extensive investment program. As part of this investment program a modernized steelmaking complex was launched at Otelu Rosu plant in Romania. The rolling mill #250 at Izhstal is being prepared for commissioning, and construction of the universal rolling mill at Chelyabinsk Metallurgical Plant continues.

Ferroalloy Segment: Ferroalloy segment sales totaled $124.1 million, up 30.7% from the year-ago level. The segment constituted 4.2% of consolidated revenue. The segment recorded an operating income of $11.9 million in the first quarter of 2011 against operating losses of $6.7 million in the first quarter of 2010.

Despite increased cash costs the segment’s revenue was almost at par with the previous quarter’s results due to increased electricity and coke prices, favorable price conditions and growing volumes of production and sales of ferrochrome.

Power Segment: The Power segment generated about 7.7% of revenues, which totaled $225.1 million, up 21.4% year over year. Operating income for the segment in the reported quarter increased 59.8% to $33.5 million. Mechel’s power segment keeps growing and developing and also aims at optimizing costs. The company remains optimistic about the segment’s results in the upcoming quarters.

The company results in the current quarter grew significantly over the last quarter due to the increase in average electricity tariffs and consolidation in the company’s performance the results of Toplofikatsia Rousse, as Mechel increased its stake in the power station’s charter capital up to 100%.

Financial Position

Mechel has a large capital-spending program. Capital expenditure for the first quarter of 2011 amounted to $335.2 million, of which $179.3 million was invested in the mining segment, $141.1 million in the steel segment, $7.5 million in the ferroalloy segment and $7.3 million in the power segment. Total debt was about $8.2 billion, while cash and cash equivalents stood at $212.9 million as of March 31, 2011.

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 short-term (1 to 3 months) Zacks #3 Hold rating and a long-term (6 months) Neutral recommendation.

Competitors

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

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