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By John Helmer in Moscow

Mechel, the fifth-ranked Russian steelmaker and leading coal miner, lost 2.6% from its New York-listed share price as the market failed to react positively to this week’s company’s release of nine-month financial results. The Mechel group’s market capitalization is currently $2 billion. It was twelve times larger, $24.4 billion, when the share price hit peak on May 19 of this year.

Mechel is one of the leading Russian suppliers to China of coking coal and iron-ore concentrate, which are shipped from Posyet, a company-owned port close to the North Korean border.

The state guarantee implied in the award of a $2 billion loan from Vnesheconombank (VEB) — reported in the Moscow press at the start of December, but not confirmed by the bank or the company — has also failed to lift confidence in Mechel. One reason may be that VEB has so far refused to lend the money.

A company-inspired press leak on December 1 claimed that VEB had given “preliminary approval” to the big loan. According to VEB announcements last month, it has undertaken to process loan approvals within 18 days of application. In Mechel’s case, the deadline has now passed. Three weeks after the press leak, according to Mechel spokesman, Ilya Zhitomirsky, the company is not confirming or denying whether it applied for the VEB loan. Nor is Mechel saying whether it will get the VEB money.

Instead, a posting on the Mechel website, dated December 4, suggests the company has had to make do with a smaller line of credit as a consolation prize. According to the announcement, the state-controlled Vneshtorgbank (VTB) has agreed to extend Rb15 billion ($543 million) in credit lines to Mechel’s fareastern coalmines.

Despite the record-breaking financial performance, cash reported at September 30 amounted to just $137 million. At the same time, total debts, including both short-term and long-term obligations, amounted to $5.1 bilion.
Troika Dialog metals analyst, Sergei Donskoy, reports that so far Mechel management “did not provide much color on debt refinancing, saying that negotiations are under way to roll over or refinance the $1.5 bln bridge loan maturing in March. Mechel will have to repay or refinance $2.9 bln by end 2009, which looks like a very complicated task and remains a major concern.”
Revenues reported for the nine-month period are reported at $8.58 billion; they are up 85% on the same period of 2007. Ebitda grew 138% to $2.9 billion, while net income for the period rose 132% to $1.6 billion. Un like other steelmakers, Mechel has not issued quarterly comparisons, enabling assessment of the slowdown in steel and coal demand between the second and third quarters of this year, and the concomitant pressure on the company’s financial performance through to the close of the fourth quarter.

A report by Moscow brokerage UnicreditAton estimates that Mechel’s revenues in the third quarter were $3.2 billion, just 7% up on the second quarter. Ebitda gained 25% quarter on quarter to $1.3 billion. However, net income fell in the third quarter to $535 million, a drop of 11%.

Controlling shareholder and chief executive Igor Zyuzin announced that “Mechel’s record financial and operational performance in the first nine months of 2008 was the result of successful implementation of our strategy to grow the Company both organically and through acquisitions. Favorable market conditions for mining and steel products also contributed to the Company’s performance.”

Mechel’s mining division accounts for 20% of the group’s revenues reported; but with lower costs and higher profitability, the mining division accounts for 59% of Ebitda, and 62% of net income. Sales to external customers by the mining division grew by 221% this year, compared to a year ago. The division produced 21 million tonnes of coal, of which 12 mt was coking coal; these volumes were up 54% and 95%, respectively, compared to the nine-month period of 2007. Iron-ore dropped 3% to 3.6 mt.

The steelmaking division reported 55% growth, year on year, in 9-month sales revenues of $4.8 billion. Ebitda and net income grew by 96% and 82%, respectively. Pig-iron volume fell 2% to 2.8 mt; crude steel gained 4% to 4.8 mt; and rolled production gained 11% to 4.3 mt. Supervbising executive for steel, Vladimir Polin, is quoted on the company website as explaining the steel results as due to “optimization of our sales structure and our production cost reductions program, as well as a favorable pricing environment for steel products and the contribution of acquisitions.”

Mechel is also moving into the domestic steel service centre (SSC) sector. According to Polin, “this year we have significantly expanded the branch network of Mechel Service OOO, which is engaged in steel product sales to end customers. Given the current soft rolled product market, these efforts give Mechel competitive advantages and guaranteed volume for its metal products orders by avoiding bulk traders who for the most part ceased their offtake.”

Sources report that Mechel is currently considering a takeover bid for Inprom, the southern Russia-based SSC group, owned by Igor Konovalov.

The ferroalloy division, to which Mechel has added the chrome mine and refinery assets of Oriel Resources, acquired early this year, is reported to have had sales revenues from external customers of $402 million; this comprises just 5% of the consolidated revenue figure. The division turned out 14,000t of nickel in the 9-month period (up 6%); 67,000t of ferrosilicon; and 48,000t of ferrochrome.

In a conference call for analysts, following the release of the financial report, Zyuzin claimed the company is reducing employee workhours, instead of firings.

Zyuzin also said that Mechel will cut its overall production by 20 to 25% in the fourth quarter of 2008 and the first quarter next year. To keep its profits high, he said, Mechel is increasing its sales of thermal coal and reducing coking coal production, as well as looking to ferroalloys instead of nickel. “We are adjusting production to a bigger share of steam coal, as its market has improved,” Zyuzin said, adding the demand for the coking coal had halved.

Zyuzin said he was expecting the reduction of the coking and thermal coal prices by 20 to 30% in the first half of the next year.

In its assessment of the Mechel report, UBS’s Moscow office has drawn attention to the fine of Rb790 million ($32 million), which Mechel was obliged to pay, following an antitrust investigation of Mechel and other coking coal companies’ pricing policies on the domestic market this year. This is not mentioned by the company.

“We also assume the reversal of significant forex gains in 1Q08, which positively impacted net earnings in 1Q08, due to the weaker ruble (against the dollar) at end of the period in 3Q08 relative to 1Q08,” UBS reported as well.

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