Full Year 2011 Mechel OAO Earnings Conference Call
May 10, 2012 AM EDT
Thomson Reuters StreetEvents Event Transcript
E D I T E D V E R S I O N
MTLR.MZ - Mechel PAO
Full Year 2011 Mechel OAO Earnings Conference Call
May 10, 2012 / 02:00PM GMT
==============================
Corporate Participants
==============================
* Vladislav Zienko
Michel OAO - Director of IR
* Yevgeny Mikhel
Michel OAO - CEO
* Stanislav Ploschenko
Michel OAO - CFO
* Oleg Korzhov
Mechel OAO - SVP Business Planning & Analysis
==============================
Conference Call Participants
==============================
* Dmitry Smolin
URALSIB Capital - Analyst
* Anton Rumanse
Troika Dialog - Analyst
* Dan Yakub
Citigroup - Analyst
* George Buzhenitsa
Deutsche Bank - Analyst
* Alad Zhukov
HSBC - Analyst
* Vasily Kuligin
Renaissance Capital - Analyst
* Alexander Mordan
Sovlink LLC - Analyst
* Sergey Donskoy
Societe Generale - Analyst
==============================
Presentation
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [1]
------------------------------
Thank you and good day, everyone. We would like to welcome you to Mechel's Conference call to discuss our full year 2011 results, which were reported today. With us from management today are Mr. Yevgeny Mikhel, Mechel's CEO; Mr. Stanislav Ploschenko, Mechel's CFO, and Mr. Oleg Korzhov, Mechel's Senior Vice President for Economics and Management. After management has made their formal remarks, we'll 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 late 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 Provision of the US 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 to time with the United States 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 of forward-looking statements.
In addition, we will be using non-GAAP financial measures, including EBITDA, in our discussion today. Reconciliations of non-GAAP financial measures to the most directly comparable US GAAP financial measures are contained in the earnings press release, which is available on our website at www.mechel.com.
At this point I'd like to turn the call over to Mechel's CEO, Mr. Mikhel. Please go ahead.
------------------------------
Yevgeny Mikhel, Michel OAO - CEO [2]
------------------------------
(interpreted) Good day and good morning, ladies and gentlemen, and welcome to the conference call where we will discuss the Company's performance in 2011.
On the whole 2011 was quite successful for the Company. Despite an ambiguous price dynamics and high market volatility for our Company's key products, we took full advantage of the vertically integrated structure of the holding and achieved financial results that significantly surpassed those of the year before.
Mechel's consolidated revenue in 2011 increased by 29% and amounted to $12.5 billion. EBITDA went up 19% to $2.4 billion. Net income added 11% and amounted to $728 million.
Strategic investment projects of the Company peeked in 2011. These projects are aimed at transforming the Company to make it more efficient and the leader in the industry. Today we can present concrete results of the investments made in the course of the last several years.
In particular, in August 2011 we started full scale mining of coal at Elga deposits and at the end of the year a railroad linking the deposit with Baikal-Amur Mainline was opened. That link will facilitate deliveries of cargo that is needed to increase coal production at Elga and lower transportation costs associated with shipments of coal to customers.
This year we plan to complete construction of the seasonal coal washing facility at Elga. With it we will be able to produce coking coal concentrate out of the deposits, which will improve efficiency of the Elga coal complex, and will open up new possibilities for direct delivery of Elga concentrates including its export.
Speaking about the performance of the Mechel's Mining Division in the last year, I have to say that, despite certain challenges caused by suspension of operations of the washing plant at Yakutugol for one and a half months and with a favorable market price environment since the start of the year, we spared no efforts to build up production. As a result, we raised sales of coking coal concentrate by 9% on the previous year.
We managed to achieve an even better dynamics in the sales of Anthracites and PCI coal whose sales grew respectfully by 36% and 332%.
As the end of the year Mechel sold 16.8 million tons of metallurgical coal and entered top three of the leading global producers.
During the year Mechel reaffirmed its leadership in reserves and resources and audits based on JORC standards shows that the Company has coal reserves and resources of 3.3 billion pounds and 4.4 billion pounds respectively. We look confidently into the future as the Group's strategy aimed at strengthening its leadership in mining of metallurgical coal is supported by a strong resource base.
Implementation of strategic projects in Mechel's steel segment was no less than intensive. In the last year we made significant progress in our project for construction of the universal rolling mill at the Chelyabinsk Metallurgical Plant. By this time we have put into operation the first stage of this unique integrated steel processing facility. Now, even as we speak, the pump produces high quality billets for the universal rolling mill with all the properties that are required to manufacture 100 meter rails with increased wear resistance surface endurance and lower temperature robustness.
I note with pleasure that the steps that we were taking for the past two years to operate the Beloretsk Metallurgical Plant enabled that steel works to report record figures in hardware production in 2011.
B&B has established itself firmly as the leader of the Russian hardware market. In 2011 alone Mechel's sales of hardware products increased by 17% closely approaching the level of one million tons.
Our services and sales network was also developing very actively. In 2011 Mechel Service Global shipped more than 4.7 million tons of steel products, 57% more than in the previous year. Today Mechel Service Global has 160 offices in 16 countries, which enhances companies' flexibility and stability during seasonal fluctuations of demand for steel products in different regions.
It was demonstrated once again in the fourth quarter of the last year, given Mechel Service Global mature infrastructure and broad presence in the most appealing regions, our current priority is to sponsor developing intensively rather than extensively. We will do that by expanding our services and treatment of rolled products at the storage facility, which will increase added value of products sold.
Summing up the results of 2011, ladies and gentlemen, I must say a few words on how we see the development of our business.
You must have already observed that in the last several years Mechel's production was growing at an accelerating pace in many aspects. We significantly expanded our production base in terms of our geographical presence and products diversification. Parallel with those activities we were implementing a rather ambitious investment program aimed at laying the foundation for the Group's successful development in the years to come.
However, the reverse side of that synchronous accelerated development was the mounting debt of the Mechel Group. This strategy was justified by the growing market. At the same time since the fourth quarter of the last year we have witnessed a lot of market volatility. There are no clear indicators that global economy is growing at the rate that we enjoyed throughout the last decade.
All that made us conclude that the current leverage ratio may impose considerable constraints on the development of business. That is why one of the Group's priorities today is reduction of debt. In order to achieve that objective, we must remove the very driver of a further growth, extensive business development in all areas. In this connection we decided to review the development strategy to put an emphasis on the key elements of our businesses' growth, our competitive advantages which offer the highest potential for increase of the shareholder value.
The new strategy is based, as before, on the concept of a vertically integrated mining and metallurgy holding, which has proven its merits in the context of industrial cycles and stability in the times of turbulence and the sales market. Our focus in the vertically integrated holding will be on the following objectives.
First, prioritize development of the mining division on the basis of the coking coal reserves and one of the largest in the world. We believe that the unique combination of the richest resource base, geography and product diversification, closeness to the key sales markets, relatively low production costs, Group's own logistics capabilities and enormous experience with projects in the mining industry has the greatest potential for high profitability and added value for our shareholders and we must unlock that potential.
There is a reason why I mentioned our long logistics to success in monetizing the reserves on which our value is built, control the transportation component [improving costs] is a crucial factor. It will also be in the center of our attention in the context of the mining division development.
Second, we intend to increase profitability of our business by cementing Mechel's position as the largest supplier in Russia and the CIS in the market of steel products for the construction industry. Among our competitive advantages in that market are the largest service and sales network in the country and the comprehensive range of steel products for the end customer.
When the universal rolling mill is put into operation and this project has reached its final stage, our leadership in this market will become stronger. We will expand our products range even further, which will guarantee us a tangible share in all major infrastructure projects in the coming decades and which will be reflected in the financial results and cash flow.
Third, our competitive advantage of our Steel Division is its material share of the higher value added products, primarily specialty steels, stainless rolled products and hardware. We are number one in Russian production of some of these products.
This lead is founded on a sizable market share and unique technologies. If we advance those technologies we will be able to significantly expand the product line and improve the quality, which will contribute even more to profitability of this business.
An extensive European network of Mechel Service Global allows us not only to substitute imported products of this segment into Russia but to build up exports to Europe. We have a good understanding of the potential growth of sales in this segment since we already sell our own and third-party products in Europe.
This strategy will provide a focus on those areas of business that are most profitable and at the same time that secure the Group's leading positions in their respective segments of the market. It will also have clear criteria for the structure of our business and the need to own and manage certain assets in the context of the new strategy implementation.
To that end, we have already started reviewing all our assets, their conformity to the list of criteria and contribution to the strategies of execution. We will also assess alternative costs of owning these assets. Today they are relatively high, given the current level of debt and the investment program which must by carried out. Assets, which won't pass the test, will be divested thus reducing our gearing.
We are convinced that in the present days there are abundant opportunities, as well as instability in the key markets and also financial markets, and we must be ready to take bold decisions to maintain and develop one's competitive advantages.
I am certain that the new strategy approved today by the Board of Directors will not only ensure a high value of business already in the [midterm] but will also improve operational cash flow and lower Mechel's leverage to what we believe to be the optimal level of net debt to EBITDA of not more than two to one through the sale of non-priority assets among other things.
And now I pass the floor to Stanislav Ploschenko, Senior Vice President for Finance, who will cover our financial results for 2011 and details of the revised strategy. Thank you for your attention.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [3]
------------------------------
Ladies and gentlemen, good morning and good afternoon. We will begin the overview, as usual, with the results of the mining segment.
The fourth quarter was quite challenging, largely due to the uncertainties our customers faced from acceleration of the European sovereign debt crisis in the second half of 2011. These uncertainties led to a significant decrease in European steel production and, to a lesser extent globally, which could not leave our key sales markets unaffected.
Although our fourth quarter coking coal sales and physical volumes remained flat quarter-on-quarter, the average FCA price decreased by 12% to $181 a ton with a $66 million negative effect on the net revenue.
Coke sales volumes were also off quarter-on-quarter by 38%, while the sales price was down by 6% to $291 FCA. That reduced the revenue by another $46 million.
Other met coal, that is to say Anthrocites and PCI, on the contrary was a bright spot as it was all year. The market notwithstanding we were able to increase quarter-on-quarter sales volumes by 27% which, along with flat FCA prices at around $104 per ton, contributed $52 million to the revenue from third parties.
Steam coal sales volumes decreased by16% although the flat to slightly positive price dynamics due to high season did have a sensible impact on the revenue. As a matter of fact, the share of thermal coal fell to just 3% of the third-party revenue in Q4, as you can see on slide number six, which means it can hardly have an effect on the total picture and is fully in line with our strategic focus on met coal.
Iron ore FCA price has decreased by 5% to $101 a ton. However, an 8% drop in sales volumes quarter-on-quarter offset the price effect on the revenue completely.
Overall, mining segment revenue decreased by 7% to just $1.061 billion in Q4. The inter segment revenue, on the contrary, grew by 5% to $264 million.
It will also be interesting to take a look at the change in geography of sales on the same slide. As you can see, the high volatility of sales in Q4 affected mostly international sales pushing the sales to Russia and CIS from 30% in Q3 to 38% of total sales in Q4.
Amongst others the sales to China were affected most of all, as its share decreased from 28% to 23% with the rest of Asia growing from 13% to 18%. The total share of Asia at the same time remained unchanged at 41% of sales. This example illustrates the benefits of sales diversification, which we have been pursuing over the past several years. It fully paid off in the fourth quarter when China proved again to be probably the most volatile market for met coal.
Faced with increased volatility in our core markets and decreasing revenue in some of our mining products, the management dedicated all its efforts to keep the cash cost under control and we are proud to say that we achieved a considerable success here. Cash cost at Southern Kuzbass and Yakutugol held steady at $35 and $32 per ton respectively, despite high season for maintenance, power and fuel expenses. Cash cost at Korshunov iron ore plant ticked up only by $1 to $42 per ton.
At the same time, cash cost at our North American operations increased by $17 to $113 per ton. This was driven by a 9% decrease in sales volumes quarter-on-quarter as the decreased European steel production most directly impacted our Bluestone operations.
As of the end of the year, we took two mines, [Spider Ridge] and [Job 32], temporarily off line, as it is not economical to operate them in the current environment. Taking these two mines off line in conjunction with other cost saving measures, we plan to get cash cost per ton back under $100.
Overall cost of sales in Q4 decreased relative to Q3 by 5% to $582 million. That decrease versus the 7% fall in revenue led to the gross income quarter-on-quarter decline by 5% to $744 million, remaining however at the same 56% of the segment revenue as in the previous quarter protecting the profitability of the segment.
Selling and distribution expenses decreased by 37% to $167 million. The decrease was primarily driven by two factors; a 4% decrease in overall segment sales volumes and an increase in the portion of sales on the FCA basis as opposed to DAF and CPT.
To illustrate the effect of the shift to FCA sales in Q4, the selling and distribution expenses as a percentage of third-party revenue decreased from 23% to 16%.
Non-profit taxes posted a gain on $3.5 million in Q4 versus a $15 million expense in Q3 due to a $20 million correction of the mineral extraction tax for the previous period at our Russian coal and iron ore operations following the recalculation of the taxable base using the production costs as opposed to the previous calculation based on the average sales prices.
Administrative and other operating expenses increased quarter-on-quarter by 11% to $84 million, primarily due to a decrease in gain from disposals of fixed assets.
The cumulative effect of all of the above translated into an almost 16% quarter-on-quarter increase in the mining EBITDA to $593 million or 45% of total segment sales, up from 37% in the previous quarter and the highest since the third quarter of 2008. It probably should go without saying that we're quite pleased with such a result, given the difficult market environment prevailing during that period.
The net interest expense decreased over the same period by 46% to $30 million, largely due to a notable reduction in bank interest rates for the mining segment in Q4, as profitability of the segment improved and refinancing of certain debt attributed early to the mining segment by the steel segment.
Profit taxes were 12% down quarter-on-quarter to $46 million, the fall attributable to a combination of growth of the segment taxable income resulting in additional $37 million of income tax, an increase of $44 million in deferred tax benefit related mostly to change of future corporate taxes in Bluestone.
The segment also recorded a $39 million, a fixed gain in Q3, as compared to $290 million loss in the previous quarter. Given a translation difference of $329 million and I was referring to Q4 where we had a $39 million FX gain. As a result, the net profit was quarter-on-quarter up by $425 million.
For the full year our mining segment's realized sales to third parties of $4.140 billion, an increase of 36% over the level 2010. The increased revenue was driven by sales growth in all our key products except the thermal coal, the reduction of which is consistent with our stated strategy of further progressing into PCI [raw] coal previously sold into the thermal coal markets.
In particular, coking coal sales were up by 16% in physical terms, despite the temporary halt of the washing plant at Yakutugol due to an accident in December 2009. PCI and Anthracite sales were up 112% tonnage wise at the expense of steam coal where sales volumes fell by 16%.
It is also notable that price dynamics were also positive comparing 2011/2010 with only average realized steam coal price down 22% as proportion of middlings and lower quality thermal coal in our sales increased with higher quality coal processed into PCI.
Inter-segment revenue also grew by 31% to $1.052 billion, largely through sales to the steel segment where a combination of iron ore supplies increased by over one million tons and coke supply decreased by 130,000 tons, coupled with growing sales prices led to $181 million inter-segment revenue growth.
Although we managed to put cash costs under control in the fourth quarter as they averaged high in 2011 versus 2010 due to overall increase in input prices for electricity, fuel and labor, as well as scale effect, the temporary closure and then under capacity utilization of the washing plant at Yakutugol in the first half of the year and closure of Sibirginsk Mine at Southern Kuzbass in June.
The combination of revenue and cost dynamics resulted in the gross income margin ticking up only by 1% to 56% of the revenue. Operating expenses grew by 28% to $1.196 billion, largely driven by selling and distribution expenses, which grew in line with sales.
At the same time, the share of these expenses in the segment revenue declined from 24% in 2010 to 23% in 2011. For the full-year EBITDA increased by 38% to $2.024 billion, or 39% of the revenue, 1% up from previous year margin.
Net interest expenses decreased by 15% to $171 million, due to an overall reduction in interest rates.
The superior profitability growth of the mining segment led to a 63% increase in income tax expenses, which reached $303 million in 2011. The ruble depreciation in 2011 resulted in a $61 million loss on currency translation versus a $9 million gain in 2010. The resulting effect on the segment's bottom line was a 41% year-on-year improvement to $1.071 billion, or 21% of the revenue.
Now let us turn to the steel segment. The downturn in the financial and commodity markets in the fourth quarter affected the steel segment's performance most. The prices experienced correction across the entire product range. However, the long steel did not suffer as much as flat products, where (inaudible) on dynamics were more pronounced. FCA price carbon and low-alloy [sheet] moved 10%. Stainless led 12% down.
At the same time long steel semi-finished products and hardware, which constituted 74% of the segment's fourth quarter sales, experienced a much less pronounced turbulence with prices for rebar and wire down 8% and 7% respectively, billet and engineering steel 8% and 6% respectively, alloyed long steel 4% down.
The pressure in our key products was partly alleviated by the contraction in sales volumes, as MSG was restocking for the winter season. The supply/demand situation was also different in Russia and Europe, which are our key sales markets.
The downturn in European demand was more pronounced fueled by distressed financial markets, whereas in Russia, despite the seasonal slowdown in sales to the construction sector, the downward moment in price halted in the end of November and remarkably stayed at that level through the entire winter, which was exceptionally harsh, both in Russia and Eastern Europe.
The physical sales volumes of higher value added products with longer cash conversion cycle were also affected more as stainless flat volumes went down by 14%, engineering steel by 16%, alloyed long products by 13%.
In comparison, the physical sales volumes of rebar reduced only by 8% and stampings by 6%, the only item where realized price grew by 3% in the reported period.
In order to counter the reduction in cash flow resulting from lower sales, we increased the trade in billet, where sales volumes grew by 18%, mostly account of sales of third-party product supplied by Russian steel mills.
The combination of the volumes and price dynamics described above led to the third-party revenue decreasing by 14% to $1.541 billion.
Despite a reduction in cash cost due to similar downward trend in input prices, the cost of rebar at Chelyabinsk went down by 13% to $511 a ton. The gross income fell by 64% to $119 million, or 7.3% of the revenue.
The selling and distribution expenses grew by 8% to $147 million due to a substantial increase in export sales of billet mentioned above.
In the environment which imposed a significant stress on the cash flows the Company took certain measures to improve the collection of receivables, which led to a reverse in the doubtful accounts provision by almost $9 million as compared to the third quarter.
The administrative expenses were also cut 19% to $54 million going from 4% to just 3% of the segment's revenue, largely due to a reduction in pension liability as a result of the pension plan amendments.
Despite these measures, the segment's fourth quarter EBITDA fell by $203 million to a positive $50 million negative figure. The FX loss of $22 million was almost equal to that posted in the previous quarter.
Income tax expense grew more than four times quarter-on-quarter to $20 million as a result of an adjustment of the effective tax rate at Izhstal as well as FX income realized at a number of subsidiaries due to repayment of dollar denominated loans. The result was a $194 million net loss in the fourth quarter versus an $18 million profit for the previous period.
Comparing the full-year 2011 with the previous one, we still see a considerable 28% growth in top line to a record $7.154 billion fueled by the expansion of sales in Russia and Europe along with other increase in steel in sales prices.
Despite a contraction of Europe's share in Q4 revenues to 22%, as you can observe on the slide number eight, in annual sales Europe's sale grew from 18% in 2010 to 23% in 2011. That is explained by two factors. The fast growing distribution network of MSG in Europe supported by gross share in finished products in the segment's revenue, which rose from 73% to 79% as our previously completed investment began to bear fruit.
The rising prices for roll feet however, in particular coal and iron ore, did not allow the gross profit to grow at the same rate as the revenue, the former having increased by only $20 million over the figure of 2010 posting $1.127 billion.
The operating cost grew by 16% to over $127 million, largely due to 17% growth in selling and distribution expenses, which increased to $614 million, as our sales grew dramatically year-on-year.
The thinner margins we have seen in 2011 and the market downturn in the last quarter resulted in negative EBITDA dynamics, which decreased by 23% year-on-year to $319 million.
The net interest expense for the segment grew by sensible 59% to $360 million -- excuse me, $306 million, mostly on the account of inter-segment expenses, which increased by $70 million year-on-year.
That was largely due to different allocation of loans between segments as loss previously attributed to ferroalloy segment and related to the acquisition of overall resources were repaid in the second half of 2010 through a refinancing largely allocated to the steel segment.
The $81 million FX loss in 2011 can be compared to only $7 million in 2010 as ruble depreciated faster during the reported year.
That all resulted in net loss of $233 million in 2011 versus $91 million income in the previous year.
The quarterly revenue dynamics in the ferroalloy segment were influenced by a combination of a slowdown with price trend across all the products and increase in sales volumes in nickel and chrome countered by a temporary decrease in ferrous silicon sales.
The ferronickel realized price experienced the biggest quarterly decrease, 15%, to almost $18,000 FCA. The third-party sales volumes grew on the contrary to 46% to 3,500 tons. That was all at the expense of decreased inter-segment sales as the ferronickel stock accumulated in our steel segment in the third quarter was sufficient to last into the fourth one.
The chrome third-party sales volumes grew by almost 18% to 14,500 tons. Inter-segment sales volumes also increased by 65% as production of chrome concentrate at Voskhod and consequently chrome smelting in Tikhvin continued to grow.
The realized price edged only by slight 4% down to $2,180 as similar price dynamics was observed for ferrous silicon, down 5% quarter-on-quarter to $1,363 a ton at a time when third-party physical sales volumes fell by 17% to 9,900 tons due to halt of the -- of one of the four furnaces for modernization in August 2011, partly compensated by higher inter-segment sales volumes. The furnace was subsequent re-launched in March 2012.
As increase of third-party physical sales volumes led by nickel sales outpaced price consolidation, the third-party revenue grew by 12% to almost $116 million in Q4. At the same time a sharp decrease in inter-segment nickel sales by 73% to only $16 million led to the overall segment's revenue fall by 19% quarter-on-quarter.
The cash cost of ferrochrome decreased by 5% to $2,047 a ton, as a 9% increase in the cash cost of chrome concentrate attributable to seasonal factors was more than offset by ruble depreciation and overall increase in production in the fourth quarter.
Nickel cash cost remains flat at $20,600 as seasonal increase in use of coke was offset by a slight decrease in coke prices and ruble depreciation. At the same time, cash cost of ferrous silicon production grew slightly by 4% to $912 a ton due to temporary decrease in production. The combination of these factors led to a 6% decrease in the cost of sales, lower than revenue resulting in the thin gross profit margin in the third quarter reversed to a $19 million negative figure on a gross basis in Q4.
The selling expenses decreased by 52% to $3.5 million due to the reclassification of the inter-segment transportation costs to the cost of sales. If that effect is stripped off, the selling expenses would have stayed at the level of the third quarter as (inaudible) revenue rising from 4.4 to 5.6% as the third-party revenue decreased.
This is due to the effect of higher export sales of nickel and chrome volume wise, as prices for these products were on the contrary decreasing. Consequently the operating expenses fell by 23% to less than $17 million in Q4. This, however, did not help to offset the fall in the gross item, which led to the fourth quarter EBITDA posting a negative figure of $11 million versus $2.8 million income in the preceding periods.
Net interest expenses fell quarter-on-quarter by almost 80% to just $1.5 million, largely due to a change of allocation of external loans between the segments, as discussed above in the steel segment analysis. The FX effect in the ferroalloy segment posted a $2.6 million negative figure, as the dollar appreciated versus a $15.6 million gain in the third quarter.
The income tax expense of $1.4 million compared to an asset of $1.3 million in the third quarter. That increase was mostly due to an additional $4.1 million income tax at Voskhod accrued following into the full utilization of tax loss carried forward.
Comparing the year 2011/2010 the third-party revenue from the ferroalloy segment grew only by 4% to $475 million. Inter-segment sales improved more, having demonstrated a 15% growth to almost $200 million.
While the price dynamics year-on-year were not dramatic, nickel and ferrous silicon [assay] prices rising by 9% and 6% respectively, while chrome prices remaining flat, a 15% increase in chrome physical sales was balanced off by a 14% reduction in ferrous silicon sales due to a temporary halt of one of the four furnaces in the second half of the year for modernization.
Operating expenses grew by 8% to $78 million, along with growing export sales of chrome. In 2011 the segment contributed $46 million EBITDA to the consolidated number versus $94 million in the previous year. The reduction is largely due to higher cost per ton of nickel and ferrous silicon effect and the profitability of the entire segment; the former due to a substantially higher average price of coke, while the latter affected by lower production and sales volumes in the second half of the year due to the modernization of the furnace that I just mentioned.
The net loss, however, more than halved year-on-year from $186 million to $71 million. The decrease in the gross profit of $62 million was offset by a similar decrease in income tax expense due to a revaluation of the income tax liability at Voskhod overall recognizing a cancelation of the statutory tax reduction from 20% to 15% that we reported in our 2010 accounts.
Decrease in interest expenses added another $78 million to the bottom line. However, $70 million of that decrease was transferred to other segments, primarily steel, due to change of inter-Company loans allocation.
The FX effect added $41 million to the net income, as the year 2011 posted a $24 million gain versus a $17 million loss in the previous one.
The fourth quarter was traditionally good for the power segment due to high season for electricity and heat consumption. The revenue grew by 28% quarter-on-quarter to $211 million. The cost of sales on the contrary decreased by 7%, largely due to substantial increase in heat and electricity generation. At Southern Kuzbass Power Plant the cash cost per megawatt hour decreased from $50 to -- in the third quarter to $34 only.
Inter-segment sales also grew by 12% to $126 million driven by the same factors. As a result, the gross profit shot 87% up to almost $90 million. The gross margin improved from 17% in the third quarter to almost 27% in the fourth one. Not surprisingly, selling and distribution expenses increased by 19% quarter-on-quarter to $67 million due to higher transmission charges as sales grew significantly.
Administrative expenses also increased by $19 million, largely due to a $4.7 million provision for asset retirement obligation at Southern Kuzbass Power Plant and an 8.5% -- excuse me, $8.5 million difference between the preliminary value of permission rights at Toplofikatsia Rousse posted as of the end of the third quarter and the result of the power plant's final appraisal for accounting purposes done in the fourth one.
The combination of higher gross profit and operation expenses affected by mentioned above one-off effect on administrative expenses summed up to $3 million of EBITDA for the fourth quarter of a $7 million negative figure in the previous one.
The FX effect on the segment's P&L was negligible.
The net interest expenses of $4.1 million remains virtually unchanged. The income tax expense grew by $4 million quarter-on-quarter, as profitability significantly improved due to high season. As a result, the net loss more than halved quarter-on-quarter to just $5.9 million. For the full-year 2011 the segment increased its revenue from third-parties by 19% to $778 million as a slight (inaudible) in physical sales volumes due to maintenance was more than compensated by the growth in tariffs.
The inter-segment sales also increased by 24% to $507 million. However, due to a similar increase in costs as coal price demonstrated a superior growth in 2011 versus 2010 levels, the gross income grew only by 3% to $308 million. Therefore, a 13% growth in operating expenses largely driven by growth in transmission tariff not unexpectedly led to a 40% reduction in the segment's EBITDA to just under $37 million.
This coupled with the two times increase in administrative expenses, driven entirely by the fourth quarter one-offs described earlier, were the reason behind the reversal of the net income performance $17 million in 2010 into a $5.8 million loss in 2011. It would be fair to say that despite electricity tariff growth in 2011, the economics of the power segment were transferred to the mining one through the increase of the market price for thermal coal.
The combined segments results led a 9% quarter-on-quarter decrease in the consolidated revenue to $2.9 billion, which on almost flat cost of goods sold resulted in 21% reduction of the gross income to a $934 million or 32% of the revenue versus 37% in Q3.
The EBITDA decreased by 21% quarter-on-quarter to $536 million. The $296 million FX lost posted in the third quarter reversed into a $14 million gain in the fourth one.
The income tax expense increased by 30%, largely due to the factors described in the steel segment discussion. All that resulted in a $201 million net income for the fourth quarter, which can be compared with only $26 million in the previous one.
Overall for the full-year 2011 the business increased the revenue by almost 30% to $12.5 billion and gross profit by 20% to $4.3 billion, or 35% of sales.
The consolidated EBITDA also rose by almost 20% to a near $2.4 billion, that growth entirely attributable to the mining segment.
The net interest expense remained virtually unchanged at $544 million.
The depreciating throughout the reporting period ruble led to an eight times increase in FX loss to $117 million, which coupled with a 30% growth in income tax as profitability improved, could not offset the superior dynamics in the operating result and ended up in an 11% year-on-year increase in the net income to $728 million.
Now, let us turn to the cash flow and balance sheet analysis.
The volatility in our core markets in Q4 and uncertainty about further market development substantially increased the risks of the business, which had been growing very rapidly in the previous financial periods. Having enjoyed almost two years of positive market dynamics in a post crisis recovery, we have invested substantial efforts and resources in taking advantage of our superiority position in coal and steel markets having amongst others capitalized on our strong presence in long steel market and the biggest steel distribution platform in Russia.
The latter has been allocated a significant part of our investment in working capital, having grown its European operations almost non-existent prior to the 2008 crisis to the same size as its Russian operations in sales volumes. The investments in the distribution also gave us another advantage. Being a Tier One producing and selling Company in the segment we have successfully used our position to increase our market share at the expense of smaller and weaker players, which have suffered more during the crisis.
However, these achievements were paid for with a significant investment in working capital, which totaled $1.423 billion in 2010 and another $1.2727 billion for the first nine months of 2011. This strategy was justified in a rapidly growing market where sharp improvement in competitive advantage in a struggle for market share, which in its turn would guarantee stable sales and cash flow, was worth the investments made.
However, the abrupt change in the market environment and significant decrease in market visibility witnessed in Q4 made it clear that investments in the rapid growth of business we had been making are becoming excessively costly and become a direct competitor for funds to the investment that we have been making in the fixed assets and new projects like Elga and the universal rolling mill.
This competition has become very narrow as our net debt grew to almost $9.3 billion and the consolidation EBITDA decreased by 21% in Q4. Our net debt to EBITDA ratio shot to 3.9 times entailing negotiations of our account and bridge with our banks and limitation on further debt raising. Faced with this choice in the fourth quarter, we have carried out a re-think of our global strategy and laid out the three pillars which have been mentioned by Mr. Mikhel, and measures to be taken short to medium term in order to dramatically improve our financial position and return our market capitalization to the level where it will reflect the true value of our business.
These measures will concentrate around two targets we will be pursuing in the next at least two years. Number one, improvement in the cash flows; in the fourth quarter 2011 we halted the expansion of MSG, which had been our main cash consumer lately. We believe we have grown a significant enough franchise to comfortably retrench and dedicate our efforts to improve the economics of its corporation with our producing assets and other market players without the need to struggle to win a higher market share, which will require more resource.
We have also taken a few measures to curb inventory buildup in the volatile market and lay a path for their gradual reduction. We change the production plan so that our production fully reflects current sales including any over investments in the working capital. We further improved the management of receivables and payables in Q4 2011 and Q1 2012.
Despite the fact that any change in production profile takes two, three months to be visualized in sales, all these efforts led to a dramatic improvement in the Group's cash flow already in the fourth quarter 2011. The working capital, excluding change in settlement with related parties, consumed only $62 million of cash versus $202 million in Q3 and $984 million for the entire first nine months of the last year. That figure looks even more impressive if we remember that Q4 is usually a low season for steel when inventory builds up before the year end and Christmas holidays.
Looking ahead, I am proud to say that we achieved an even more visible success in 2012 to this date in managing the inventory. The stock at MSG's warehouses has been reduced from around 1.33 million tons as of the end of December 2011 to 1.1 million tons as of today, or almost 20% during the period, most of which was low season with exceptionally harsh winter both in Russia and Europe.
It is even more impressive having the average realized price not changing much over this period implying we have not been subsidizing volumes from pricing. We plan to take the stock down by at least 150,000 tons more for the second half 2012. This reduction since the beginning of the year is expected to release approximately $350 million of cash.
Apart from inventory and payables management, we took certain measures to protect our P&L and cash flow from further deterioration in the marketplace, which would not affect -- which affect not only the Group but our partners, which are beyond our control but only through market instruments.
As you know, we have extensively cooperated with a number of independent steel mills in Russia and abroad, which brought us a substantial advantage in terms of market share and complementary product range enabling us to extract better terms, including pricing in the post-crisis years. Our biggest partner so far has been Estar Group, which we accounted for as related party transactions in our financials since 2009.
However, in return we invested over $1 billion in our relationship through working capital, Estar being by far the largest investee with $880 million exposure as of the end of 2011, up from $420 million 12 months before. Having faced a changed market environment and curbing our expansion in steel, we decided that in the new circumstances we cannot afford to keep investing in our relationships so even the present exposure be at risk should the market volatility continue.
Consequently we took steps to ensure that in the worst scenario the Group's cash flow will not be risked here further. At best we would recover this exposure fully. In order to realize this opportunity, we ended a loan agreement for $945 million with the owners of Estar secured with shares and guarantees from essentially all its assets. The proceeds of this loan were used to repay the related party receivables just enough to keep our exposure to them at a current working level. The loan expires on September 30th, 2012. Should the loan be not repaid, we will recover it through entering into possession of Estar assets of around 2.3 million tons of smelting and 2.7 million tons of rolling capacity.
As the settlement of receivables with Estar continued into 2012, the settlements with related parties item reflected $679 million in our cash flow statements pushing cash flow from operations to a remarkable $937 million in the fourth quarter. It is notable though that even stripping the related party effect, the operating cash flow rose to $258 million. This impressive achievement was largely due to the measures I mentioned above. This was all related to the target number one, improvement in cash flows.
Target number two that we will be pursuing in the next two years and that will take significantly more efforts helping to improve the cash flow is significant de-leverage of our business. Our net debt rose 7% quarter-on-quarter to $9.3 billion as of the end of 2011, or 3.9 annual backward look in EBITDA, the level that we regard unacceptable in the medium to long run for our business, especially having a very high volatility in the operating result.
Although we have managed to service our debt from the operating cash flow and meet all the repayments having seen even higher relative indebtedness levels in 2009-2011, the present size and structure of debt imposed a significant limitations on our ability to invest in key projects and hence on our growth in the selected business segments. We, therefore, adopted since the beginning of the year a policy of balanced cash flow from operations and investments, which would limit our gross debt at the current levels.
We revised our investment program and postponed all the projects which were either in the startup stage or not our key priorities, actually limiting our CapEx only three. The completion of the universal rolling mill at Chelyabinsk this year, further development of Elga and completion of the modernization of Port Posiet where capacity increase is essential for monetization of our mining assets.
If we turn to Q4 numbers, we see that investment cash flow demonstrated a substantial increase to $1.2 billion. However, clean of the loan to Estar, it was $496 million, $76 million thereof attributable to new acquisitions, most of it to the acquisition of [DM Zed]. That leaves only $436 million to purchase of property, plant and equipment, 29% down versus Q3, which was the result of the CapEx cutting program we began to implement in the fourth quarter.
Although we had planned a larger reduction, we made a decision to complete the projects, which were near completion, in order to minimize their CapEx and move the project into the payback phase, most importantly the railroad to Elga, which we had to finalize by the year end. Now that the project is done, we have more leeway on our investment program. The CapEx has already been reduced to $1.2 billion for 2012. Subsequently we plan to spend no more than $1.2 billion in 2013 and $900 million in 2014.
All this CapEx will be subject to the operating cash flow balancing policy described above, which will ensure that the net debt will not exceed the current level. The experience since the beginning of the year has demonstrated that we have been successful in following this path so far. As our previously completed investments pay back and [newly launched] equipment begins to generate cash, we plan the operating cash flow to exceed the investments by $900 million over the next four years including 2012, as you can see on this slide number 13, even if the market trends remain flat for the forecast period, all the delta directed at debt reduction.
That estimate is done on the basis of a basic scenario where working capital will continue to grow fueling expansion of sales and the market remaining relatively volatile as they are today. However, as you can see on that slide, under a more optimistic scenario where the working capital is kept at a normalized level if the market conditions improve, its cash release capacity gives an additional resource to decrease the debt by a further $2 billion over the same period. That will limit future sales volume growth, especially in the steel segment, but help to de-level faster should the circumstances require.
Nonetheless although we expect to gradually de-leverage through the superior operating cash flow, only that will not bring us to the target of two to one in terms of net debt to EBITDA in the medium term, which is the level where we feel enough room for further large investment and new growth projects. In order to achieve that, we will be taking unconventional for our Group steps suggested by the strategy we highlighted above.
As Mr. Mikhel stated, by grouping our assets around the said three pillars of our competitive advantage, we will be considering all assets which do not fit the core of our strategy where opportunity cost of operating them exceeds the incremental economics they contribute to the Group as subject for divestment.
As far as the structure of the debt and covenant package are concerned, we have taken certain measures, which led to remarkable improvement on this front, which we are proud to deliver. As we recently announced, we successfully finalized negotiations with all our creditors, which resulted in a significant amendment of our covenant package.
The net debt to EBITDA covenant has been lifted to 5.5 times through the end of the year 2012 coming down to 4.75 and 4.4 as of June 30th and December 31st, 2013 respectively; then 3.75 and 3.5 as of the end of June and end of December, 2014; 3.25 times at the end of June 2015 and finally to the run rate of three to one starting from the year end 2015. These new levels were to provide for higher escalation in the Group's EBITDA should market volatility increase again.
The maturity structure of our debt also experienced a significant revamp to date. Since the beginning of the year we completed several transactions. A $500 million of five-year loan from Gazprom Bank has another $460 million VTB debt was extended by five years, $167 million worth of ruble denominated bond and another $500 million worth of ruble commercial paper placed with VTB, altogether $1.6 billion of long-term debt.
All these funds have fully been utilized to meet current repayments and repay short-term debt. Our most recent achievements were signing of 22 billion ruble worth of three to five-year facilities with Gazprom Bank, which we will be utilizing to repay the debt with short-term maturities in May and June. This has brought the amount of debt repayable till the end of 2012 to just $1.6 million -- billion dollars, which is more than manageable having currently $2 billion worth of cash and unutilized bank limits to our disposal, as you can see on the slide number 15.
Additionally, our investment program is insured by $531 million of committed projects related long-term facilities. Our further actions are aimed at diversification of long-term instruments after stabilization of our credit rating, which is now at B1 with negative outlook. We plan to tap Eurobond markets, which could be towards the year end or in the first half 2013, after we have demonstrated certain de-leveraging. We also plan to continue to use ruble bonds and commercial paper, which has proven to be an efficient instrument to diversify from bank debt into an unsecured covenant free long-term public debt.
To sum up, ladies and gentlemen, the results demonstrated by our business in 2011 reflect significant growth achieved in the previously years and the potential yet to be realized. In order to do that, we need to undertake significant changes in our business combination, dramatically reduce debt and concentrate on our key competitive advantages. Having put it on our agenda, we are confident that we will be able to achieve it in the short to medium term, which will help us to realize our flagship projects, monetize our high quality reserves and through that bring a significant improvement to the shareholder value.
And now we are ready to answer your questions, ladies and gentlemen. Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [4]
------------------------------
Thank you. We will now take questions. We would ask that participants please state their name and company before asking their question, and allow some time after for translation. When questions are answered in Russian, they will be followed by a translation, so you may ask your question in Russian also, and we will translate. Thank you.
==============================
Questions and Answers
------------------------------
Operator [1]
------------------------------
Dmitry Smolin, URALSIB Capital.
------------------------------
Dmitry Smolin, URALSIB Capital - Analyst [2]
------------------------------
Thank you for the call and very detailed presentation. I have three questions. First on your new strategy, given that almost all your segment, apart from mining, were loss making in the fourth quarter. Should we expect that the Company could sell its ferroalloys and power segment as well as some loss making (inaudible)? Beyond that I don't believe that it's possible to sell in this, the tough market, any ferro assets but I guess that you can find some bidders for your ferroalloys and power segment.
Then, according to some fuel traders, we are hearing that fuel demand was deteriorating on export markets in May and due to turbulence on financial markets do you see any weakness in the month, or softening prices, from your key customers now in May?
And also, do you consider any other options for reducing your debt apart from the sale of the assets, I mean, maybe IPO of mining assets for this year or any other options available at the moment? Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [3]
------------------------------
Please we'll ask Stanislav to prepare the question. Stanislav Ploschenko will answer the first question.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [4]
------------------------------
Was asked in English. Since the question was asked in English, I will reply in English as well.
We stated the main principles of our strategy and we, although de-leveraging is one of the points of the strategy, it would be a little bit superficial to say that we will sell everything apart from the mining segment. As you've noticed, two elements of our strategy concern the steel segment as well. We will definitely be reviewing the asset base and look at the assets, first of all the ones which generate loss or generate a very thin margin, and this analysis will continue for a few months.
So it wouldn't be fair to say that -- it wouldn't be fair to gage our ability to de-leverage judging by today's market circumstances. By all means we will be looking not at a particular segment but at particular assets within the segment, including the ferroalloy segment as well. Ferroalloy segment has very profitable assets like Bratsk Ferroalloys Plant, for example, and we will be considering not only the possibility to sell an entire segment but certain assets, selling certain assets, and retaining certain assets as well.
I will repeat this process will take a few months to be completed because we need to be absolutely sure and to present to our Board the suggestions by highlighting all the factors and having proven that we have evaluated all the factors and we have substantial proof, both for the Board and for our investors that we consider and we recommend to get rid of certain assets.
And this is the answer to the question number one.
The question number three early on we considered an IPO of Mechel Mining and, although in these market circumstances it would be very challenging to do that, we and because of that we have postponed this project for the time being. I don't want to use the word indefinitely but certainly for a prolonged time until the market recovers but we never associated an IPO of Mechel Mining with the de-leveraging. We associated the IPO with the attraction of funds to further develop the result base of Mechel Mining.
That notwithstanding, we are prepared to look at partnerships and minority investments in our key assets, the ones which fit into our strategy and the ones which we are going to retain and develop further. If that helps not only de-leveraging but also bringing in new experience, know how, technology.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [5]
------------------------------
The second question will be answered by Oleg Korzhov.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [6]
------------------------------
(interpreted) To answer the second question, I will have to say that with respect to the sale of steel products in May, we do not right now conceive any obstacles or constraints in the market in terms of sales. Our shipments of steel products in May will be higher than in the same period of last year and perhaps this should be attributed to a very mature, very well developed network of distribution and sales that the Company has.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [7]
------------------------------
We are now ready for the next question please.
------------------------------
Operator [8]
------------------------------
[Anton Rumanse], Troika.
------------------------------
Anton Rumanse, Troika Dialog - Analyst [9]
------------------------------
Good evening, gentlemen; thank you for your presentation. I have got several questions. The first one, could you please tell me if I am right that in the fourth quarter the additional weakness in Steel Division performance was due to the sale of expensive stocks by Mechel Service Global because I think that there should be some large stocks accumulated in the previous quarters when the prices for steel had been high and by the end of the year Mechel Service Global should -- I think that they should have realized them at lower price maybe, even lower than they have purchased?
And the next question is about the recent media speculations about (inaudible) and Rosnedra review of violations on Yakutugol, of mining licenses violations on Yakutugol. Could you please tell what the current status of these, or actually of the whole situation is, and how the Company plans to act in this situation?
And my third question is could you please give us some breakdown of your reduced CapEx in 2012 and also, if I am right, that you will now postpone the development of Sibirginsk and your (inaudible) one underground mines and concentrate only on Elga development? Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [10]
------------------------------
First question will be answered by Stanislav Ploschenko.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [11]
------------------------------
If we talk about the inventory at Mechel Service Global in the fourth quarter, there is no direct effect from the inventory dynamics in the reported period and the fallen profitability. As a matter of fact, inventory in the fourth quarter grew because the efforts we had taken to balance the production in line with the sales took two to three months, as I said previously, to materialize and we were replacing one product with another one and, which suggests for the absence again of the inventory write down in the fourth quarter that most of the effect on the profitability was simply coming from the falling prices across the market, as simple as that.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [12]
------------------------------
The second question will be answered by Yevgeny Mikhel.
------------------------------
Yevgeny Mikhel, Michel OAO - CEO [13]
------------------------------
(interpreted) To answer the second question, in the fourth quarter and over the last year and in the first quarter of this year there were indeed scheduled audits in the South Kuzbass and Yakutugol. These audits were conducted by Rosnedra and (inaudible) the Advisory Authority with respect to the compliance with the license terms and (inaudible) reported to Rosnedra that there were some violations of the license identified.
However, most of these violations were related to the technology of the development of the technology of the works and there is a special commission within Rosnedra by the official meeting of this commission on the 3rd of May, both enterprises have removed most of the concerns of the Advisory Board's and submitted further plans of action to these supervisory authorities. On the 3rd of May Rosnedra decided that there are no grounds to revoke the licenses.
With respect to (inaudible) that the South Kuzbass, that plan of action was noticed and with respect to Yakutugol, they received a special notice listing the measures and the time line during which the still remaining violations must be fixed, so at the moment there is no talk and there are no reasons to even discuss the possibility of a license revocation.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [14]
------------------------------
Third question will be answered by Oleg Korzhov.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [15]
------------------------------
(interpreted) To answer the third question, with respect to our CapEx budget in 2012, the overall CapEx budget is $1.2 billion. $200 million is for maintenance of existing facilities. $1 billion is our investment program. We decided to focus on our priority projects that, first of all, are in high stages of readiness and also that are vital for Mechel's future and we identified five priority investment projects for ourselves, which will consume 85% of the CapEx budget.
First one is Elga. It will take $350 million. Then the construction of the universal rolling mill, $320 million; construction of the Posiet Port, $85 million; the grinding mixing complex of $40 million and Sibirginsk, construction on the Sibirginsk Mine, $25 million. In Sibirginsk we will construct and reinforce the vertical shaft and with respect to [Makoska] Mine, there we are currently conducting preparatory work and this project will be fully realized in the next year. That's when we plan to continue construction.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [16]
------------------------------
We are now ready for the next question please.
------------------------------
Operator [17]
------------------------------
Dan Yakub, Citi.
------------------------------
Dan Yakub, Citigroup - Analyst [18]
------------------------------
Guys, thanks for the presentation. I have a couple of questions. Some of them are more follow-up questions. One, the first question is on the Elga CapEx. You mentioned $350 million that will be spent on that. What's the -- what are the main cost items, given that the railroad is now fully completed, you know, what will be spent?
Is it the seasonal factory that's taking $350 million or is it remainder of infrastructure, electricity? What's the main CapEx component in that $350 million that will be spent and this year and maybe if you have a number, ballpark number, for 2013 in terms of the CapEx for Elga?
And then the second question is on production guidance there you produced 27.6 million tons of run-of-the-mine coal in 2011 and is I would say approximately a third of that was a steel coal remainder; two-thirds was coking coal so what's the first of all production guidance for 2012 in terms of the run of the mine coal? And second, what is the breakdown between steel and coking is going to look like in 2012? I think we've noticed some significant shift in the first couple of months of 2012 in favor or steel coal, so maybe you can expand a little bit on that change in the product mix? These would be the two questions and I may have one follow-up question. Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [19]
------------------------------
Oleg Korzhov will answer the questions.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [20]
------------------------------
(interpreted) To answer your first question about Elga and $350 million, approximately one half of that amount will go into completing, fully completing, finalizing the construction of the railway link. Right now we have a link that connects the deposit with the Baikal-Amur Mainline but we still need to build 27 bridges. 20 of them will be constructed in 2012 and seven will be built in the first six months of 2013. The fact that right now we don't have these bridges does not affect the shipments from the deposits and the throughput capacity of that link whatsoever.
The second half of our investment into Elga this year will be broken down into two parts. Approximately $7 million will be consumed by the seasonal washing factory and the remaining part will be spent on the development of the infrastructure purchase and equipment and building the camp for the workers.
As to the power, as to the electricity, this investment is fully carried by the Federal Grid Company.
Now with regards to our investment guidance for 2013 for Elga we, at the moment, we plan to invest about $600 million. Thank you.
With regards to the second question, the production of the shipment guidance for 2012, the run of mine coal, we plan to produce about 30 million to 31 million tons and speaking about the finished products, that was about 27 million tons of those including 13 million tons of coke and concentrate, 10 million tons of steam coal and 4 million tons of Anthracites and PCI.
There was an additional question, how much of that production will be done in Russia and how much in the US? Out of the 30 million or 31 million tons 4.1 million is US production. Everything else is Russian.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [21]
------------------------------
We are ready for the next question please.
------------------------------
Operator [22]
------------------------------
George Buzhenitsa, Deutsche Bank.
------------------------------
George Buzhenitsa, Deutsche Bank - Analyst [23]
------------------------------
Thank you for the presentation. Had one question on your Estar transaction; can you please qualify is that correct that if Estar does not repay the loan that you provided them, then you will be consolidating all from Estar assets to your balance sheet and, if so, how do you think your debt balance will change? Is there any debt on those assets?
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [24]
------------------------------
Stanislav Ploschenko to answer.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [25]
------------------------------
Yes indeed. If the loan is not repaid we will enforce the security, which is the pledge of shares of essentially all Estar assets and the guarantees from them. And, having done that, having entered into possession of Estar, we will according to US GAAP consolidate the assets.
Estar assets altogether have about $1 billion debt outstanding but it's important to note two things with respect to that debt. First of all, our analysis and experience of dealing with Estar shows that even in the present market environments they have been capable of servicing the debt from their own operations.
Secondly, all the debt is structurally subordinated to Michel, which means that none of the creditors to Estar has a recourse to Mechel through a security or a guarantee so our creditors will be privileged in that sense to the creditors of Estar. And even consolidation of additional debt from Estar will not entail any current breach because the revision of the new -- of the covenant package, was performed taking into account possible consolidation of Estar and there is significant room on top of that to provide for any negative volatility in the company's operational result.
And if the eventuality is that we have to consolidate Estar and enter into possession of the smelt and consequently technically that will be tantamount to increase of debt. Our first and foremost task will be to bring the situation back to normal, meaning to reduce debt by selling part of the assets but by that time we will have performed analysis of our own asset base and the plants of Estar will follow the same rule as our own operations.
And I would like to add with respect to Estar indebtedness, all its indebtedness, or substantially all the indebtedness is in seven to 10 years settlement agreements reached or signed with the creditors when they were going through bankruptcy procedures so it's pretty much short-term debt, zero interest bearing.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [26]
------------------------------
Thank you. We are ready for the next question please.
------------------------------
Operator [27]
------------------------------
[Alad Zhukov], HSBC.
------------------------------
Alad Zhukov, HSBC - Analyst [28]
------------------------------
Several small questions; as far as I understand the production guidance, the coal production guidance for this year implies a reduction from the previous one, which was available on your website as part of the sort of medium term production strategy. If you have understanding now, what of production volumes going into say 2013 and '14, can you please provide those figures, say total production, coal production volume as well as the split between thermal and coking coal?
Second question, what is the outlook for cash cost for this year, given that you're going to have a higher production volume? Does it imply lower production cost, at least slight production cost year-on-year?
And question number three, given that you said you're considering number of options in terms of raising capital to reduce debt, would you consider selling the -- perhaps from Treasury? Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [29]
------------------------------
Mr. Stanislav Ploschenko can answer the third question and Oleg Korzhov will follow with number one and two.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [30]
------------------------------
No we did not consider sale of preferred stock held in Treasury because the preferred stock, even in today's market conditions with increased cost of debt, is a much more expensive source of financing. We follow here purely as arithmetical approach. The preferred shares are basically too expensive, more expensive than debt.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [31]
------------------------------
The first question will be answered by Oleg Korzhov.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [32]
------------------------------
(interpreted) There are three factors that cause the correction of the production guidance that we gave earlier for 2012. Fact number one is the lower production in Elga. Originally we looked at two million tons. Today we're looking at one million ton. This is explained by our, at the moment, limited washing capacities there and the schedule of putting the new washing factory into operation there. We decided that we're going to produce there only as much as we will be able to wash and to ship and to sell consequently.
The second factor is Bluestone. Technically all the capabilities are there to produce more but the market in the first and the second quarter made us suspend production in some of our sites there whether the net result was negative for us.
The third factor is the South Kuzbass that also lowered our production. Again, physically it is possible to produce more there but for this we need to purchase some rather expensive pieces of equipment and this equipment is needed for open mine production. At the moment we decided to return to this issue around the middle of 2012. We will review the market situation and our financial capacity to buy that equipment and then maybe a different decision will be taken.
As to production in 2013 and 2014, 2013 we are looking at 39 million tons and 41 million tons in 2014. Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [33]
------------------------------
Next question please.
------------------------------
Operator [34]
------------------------------
Vasily Kuligin, Renaissance Capital.
------------------------------
Vasily Kuligin, Renaissance Capital - Analyst [35]
------------------------------
Thanks very much for the presentation. I've got two short questions. First of all, about Bluestone, on the page five of your presentation I see that the cash cost on Bluestone it rose sharply, nearly [17%] quarter-on-quarter. What's the nature of this sharp growth and can we expect the same growth further in 2012?
And the second question is about your operating result falling, your first quarter (inaudible) operating results; what's the current level of your coal inventories in your warehouse and can you please provide the split of coking and thermal coal inventories if it's possible? Thanks.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [36]
------------------------------
Stanislav Ploschenko will answer the first question.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [37]
------------------------------
As I mentioned in my presentation, the increase in cash cost at Bluestone the fourth quarter vis-à-vis the third one was largely due to a contraction of sales by 9% in the fourth quarter. As Bluestone is largely an exporter and most of its export goes to Europe, the volatility in the European market in contraction of purchases in Europe as large steel producers began to cut their production in the fourth quarter affected the exports of Bluestone, which together or coupled with the decreased production increased the cash costs because of the scale effect.
Already in the fourth quarter and probably in the first quarter of this year which (inaudible) us to bring the cash cost further down below $100 a ton by closing two most costly mines temporarily until the pricing environment and demand situation recovers, so we expect that the cash cost in the first quarter, especially in the second one, would be restored to the normal level.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [38]
------------------------------
The second question will be answered by Oleg Korzhov.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [39]
------------------------------
(interpreted) As far as I understand the second question, it refers to the product that is ready to be sold as of the beginning, at the beginning of the year and I will [now] be quoting figures that take into account the coal in the warehouses of our own enterprises and also in the reports. That figure is 2 million tons. At the moment -- that was at the beginning of the year. At the moment it's 1.4 million tons. It means that we managed to reduce our inventory but by 600,000 tons. Our sales today are at 2.3 million tons a month. It means that our inventory is 20 days. We believe that 20 day is an optimal figure, was an optimal period for our Company.
As to the breakdown for the first quarter, you will find this information in the press release. Overall we produced 6.4 million tons. We sold 3.2 million tons of coking coal, 500,000 of PCIs, 614,000 of Anthracites and 1.5 million of steam coal.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [40]
------------------------------
Next question please.
------------------------------
Operator [41]
------------------------------
Dan Yakub, Citi.
------------------------------
Dan Yakub, Citigroup - Analyst [42]
------------------------------
Got just one additional question and one follow-up question; additional question is on projected or expected net interest rate, net interest expense that you expect to incur as a result of negotiations maturity, extensions, etcetera so in your -- in one of your scenarios you have $9.5 billion of debt but the year end 2012 another scenario at 9.2 so if somewhere in between that scenario and net debt will actually materialize, what's the average, weighted average net interest expense that you expect to pay or that you negotiated for that leverage?
And just one additional question on production you mentioned 4.2 million tons of finished production, finished good production in the United States. Is it possible to give to some guidance for 2012 in terms of the run of the mine coal production in 2012 for Bluestone Group assets? Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [43]
------------------------------
First question will be answered by Stanislav Ploschenko.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [44]
------------------------------
Answering the first question first I have to say that the Company's policy not to give financial forecasts and forecasting one of the items on the P&L is a financial forecast so I will try to answer your question indirectly. There was no revision to the interest rate as a result of renegotiation of the covenant package. There was an increase on overall interest rate in the first quarter when the Russian financial markets were still affected by the -- if whether I can use the word crisis in the European financial markets or the turbulence in the European financial markets.
And in the presence of liquidity concerns, the interest rates in the Russian market increased because both, for both international and Russian banks the cost of funding rose. The increase of those interest rates can be tracked by the public market instruments, for example, the yield on the ruble denominated bond of Michel.
The situation in the second quarter became easier. There is no concern about the liquidity so the situation started to improve. It is not in our place to give forecasts about the macroeconomic measures, especially the development in the liquidity position in the global financial industry but this is the situation, which we have had for the part of the year that we lived through.
------------------------------
Dan Yakub, Citigroup - Analyst [45]
------------------------------
And just one follow-up question on that, and what was the average interest rate, net interest rate that you were paying in 2011, so just devising that interest expense by the average net debt, do you have that ballpark number at your disposal?
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [46]
------------------------------
I will answer that question after Mr. Korzhov replies to the other one.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [47]
------------------------------
(interpreted) When I mentioned the figure of 4.1 million tons at Bluestone, that was done in the context of the overall guidance production for Michel of 30 million tons and speaking about -- so that was actual run of mine coal. So, once again, in 2012 we expect to produce 4.1 million tons of run of mine coal at Bluestone and 3 million tons of finished products will be shipped.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [48]
------------------------------
Answering the question about the average interest rate, we do not derive the average interest rate for the entire debt portfolio but if you can follow up on our financial statements issued today, the average interest rate for ruble denominated long-term debt in 2011 was 9.1%. The US dollar denominated long-term debt was 5.6% and Euro denominated long-term debt 4.2%.
With respect to the short-term debt, the ruble denominated stood at 7.2%; the dollar denominated 4% flat and Euro denominated 4.9%.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [49]
------------------------------
Next question please.
------------------------------
Operator [50]
------------------------------
[Alexander Mordan], Sovlink.
------------------------------
Alexander Mordan, Sovlink LLC - Analyst [51]
------------------------------
I have some questions; just what is your expected target level on EBITDA margin for 2020? And second question is do you plan to reduce production in metals sector if some global markets continue reduction? Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [52]
------------------------------
Stanislav Ploschenko to answer the first one.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [53]
------------------------------
Unfortunately I have to return to my earlier comment that we don't give financial forecasts, especially for such a very long period as 2020, but I would like to refer to the outlines of the strategy that Mr. Mikhel and myself discussed earlier on the conference call. The -- all these strategic initiatives that we have described, they have only one target, the improvement and dramatic improvement in the profitability of the business which will be translated into the improvement of the shareholder value and since you are giving us time till 2020 we believe we have sufficient room to improve it considerably.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [54]
------------------------------
The next question will be answered by Oleg Korzhov.
------------------------------
Oleg Korzhov, Mechel OAO - SVP Business Planning & Analysis [55]
------------------------------
(interpreted) May I translate the answer to his question? Thank you very much.
Now, regarding our production of field products, you have already heard about our strategy. Our strategy is to produce only as much as we're capable of selling and we will not produce to make a loss for the Company or will not produce for the production sake so every time a decision is taken, its economics is calculated and every time a decision is made regarding the feasibility of this or that move. So if the calculations demonstrate that the decrease of production is feasible and is necessary, then of course such a decision will be taken. But I hope that the market conditions will not deteriorate and that the demand will restore and will not have to take that step. Thank you.
------------------------------
Alexander Mordan, Sovlink LLC - Analyst [56]
------------------------------
(interpreted) It's a follow-up question to the first one regarding the forecast or the EBITDA margin target in 2012. The question is really not about the absolute figure but rather about an upward or downward trend. What does the Company expect with respect to the EBITDA margin?
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [57]
------------------------------
I have to verify. Am I right if we are talking about 2012, not 2020?
------------------------------
Alexander Mordan, Sovlink LLC - Analyst [58]
------------------------------
(spoken in Russian).
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [59]
------------------------------
Well, then we're talking about two short-term projection, which is difficult to make in a volatile market, precisely to provide for high volatility in the operating results, we for example introduced or we have capped our debt in the financial covenants with our banks at $11 billion net, which was a measure to ensure that the debt because according to the -- or due to the volatile markets, the financial metrics may oscillate significantly.
Therefore, I would stay short of making any projection for the financial results but the measures that Mr. Korzhov has just described will ensure that even if the market remains volatile, we are affected least by these events and our financial result stays or is affected to the minimum extent.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [60]
------------------------------
Next question please.
------------------------------
Operator [61]
------------------------------
Sergey Donskoy, Societe Generale.
------------------------------
Sergey Donskoy, Societe Generale - Analyst [62]
------------------------------
I have two short questions but before I ask, one follow-up on your loan to Estar just to clarify. Was this loan to Estar itself or to the company's shareholders?
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [63]
------------------------------
It was a loan to the shareholders of Estar. Otherwise the shares in the plants could not have been pledged.
------------------------------
Sergey Donskoy, Societe Generale - Analyst [64]
------------------------------
Understood thank you. And then two questions; first of all, on profitability of your mining division, I think that you've touched upon it in your presentation but just to again, to clarify, so far as I understand the sales volumes in the division were flat quarter-on-quarter, kept costs, so they were also flat or slightly up, prices flat or down. How was it possible that the mining division achieved 16% increase in EBITDA quarter-on-quarter? That's question number one.
And question number two, looking at your working capital dynamics in Q4 I notice that there was an approximately $608 million inflow, cash inflow, from settlement with related parties. Could you please clarify what was the nature of this transaction? Thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [65]
------------------------------
Stanislav Ploschenko will answer the questions.
------------------------------
Stanislav Ploschenko, Michel OAO - CFO [66]
------------------------------
If you look at the financial analysis and the segment's financials in the mining, we had a significant improvement in the items below the gross income in particular, the selling and distribution expenses decreased by 37%. Largely -- or not only due to the overall decrease in sales, which was not significant but most importantly due to increase of the share of sales on the FCA basis of course to longer-term delivery, like CPT or DAF. Plus we had an improvement in the administrative expenses coming -- or excuse me, in the non-profit taxes due to the recalculation of the mineral extraction tax and apart from other reasons these are probably the two main ones that led to the improvement in profitability.
Answering your second question, when I described the relationship or the origins of the Estar loan, I mentioned that that loan was extended to the Estar shareholders precisely in order to repay the net receivables. We had extended to Estar when the market was growing and we were relying on the larger scale of operations. And our task was to protect the P&L by turning the unsecured receivables into assets secured loan to repay those receivables. Since the settlement with Estar continued into the first quarter of 2012, we only reflected $679 million of net inflow of -- from Estar in settlement of those receivables. So basically the money revolved from the loan to Estar back to our Group through the repayment of receivables.
------------------------------
Sergey Donskoy, Societe Generale - Analyst [67]
------------------------------
Understood, thank you.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [68]
------------------------------
Next question please.
------------------------------
Operator [69]
------------------------------
Thank you. We currently have no further questions coming through. Suggest another reminder. (Operator Instructions). We've got no further questions coming through. I'll hand you back to your host to wrap up today's call.
------------------------------
Vladislav Zienko, Michel OAO - Director of IR [70]
------------------------------
Ladies and gentlemen, thank you for taking the time to join Mechel's full-year 2011 financial results conference call today. The replay of the call will be available on Mechel's website. If you have any further questions, please contact the IR office. Thank you again from all the team here.
------------------------------
Definitions
------------------------------
PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the
Transcript has been published in near real-time by an experienced
professional transcriber. While the Preliminary Transcript is highly
accurate, it has not been edited to ensure the entire transcription
represents a verbatim report of the call.
EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional
editors have listened to the event a second time to confirm that the
content of the call has been transcribed accurately and in full.
------------------------------
Disclaimer
------------------------------
Thomson Reuters reserves the right to make changes to documents, content, or other
information on this web site without obligation to notify any person of
such changes.
In the conference calls upon which Event Transcripts are based, companies
may make projections or other forward-looking statements regarding a variety
of items. Such forward-looking statements are based upon current
expectations and involve risks and uncertainties. Actual results may differ
materially from those stated in any forward-looking statement based on a
number of important factors and risks, which are more specifically
identified in the companies' most recent SEC filings. Although the companies
may indicate and believe that the assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate or
incorrect and, therefore, there can be no assurance that the results
contemplated in the forward-looking statements will be realized.
THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION
OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO
PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS,
OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS.
IN NO WAY DOES THOMSON REUTERS OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER
DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN
ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S
CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE
MAKING ANY INVESTMENT OR OTHER DECISIONS.
------------------------------
Copyright 2017 Thomson Reuters. All Rights Reserved.
------------------------------