Half Year 2016 Mechel PAO Earnings Call

MTLR.MZ - Mechel PAO
Half Year 2016 Mechel PAO Earnings Call
Aug 29, 2016 / 03:00PM GMT 

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Conference Call Participants
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   *  Alexey Lukashov
      Mechel PAO - Director of IR
   *  Oleg Korzhov
      Mechel PAO - CEO
   *  Sergey Rezontov
      Mechel PAO - CFO
   *  Oleg Petropavlovsky
      BCS - Analyst
   *  Barry Ehrlich
      Citigroup - Analyst

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Presentation
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Operator   [1]
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 Good day, and welcome to the Mechel reports first-half 2016 financial results conference call. Today's conference is being recorded.

 And at this time, I would like to turn the conference over to the Company. Please go ahead.

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 Alexey Lukashov,  Mechel PAO - Director of IR   [2]
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 Thank you and good day, everyone. I would like to welcome you to Mechel's conference call to discuss our first-half 2016 results, which we reported today. With us from management today are Mr. Oleg Korzhov, Mechel's CEO; and Mr. Sergey Rezontov, Mechel's CFO. After management has made their formal remarks, we will take your questions to the presentation team.

 Please note that during this call, management will make forward-looking statements, some of which may have been made in the press release. Some of the information in this conference call may contain projections or other forward-looking statements regarding future events or the future financial performance of Mechel, as defined in the Safe Harbor provisions of the 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 time 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 or forward-looking statements.

 In addition, we will be using non-IFRS financial measures, including EBITDA, in our discussions today. Reconciliations of non-IFRS financial measures to the most directly comparable financial measures are contained in the earnings press release, which is available on our website at www.Mechel.com.

 At this point, I would like to turn the call over to Mechel's CEO, Mr. Korzhov. Please go ahead.

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 Oleg Korzhov,  Mechel PAO - CEO   [3]
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 (interpreted) Good afternoon and good morning, ladies and gentlemen. We are glad to welcome you to the conference call for the Company's financial results of the first half of 2016. First of all, I would like to thank everyone who congratulated our Company with our professional holiday which took part yesterday, the Miners Day. And, further, I would like to turn further to our report.

 Mechel's consolidated revenue over the first half of this year totaled RUB130 billion, with consolidated EBITDA at nearly RUB26 billion.

 I would like to start with a quick assessment of changes on our markets in the past half-year. This year began with minimal prices both for coal and for our steel division's products, but positive trends began to form early as in the third quarter. The growth of prices for steel products on channels domestic and export markets inevitably prompted a hike in prices on other markets, including the Russian one, which is key to our steel division.

 As the construction period set in, this growth accelerated, with prices reaching their peak in May. Throughout the summer, prices became adjusted downwards; but, nevertheless, remained higher, as they have been in the year's beginning.

 The coking coal market also demonstrated positive dynamics in the first half year. The rise of contract prices for coking coal in the second quarter from $81 a tonne to $84 became the first important signal of this improvement. This was the first growth of quarterly contracted prices have been over the past few years. After a brief weakening in the trend in May, spot prices resumed their growth with newfound vigor. And contract prices for the third quarter were set at $92, which is 10% higher than the second-quarter price.

 Recently, spot prices for Australia coking coal reached $132, practically reaching the level of early 2014. As such, there is a strong chance that contract prices for the fourth quarter will also go up. We have already begun signing contracts with our foreign consumers for new higher prices.

 As for the Group's operations, in the first half of 2016, we retained stable production levels as compared year on year. There was a small increase in coal production. We managed to increase sales of all our key products. Coking coal concentrate sales went up by 10%; steam coal sales are up 18% year on year; sales of long and flat roll -- long products, went up by 10% and 7%, accordingly.

 Our key investment projects made their contribution to this growth. Elga Coal Complex continues to increase its mining volumes, with the share of coking coal in overall volumes also on the increase, which makes us happy. But if Elga, which in 2015 yielded nearly 4 million tonnes, became our last year's breakthrough, this year, Chelyabinsk Metallurgical Plant's universal rolling mill has proved itself. Thanks to the fact that since January 2016, we have started supplying Russian railways with our rails, the universal rolling mill has its increased its production volumes significantly.

 Starting with supplies of some 8,000 tonnes in January, in July we have shipped over 24,000 tonnes of (inaudible) rails to Russian railways. The overall supply volume of rails in the first half of this year totaled nearly 100,000 tonnes, and we expect to ship a total of some 250,000 tonnes of high quality rails to Russian railways this year.

 We also expect that this amount will be increasing next year. As the mill produces rails for other customers also, as well as other types of structural shapes, this year the mill float can reach 60% on a monthly basis.

 Port Posiet demonstrated a significant improvement in its results. After modernization was completed, the port's tonne shipment volumes grew by some 50% year on year. And at the first half of 2016, the port's tonnes shipped over 3.5 million tonnes of coal. The port also began [trans shipping] cargoes for third parties, which generated additional profit for the Group. Third-party coal in this period accounted for 10% of all cargo processed by the port, and this share will be increasing.

 In the first half of this year, we made significant progress in working on our debt portfolio. We have completed the restructuring of our debt to our major lenders, Sberbank, Gazprombank, and VTB. We restructured our bond obligations and closed a deal on selling 49% of Elga Complex to Gazprombank. The cash we received from this deal enabled us to reduce our debt by nearly RUB33 billion, and bring our net debt to EBITDA ratio down from 11 to 9.5.

 Thus, the Group has worked successfully over the first six months of 2016, retaining stable production levels and revenue, increasing profit margin, and decreasing debt.

 And now I would like to give the floor to our Chief Financial Officer, Sergey Rezontov, who will give details of the financial results of all of our business segments. Thank you for your attention.

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 Sergey Rezontov,  Mechel PAO - CFO   [4]
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 Good morning, good evening, ladies and gentlemen. First of all, we'll focus on financial results of mining segment. The unprecedented turbulence in the commodity markets we witnessed in the fourth-quarter 2015 and first-quarter 2016 has affected the results of the mining segment. At the end of the last year and the beginning of this year, we saw the lowest benchmarks in spot prices from the coking coal in the past 11 years, which lowest point at the level of $75. There was a slight recovery in the benchmarks to $84 in the second quarter of 2016.

 During the first-half 2016, overall revenue amounted to RUB40.1 billion, which showed a decrease by 7% compared with first-half 2015, as a result of two major factors: firstly, lower average sales prices, which was not compensated by an increase of sales volumes for coking coal by 10%, and steam coal by 18%; and, secondly, the Group's strategy to replace purchase of coals from the third parties with its own production, including Elga coal project. Close control for the operations supports lowest level of average cash costs in open pit mines of Yakutugol and Elga at [11 of $20] per ton.

 Strong demand from Asian markets remains the key for the Group's coal sales, with an increase of its market share from 46% to 51% half-on-half. Domestic sales increased due to the replacement of purchase of coal products from third parties. Our sales to European market mostly consist of sales of anthracite and coal.

 The ability of the Group to increase production and sales volumes should support better financial results going forward, especially taking into account current spot for coking coal at the level of $131.6 per tonne.

 100% of our iron ore production was dedicated to internal consumption. For the quarter, the combined effect of lower revenue and volumes of external sales, together with the decreased cost of sales, drove the EBITDA to RUB14.4 billion, which is 10% above the previous year. Market recovery and prices growth in the steel industry started earlier than in coal market in March. Average increase in sales volumes amounted to 4.8%, including 7% increase for flat products and 10% for long products. These two factors supported the significant increase of revenues in steel segment of the Group, up to RUB78 billion, which is 5.5% higher, half-on-half basis.

 83% of sales from Russian steel plants are dedicated for the domestic market. Sales volumes for the domestic market are constantly increasing with implementation of a new product mix strategy. The Group didn't increase total crude steel production, but concentrated on larger volumes of higher-margin steel products. This major effect comes from the increase in production at the universal mill, which has produced during the first six months of the year 121,000 tonnes of rails, including 99,000 tonnes for Russian railways and 92 tonnes of beams.

 Most of European sales comes from the distribution business of Mechel Service Global through its warehouse, which demonstrated today's stable operations and profits after a consideration of the distribution strategy and increased purchase of steel from the local producers. Further utilization of capacities from universal mill project will support an increase of the production of higher-margin products.

 Production costs for almost all product range remain stable. Increase of sales revenue correlated with the increase of costs, which led to stable levels of EBITDA at a level of RUB9.5 billion. The spot volatile price environment was a general downward trend in third-quarter 2016. We hope that the cost efficiency program and new product mix will support stable financial results of the steel segment.

 Power segment's performance achieved a [50%] increase in gross profits, up to RUB6.8 billion; and a 42% increase in operation profit, to RUB1.3 billion; and EBITDA increased 1.5 times to -- or the level of RUB2.0 billion. The main drivers for the improved operation results were decreased costs after completion of the modernization program, as well as favorable market conditions for sale prices increased by 36% in second-quarter 2016 compared with the second quarter of 2015.

 On a consolidated basis, the revenue remained stable at the level of RUB130 billion, as the fall in the mining segment was compensated with the increase in steel and power segment's revenue. The gross income increased by 9% to RUB58 billion, with the gross margin ending up at 45% of the revenue. The commercial expenses were up 6%, entirely due to the increase in transportation tariffs and the changed basis of the delivery for our steel products. We have increased volumes of deliveries of our products to our final customers using our own transportation.

 The net interest expenses, net from the fines and penalties on overdue loans and borrowings, and finance lease payment, grew by 15% to RUB25.2 billion. This was mostly due to an increase in the average rate of borrowings in USD, due to the increase of the LIBOR rate; while the level of Central Bank rate was decreased to 10.5%, but only in the middle of June 2016.

 Interest income of RUB3.8 billion is the result of write-off of fines and penalties on overdue loans and borrowings, and finance lease, after the completion of the restructuring with Sberbank. The positive FX effect of RUB7 billion, which is the result of the regulation of USD and euro-denominated debt. As a result of all these above-mentioned factors, the Group's net income for six-months 2016 amounts to RUB8.3 billion.

 Let's now turn to the cash flow statements. I am proud to say they that our efforts aimed at improve the business, cash generation capability, continued to pay off the -- half-on-half basis. The reported period is usually marked by an accumulation of stocks of raw materials for an increase of sales in summer periods.

 This year, both steel and coal markets started with very weak prices; therefore, the Group was focused on accumulating materials, and increased sales immediately when the market growth started. As a result of this strategy, the cash flow from operations totaled RUB19.3 billion for first-half 2016, which is lower by RUB5.5 billion than the previous year.

 Accumulated cash was enough to cover Group's interest in capital expenditures, amounting to RUB7.4 billion and RUB1 billion, respectively. With the completion of the transaction with Gazprombank for sale of 49% in the Elga coal deposit for RUB34.3 billion, that Group used these proceeds to repay the debt with Sberbank for RUB31.5 billion, and current and overdue interest for amount RUB2.8 billion.

 The net debt reduction from the beginning of the year totaled RUB41.9 billion as a result of partial repayment of the debts and regulation, which we regard as a great achievement in the year of volatile markets. [Through this period we've analyzed] debt restructuring with the Russian state banks, other lenders; as well as completed the restructuring of the ruble-denominated bonds, with an extension of a repayment for five years, with a quarterly amortization.

 Restructuring with the Russian state banks assumes two options for repayments [shadow]: either from first-quarter 2017 until first-quarter 2020, or starting from first-quarter 2020 until first-quarter 2022. Gazprombank and Sberbank have supported long-term restructuring by 2022, but one of the conditions for achievement of similar terms with VTB by the end of 2016. We have held fruitful discussion with the bank on this subject and hope that they will be finalized during the indicated period.

 We are continuing our dialogue with the syndicate of international lenders on the restructuring terms, and will provide the information public as soon as they are finalized.

 Overall, ladies and gentlemen, the first half of this year has brought positive dynamics in the Group financial results, despite all challenges we faced in the beginning of the year. The volatility in our commodity markets, both in the mining and steel segments, with the recovery in the second quarter supported by increase of the coking coal and steam coal sales, reflect an improvement on our major markets.

 Growth of steel segment sales to take advantage of higher pricing and favorable markets; increasing operation profits, EBITDA, and EBITDA margin. Two-thirds of operation profits has been earned by the Group right in the second quarter, which should be an indicator for future periods. Adjustment of our working capital translated into significant efficiency improvement.

 At the same time, the efforts of the have been undertaking since the last year to make the restructuring of our debts in order to align our cash flow with the payment obligation of our debts was successfully completed with major of our lenders.

 Looking ahead, I can say that after the turbulent market environment and very challenging dialogue with our creditors, the Group should now focus on further improvement of its operations, decrease of cost of borrowings, and also on return on the realized investment projects: Elga Coal Complex and the universal mill.

 Thank you for your attention, ladies and gentlemen. The management now is ready to take your questions.

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 Alexey Lukashov,  Mechel PAO - Director of IR   [5]
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 Thank you. We will now take questions. We would ask that participants please state their name and company before asking the question, and allow some time after for translation.

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Questions and Answers
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Operator   [1]
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 (Operator Instructions). Oleg Petropavlovsky, BCS.

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 Oleg Petropavlovsky,  BCS - Analyst   [2]
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 Such a good pronunciation. Good evening, gentlemen. Thank you for the presentation. Oleg Petropavlovsky from BCS. Just one question from me. In the first half, you invested less than RUB1 billion into your operations. We are wondering how a Company of such scale may leave with such low CapEx. And what are your projections for the 2016 as a full year? Thank you.

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 Alexey Lukashov,  Mechel PAO - Director of IR   [3]
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 (spoken in Russian)

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 Sergey Rezontov,  Mechel PAO - CFO   [4]
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 (spoken in Russian)

 Now I will translate the answer and the question in English. As was correctly mentioned, the total amount of capital expenditures, in accordance with IFRS accounts, amount to approximately RUB1 billion. But if you well take the management accounts in accordance with the Russian accounting standards, the capital expenditures on the investment projects amounted to RUB1.7 billion. And maintained CapEx amounted to RUB870 million, which is -- the difference came from the difference in the accounting standards between the Russian accounts and the IFRS.

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 Oleg Petropavlovsky,  BCS - Analyst   [5]
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 (Spoken in Russian)

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 Alexey Lukashov,  Mechel PAO - Director of IR   [6]
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 So the question is, what will be the volume of capital expenditures by IFRS for the full 2016 year?

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 Oleg Korzhov,  Mechel PAO - CEO   [7]
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 (interpreted) In accordance with the Russian standards, we expect that the total amount of the capital expenditures for the year will amount to RUB5 billion.

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 Oleg Petropavlovsky,  BCS - Analyst   [8]
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 (Spoken in Russian)

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 Alexey Lukashov,  Mechel PAO - Director of IR   [9]
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 Next question, please.

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Operator   [10]
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 Barry Ehrlich, Citigroup.

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 Barry Ehrlich,  Citigroup - Analyst   [11]
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 It's Barry Ehrlich from Citi. Thank you for the presentation and taking questions. The interest expense in the income statement during the period was RUB29.8 billion. The cash interest paid in the cash flow statement was RUB17.2 billion.

 My first question was whether I correctly understood that the difference between these two figures is the accrued interest.

 The second question is, you state in slide 14 that you expect the average paid interest rate, with peak, which I guess is the accruals, to be 7.7% going forward. So, does that mean that the income statement interest will fall significantly, going forward, to a level of around RUB17.5 billion? Did I understand that correctly? So if you can take that question, and then I have also have another question. Thank you.

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 Sergey Rezontov,  Mechel PAO - CFO   [12]
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 And then I will translate the question into Russian. (Spoken in Russian).

 Now I will try to answer your question in English. You correctly mentioned that RUB29.8 billion is the accrued interest, which includes the current interest, plus the peak, plus the fines for -- and penalties on the overdue loans and borrowings which came from the banks. And you are correctly saying that RUB17.2 billion is the cash payment which has been done by the Group for service the debt during this period.

 But you also should take into account that from this RUB7.2 billion, amount of approximately RUB2 billion, RUB3 billion is the amount of the overdue interest which was paid exactly in the first half, over the completion of the restructuring of the proceeds of the sale of Elga, which I have mentioned in my speech.

 On the second question, you mentioned at that on slide 14, you see that the average rate which we in dedicated is 7.7%. This is actually the cash payment which the Company will do for the debt -- after the completion of the restructuring. And the average interest rate is 10.3%. This is the average rate of the overall portfolio, and the difference will be the capitalized interest. (Spoken in Russian).

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 Barry Ehrlich,  Citigroup - Analyst   [13]
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 Thank you. So, I also have two additional questions, if I may. First, the cash flows that are shown to DEMP that are continuing in the first half of this year -- those are actual cash flows out of the Group, my question, and for how many further periods do you expect those to continue? Also, we can see that there was an expansion in receivables during the period. It was considerable. Was that related to Russian railways, or what was the reason for that expansion? Thank you.

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 Sergey Rezontov,  Mechel PAO - CFO   [14]
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 (Spoken in Russian). With regard to the questions which have been received, the amount which is indicated in the financial statements with regard to the DEMP payment is correctly pointed out, and the payments shall be done by the end of 2018.

 With regard to the balance sheet statements, the increase of the debt obligations is the result of a seasonable factor which has been influenced by the market conditions. And this increase is not linked to the sales and the supply to the Russian railways. The Russian railways has deferred payment terms for the supplied rails, but the amounts are not so substantial.

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 Barry Ehrlich,  Citigroup - Analyst   [15]
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 Thank you.

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 Alexey Lukashov,  Mechel PAO - Director of IR   [16]
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 Next question, please.

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Operator   [17]
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 (Operator Instructions). There are currently no questions in the queue at this time. I will turn the call back to your host.

 Pardon the interruption. We do have one question.

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Unidentified Participant   [18]
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 (Spoken in Russian).

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Operator   [19]
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 The caller seems to have stepped away. There are now currently no questions in the queue.

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 Alexey Lukashov,  Mechel PAO - Director of IR   [20]
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 Ladies and gentlemen, thanking you for taking the time to join Mechel's first-half 2016 financial results conference call today. The replay of the call will be available at Mechel's website. If you have any further questions, please contact the Investor Relations office. Thank you again from all the team here.

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Operator   [21]
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 Thank you, ladies and gentlemen. That will conclude today's call. You may now all disconnect.

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Editor   [22]
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 Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.




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