Nine Months 2016 Mechel PAO Earnings Call

Nov 29, 2016 AM EST
MTLR.MZ - Mechel PAO
Nine Months 2016 Mechel PAO Earnings Call
Nov 29, 2016 / 03:00PM GMT 

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Corporate Participants
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   *  Alexey Lukashov
      Mechel PAO - IR
   *  Oleg Korzhov
      Mechel PAO - CEO
   *  Sergey Rezontov
      Mechel PAO - CFO

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Conference Call Participants
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   *  Sergei Krivokhizhin
      Sberbank CIB - Analyst
   *  Evgenia Molotova
      Verno Capital - Analyst
   *  Rumen Ivanov
      ICE Canyon LLC - Analyst
   *  Nikolay Sosnovskiy
      Prosperity Capital Management - Analyst

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Presentation
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Operator   [1]
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 Good day, ladies and gentlemen and welcome to the Mechel Reports The Nine Months 2016 Financial Results Conference Call. For your information, today's call is being recorded. At this time I would like to turn the call over to Alexey Lukashov. Please go ahead.



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 Alexey Lukashov,  Mechel PAO - 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 nine months 2016 results, which were 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 United States 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 those statements. We refer you to the documents Mechel file 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 discussion today. Reconciliation 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, and welcome to the conference call for the Company's financial results of the first nine months of 2016. Mechel's consolidated revenue over these three quarters of the year totaled RUB196 billion with consolidated EBITDA at nearly RUB41.6 billion and net profit attributed to Mechel PAO's shareholders at RUB5.5 billion.

 Well, it is hard to assess the accounting period on the whole and each quarter was dramatically different from the other and we already see that the fourth quarter also differed very much from the previous ones.

 As I'm sure everyone remembers, the first quarter was difficult and it was characterized by minimal prices on nearly every kind of products we make. This had its impact on the quarter's results. It has brought in only 24% of the nine-month's EBITDA.

 The increase in coal prices which began in the second quarter, though initially weak and together with an intensive growth of steel prices enabled us to significantly improve our financial results and make the Group's position more stable.

 The third quarter was characterized by a small slump in the steel market, but it was this period which this year's initially (inaudible) coal prices explode, as a result, in October, the global markets contract prices for high quality hard coking coal for the fourth quarter were set at $200 per ton, and the last time we saw such a contract price was in mid-2012.

 Meanwhile spot prices continued to grow. So we do not rule out the possibility that benchmark prices for the first quarter 2017 will be fixed at the historical highs of 2011. I must note that we will see the effect of this really -- what effect this really had on the Group's financial results only in the fourth quarter's results.

 This accounting period has been marked by several other important events apart from the market volatility. We have practically completed restructuring our debt to our major lenders, extending debt maturity until 2020 with repayment over the following three years. The Company has fully restructured its bond obligations and in the end of the second quarter, we closed the deal selling 49% of the stock in the Elga Project to Gazprombank, which also enabled us to partially repay the debt.

 This year's 9% decrease in net debt and growth of financial results enabled us to decrease the net debt-to-EBITDA ratio from 11 to 8.8. Considering that the ratio is counted over 12 months, which currently include a week of the fourth quarter 2015 and the first quarter 2016. While the current price level for our products allows us to forecast an improvement in the Company's financial results, the ratio will continue to decline, reflecting further stabilization of the Group's financial position.

 I have to note that growth of the mining segment's profit margin is linked mostly with the hike in coal prices. The improvement of the steel segment financial results is due to change in the production structure, due to organizational measures, as well as the market situation. For instance, sales of low margin billets and wire went down by nearly 25% year-on-year. At the same time, as Chelyabinsk metallurgical plant's Universal rolling mills workload reached 50% of its planned capacity, sales of its products have nearly tripled.

 As a result, it was fairly stable production volumes year-on-year. We have optimized the sales structure of our steel products while facing a major improvement in the metallurgical coal market. These factors will undoubtedly contribute to an improvement in our financial results, deleveraging, and a growth in the Company's shareholder value.

 Now, I'd like to pass the floor to our Chief Financial Officer, Sergey Rezontov, who will give details on 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 and good evening, ladies and gentlemen. During 2013 to 2015, both commodity and steel markets were under pressure and demonstrated constant decrease in prices and demand, both domestically and internationally. Low level of working capital, high interest rates and challenges in attracting long-term finances for new investment projects in the mining industry over the past year has led to the decrease of output and closure of operations on mines in United States, Australia and other regions.

 However, the situation has being rapidly changing in 2016 from quarter to quarter. In coal, China 276-days policy came as something as a supply shock for the global market and saw the impact of the slump in Chinese domestic supply spill over into the seaborne market. At the same time, we saw low inventories and some supply disruption. Although all of the above as well as other factors led to an unbelievable rally of prices for bulk commodities, with simultaneous increase in iron ore, coking and thermal coal prices. Bulk commodities has been [surprised] outperformed in 2016 and nowadays coking coal prices have nearly tripled after reaching historical lows.

 Steel prices were at the low level during first quarter 2016, but started to increase after the Chinese government announcement of supporting measures for the industry in March-April 2016 and increase by 60% from their lows. During third quarter 2016, we saw correction of steel prices, but under the pressure of high commodity prices, we have started to see increased prices for both flat and long steel products in [fourth] quarter 2016.

 Nobody can predict whether the current prices will remain stable for long, but being a vertically integrated Company, Mechel has an almost 100% self-sufficiency in resources for steel production. In addition, Mechel receives 70% of its revenues from sale of bulk commodities to third-parties nowadays and has plenty of upside to recover working capital, stabilize its financial situation and start to deleverage with the repayment of debts from additional cash flows.

 We will now move to brief description of financial results in each of Mechel Group segments. Mining segment's revenue are divided 73% and 27% between third party and inter-segment sale and totaled RUB82.5 billion for nine month of 2016. Third-party sales decreased 4% from RUB62.4 billion to RUB60 billion as the Group was focused on the replacement of purchases of third-party coal with its own products.

 After launching Elga project, the Group covered 100% of our needs of pro-grades, raw blending and coal production. Our strategy of replacement of third-party coals could vary depending on the market situation and logistic cost. Our focus on operational efficiency enables us to decrease costs by 12% for the comparable period, almost RUB6 billion, which resulted in the increase of operating profits and EBITDA.

 The mining segment's EBITDA has grown 20% from RUB19.9 billion to almost RUB24 billion. We keep average cash cost in the open pit mines of Yakutugol and Elga at the low level of $12 or $10 per ton. Our sale to Asian markets exceeded 50% of our total sales as the share of our sales to the European market went down from 20% to 13% with the less efficiency associated with logistics cost. We increased the share of supply through the domestic market from 25% to 29% of our total sales. The surplus is equally attributed both for the inter-segment consumption and third-party sale.

 The increase of coal prices has a limited effect on our financial result during the reporting period as it was always during the few weeks in the last quarter when we had sales under new spot pricing. We expect to get full benefit from the prices rallied during fourth quarter 2016, since new prices were fixed in the contrast which are linked to the quarterly benchmark and the amount, approximately 40% of our export sales, as well as all other sales that are linked to spot prices, which already in October exceeded the benchmark.

 Now we'll move to the steel segment. As I mentioned during our previous conference call, market recovery and prices growth in the steel industry started a few months earlier than in the coal market, in March. Increase in prices from nine months 2016 brought additionally approximately RUB4.4 billion and increased sales volumes brought additional RUB1.8 billion. Total steel segment revenue increased to RUB118.9 billion, 6% plus for the comparable period.

 Domestic market prevails in our sales and its share has increased from 82% to 85%. Total volume of rolled steel products has increased from 636,000 tons to 823,000 tons, plus 30%, and it comes as a result of increase of Universal rolling mill workload to almost 50%. Universal rolling mill has produced 357,000 tons of products, out of which 59% are rail. Production cost increased due to the indexation of electricity tariffs, [plus 5.7%], and increase of raw material cost, mainly iron ore and coke, which has mostly resulted in improvement of Group's mining segment result.

 Segment's EBITDA increased by 8% year-on-year and amounted to RUB15.8 billion, despite of volatile pricing environment and an increase of cost associated with bulk commodities, which has been fully compensated by the increase of prices for steel products, we believe that our efforts are aimed at improvement of our product mix and cost efficiency, will support stable financial result for our steel segment. As one of remarkable examples of the results achieved an improvement of efficiency of our steel mills (inaudible), we generated approximately RUB0.5 billion of operation profit this year comparing with operational loss last year.

 The Power segment's performance achieved a 10% increase in gross profit, up to RUB9 billion and 19% increase of EBITDA to RUB2.1 billion. The main drivers for the improved operation results were decreased cost after completion of the modernization program, as well as favorable market conditions for sales price.

 On a consolidated basis, revenue remained stable at the level of RUB196 billion as the slump in the mining and power segments was compensated by the increase in the steel segment's revenue. Gross profit went up 10% to RUB88 billion, with gross margin at the level of 45% of the revenue. The expenses were up 5%, entirely due to the increase in transportation tariffs and changed basis of the delivery for our steel products, we have increased volumes of delivery of our products to our final customers using our own transportation.

 The net interest expense decreased 18% from RUB47.8 billion to RUB39.3 billion, after write-off of fines and penalties on part of our borrowings approximately RUB3.7 billion. Also a positive effect on total interest expenses volume is the result of the decrease of the [Key Central] bank rate, which is the basis for the calculation of interest rate under the Structure facilities with Russian State Bank.

 Group strategy going forward is to find all possible means to decrease interest expenses, which would allow us to generate free cash flow for repayment of debt. During third quarter 2016, a [threatening] of our reporting currency Ruble from RUB65.3 to RUB63 has leaded to an additional positive FX effect in amount of RUB2.3 billion. This has resulted in the accumulated FX benefit for nine-months in the amount of RUB19.7 billion.

 Income tax expenses of RUB2.4 billion includes changes in the reassessments on deferred tax effects due to the revaluation before termination of consolidated taxpayer grew at the end of 2017. Because of all above mentioned factors, Group net income attributed to shareholders for nine-months 2016 amounted to RUB5.5 billion.

 Now let turn to the cash flow and balance sheet analysis, the stable situation in our core markets permitted us to generate enough operating cash flow to recover working capital. A partially repaid overdue trade and other payables finance our investment activity as well as fulfil payment obligations under the restructured loan agreements. First of all, I want to emphasize that over the last nine months, the Group has managed to decrease trade working capital deficit from minus RUB14.2 billion to minus RUB2.4 billion. This allows us to improve the stability and efficiency of our production unit's performance.

 Within the third quarter, we have substantially increased our investment volume. Group spent approximately RUB1billion for purchase of equipment without the lease payments over the first half of 2016 and during the third quarter, investments amounted to RUB1.4 billion. We will continue to increase investments in our operations to maintain and increased production capacities as well as diversify our product mix.

 The amount of paid, current and overdue interest for nine-months 2016 is RUB25.8 billion, which is approximately 75% of accrued interest. Partial capitalization of interest, which has been agreed with our lenders as part of restructuring terms permits us to invest available free cash flow in working capital and capital expenditures. The average interest rate through the debt portfolio is 10.2%, and it trends to lower value as the rate is mostly linked to the Central [Banking] rate and the average paid interest rates amounts to 7.7%. The Group fulfilled its obligations under the restructure of facility agreements with the Russian State Bank. We continue our negotiations with a syndicate of other international lenders and [ECA creditors] on the restructuring terms.

 Group's total debt remained almost unchanged comparing with the end of June 2016 and amounted to RUB444 billion, excluding the Gazprombank auction on Elga. In the meantime, with the increase of EBITDA, net debt-to-EBITDA ratio has decreased from 9.6 to 8.3 from the end of June till now. In addition, following completion of transaction with Gazprombank for sale of 49% in the Elga Coal Complex, which was signed in June and which became effective in July, we have included in financial statements our obligation to buy back the shares in case Gazprombank exercise it's put option after five years and this put option amounts to RUB35 billion.

 We're looking positively on the development of prices and demand in our core markets from the beginning of next year. However, even in the risk of price correction and challenge in outlook for bulk commodities beyond 2017 also make us cautious.

 Having said that ladies and gentlemen, I would like to thank you for your attention and welcome you to open the Q&A session.

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Questions and Answers
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Operator   [1]
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 (Operator Instructions)



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 Alexey Lukashov,  Mechel PAO - IR   [2]
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 Thank you. We will now take questions. We would ask the participants, please state their name and company before asking their question, and allow some time after for translation. When questions are asked in Russian, they will be followed by translation. So, you may ask your question in Russian also and we will translate it.



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Operator   [3]
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 Sergei Krivokhizhin, Sberbank.





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 Sergei Krivokhizhin,  Sberbank CIB - Analyst   [4]
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 (interpreted) There are two questions from Sberbank. The first one is what is your projection for the cost inflation in coal assets in the next year? And the second question is, what price do you expect for coking coal and concentrate in the first quarter of next year, perhaps you have already started negotiating with your Asian customers.



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 Alexey Lukashov,  Mechel PAO - IR   [5]
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 This question will be answered by Oleg Korzhov.



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 Oleg Korzhov,  Mechel PAO - CEO   [6]
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 (interpreted) When we budgeted for 2017, we base that budget on our forecast of the foreign macroeconomic parameters as follows; we expect as of the first of July 2017 gas prices to go up 4%, energy prices to go up 7% and the railroad tariff to go up 5.5% and the inflation in our assets that we budgeted is around 5%.



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 Alexey Lukashov,  Mechel PAO - IR   [7]
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 The second question will be answered by Oleg Korzhov.

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 Oleg Korzhov,  Mechel PAO - CEO   [8]
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 (interpreted) The contracts prices in the fourth quarter, well if I had to give you a general information because we have such a wide product portfolio, so I'll go by our products one by one. The [OS] coals for the domestic market are sold at 7,300/7,500 on the CFCA basis. The coking coal concentrate from the Neryungri mines are exported. That concentrate is exported and there are two key destinations, one is China and the export basis there is actual basis there is CIF. We started with $167 and right now, we have reached $230. And as to Japan and Korea corridor, there the delivery basis there is FOB and the price range is $155 to $170 per ton.

 PCI coals are delivered to Japan and Korea on the [C4] basis with prices around $120 to $127. Steam coals are delivered to China on the CIF basis with the sale of the prices from our Yakutugol asset and the price range is between $75 and $95. And so the prices were around $75, then they started to grow then they are back again a little bit and these are the contract prices for the fourth quarter, the current contract prices. It's very difficult to forecast anything for the first quarter and in the last week and half or so, there has been a hike in prices, but since then, the growth slowed down. So I guess, we can expect that the prices in the first quarter next year could be around the current level of spot prices.



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Unidentified Participant   [9]
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 (interpreted) There are a few questions. The first one is a clarifying question to what has been already said. The growth in the railroad tariff, the 5.5% increase, is it something that the Russian railways have already approved and confirmed or are these your expectations. And the second question is about the Elga assets. How much do you intend to mine there in terms of raw coal and what will be the expected breakdown into coking and steam coals?





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 Oleg Korzhov,  Mechel PAO - CEO   [10]
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 (interpreted) Now John, to your first question, the 5.5% increase, this is our forecast. Of course, the tariff will be approved by Russian railways later. They are currently being discussed. But this is the projection on which we based our rail budget and when we receive the actual numbers, of course we will adjust the budget accordingly.

 And to answer your second question about production at Elga, this year, we hope to produce 3,700,000 tons of coal and our plan for 2017 is to produce 4.5 million tons of coal. In recent times, we have under invested into the equipment and into the machineries at Elga and we expect that in the first six months of the next year, we'll be investing into the overhauling of our equipment and into acquisition of new machinery.

 And in the second six-months of 2017, we expect to accelerate production there and to be producing at the rate that in annual terms would equal to the overall production of 5.5 million tons a year. So it means that we will produce less in the beginning of the year and will produce more at the end of the year. So overall, we expect to reach the targets of producing 4.5 million tons of coal there. And with respect to your other part of the question, the breakdown of coals, 75% will be coking coal and 25% steam coal.



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 Alexey Lukashov,  Mechel PAO - IR   [11]
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 Next question please.



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Operator   [12]
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 (Operator Instructions) Evgenia Molotova, Verno Capital.



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 Evgenia Molotova,  Verno Capital - Analyst   [13]
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 Hi, thanks a lot for taking my question. I just wanted to know for the further expansion of railcar, do you have any potential partners for the project finance now when coal is becoming very trendy or what is the plan going forward? Thank you very much.

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 Oleg Korzhov,  Mechel PAO - CEO   [14]
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 (interpreted) As to the future of the Elga project, there are several scenarios that we are currently considering, but all of them require a financial solution to accompany them. Again, there are different options that are promising and perhaps the best solution for us would be to restore the financing for this project from the Bank of Foreign Economic Trade. That will be the optimal option for us, but we'll have to work had to make that option possible.

 And more realistic, more pragmatic option at the moment is to continue developing the project without significant capital expenditure associated with the development. One of the possibilities is to expand the beneficiation capabilities there and the other option or sub-option would be to take raw coal from Elga and ship it to South Kuzbass to be beneficiated there. It is a more realistic scenario.

 We understand that potentially the future of the Elga project depends on three key parameters. How much you can produce? That depends on beneficiation capabilities and logistics. So generally, we can produce and deliver 5.5 million tons of coal a year. If you're asking about the plans that we announced much earlier when we spoke about potential production of Elga in the range of 11 million to 15 million tons a year, then this production is possible, but it depends on the market and it also depends on financing.

 In order to find financing for that scale of production, there should be certainty in the stability of the coal market. So today, we are realistic and we will be looking to develop the Elga project gradually and in a balanced fashion without considerable capital expenditure into it. But should the market conditions become more beneficial, should they change, then we would be ready to consider other accelerated options for the Elga project development. Thank you.



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 Alexey Lukashov,  Mechel PAO - IR   [15]
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 Next question please.



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Operator   [16]
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 Rumen Ivanov, Ice Canyon.



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 Rumen Ivanov,  ICE Canyon LLC - Analyst   [17]
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 Well, thank you very much for the presentation. Since you expect substantial improvement in financial performance next year with higher coal prices, do you expect to start paying full interest, cash interest on your debt facilities, because you're still capitalizing substantial portion of interest or how is this supposed to work?



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 Alexey Lukashov,  Mechel PAO - IR   [18]
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 The question will be answered by Sergey Rezontov.



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 Sergey Rezontov,  Mechel PAO - CFO   [19]
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 (interpreted) The terms and conditions of that restructuring are agreed upon with the creditors and there are different categories of debt and rate at which the debt is paid out depending on the Company's debt-to-EBITDA ratio. As the financial performance of the Company improves, also we increase the payout of the interest in cash. So we make no projections about that, but as per our agreement with the creditors, the better the financial performance, the more debt is paid out in cash.



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 Alexey Lukashov,  Mechel PAO - IR   [20]
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 Next question please.



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Operator   [21]
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 (Operator instructions) Nikolay Sosnovskiy, Prosperity Capital Management.



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 Nikolay Sosnovskiy,  Prosperity Capital Management - Analyst   [22]
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 (interpreted) There are two questions; question one is a follow up to the question that has just been asked and answered about the debt interest paid out. According to the information that you have for the nine months of the year and the third quarter of the year, what is the share of capitalized debt versus debt paid out in cash and what is the total amount of debt on your books?

 And second question is about rebar prices; you know that rebar prices domestically are (inaudible) while billets intended for export, their prices have significantly grown. So will that have any impact on your prices in Russia if not in winter then perhaps in early spring and if you expect a change and how big a change do you expect?





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 Alexey Lukashov,  Mechel PAO - IR   [23]
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 First question will be answered by Sergey.



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 Sergey Rezontov,  Mechel PAO - CFO   [24]
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 (interpreted) In the nine months of 2016, the total amount of debt interest paid out to give with past due debt was RUB25.8 billion, which is about 75% of the total amount of debt interest charged.



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 Alexey Lukashov,  Mechel PAO - IR   [25]
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 Tech question will be answered by Oleg Korzhov.



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 Oleg Korzhov,  Mechel PAO - CEO   [26]
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 (interpreted) Now to answer this question, a few stock prices have gone up and obviously the prices on raw products together with the semi-finished products have gone up and currently we were talking above a level of $400 FOB Black Sea and historically the semi-finished products prices and rebar prices have been in parity and the rebar prices depended on the semi's prices. The current prices are RUB34,000 per ton and that means they are already in parity. RUB34,000 per ton, that's VAT included and those other prices in the Moscow market, which is one of the most expensive in Russia.

 As to the forecast, well, perhaps the prices in early spring will change as the construction season starts to open. But in any case, there is dependence between the products prices and the raw material prices. If the stock prices are stable then the prices on the semi-finished products will also be stable and the prices on rebar will be stable.

 And for a producer, it doesn't really make much difference, what you produce, rebar or semi-finished products. It all depends on the economic feasibility, cost efficiency of this production at any given time. So yes again, perhaps with the construction season, the prices would go up, but again, we will follow the prices.



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 Alexey Lukashov,  Mechel PAO - IR   [27]
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 Next question please.



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Operator   [28]
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 (Operator Instructions) It appears that we have no further question at this point.



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 Alexey Lukashov,  Mechel PAO - IR   [29]
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 Thank you. Ladies and gentlemen, thank you for taking the time to join Mechel's nine month 2016 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 Investor Relations office. Thank you again from all the team here.



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Operator   [30]
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 That will conclude today's presentation. Thank you, ladies and gentlemen for your attendance. You may now disconnect.

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Editor   [31]
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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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