RUXX Index: Mechel Stands to Lose Mining Licenses, Sees Cost of Debt Rise

NEW YORK, April 18, 2012 /PRNewswire/ -- Russian steel and mining giant Mechel may lose three coal mining licenses at Yakutugol, its core mining subsidiary, over license violations. This news creates a significant downside risk for the stock.

A recent inspection by Prirodnadzor, the Russian environmental watchdog, discovered that Yakutugol was behind on mine infrastructure construction, may be mining outside its license area limits, that some of its mines were below required production volumes, and that it did not keep proper records, the agency's statement says.

A Mechel spokesman downplayed the issue, saying that violations of this kind are common in the coal-mining business, and the company is confident that it will remedy the breaches within six months – the expected remedial time frame. However, the Subsoil Agency should issue a verdict within two weeks, and is likely to request that the Mechel subsidiary remove the violations within as little as three months or have its licenses revoked. Furthermore, a source at Prirodnadzor thinks violations of two licenses are very serious and sees revocation of these licenses as highly likely.

This is not the first time Mechel has been accused of mining license violations – its other major coal mining subsidiary, South Kuzbass, recently committed similar breaches. However, the Subsoil Agency's late March decision on South Kuzbass licenses is yet to be disclosed, according to Kommersant, Russian daily business newspaper.

Michael Thompson, a senior analyst for the RUXX Index, which includes Mechel and  other Russian stocks listed overseas, says: Mechel's situation remains highly volatile. Investors don't see the resolution, and sell the stock amid general low appetite for risk."

Mechel has also reached an agreement with VTB to restructure RUB 13.6bn (USD 460mn) of debt. The terms of debt restructuring are not disclosed, but Russian banking sources believe the new interest rate should be comparable to the coupon interest of 11.25% on a recent bond issue. This makes new debt far more expensive than the average yield of 8.8% on the company's outstanding bonds.

"The rising cost of debt is in line with our expectations, given Mechel's heavy debt burden (USD 9bn as of 3Q 2011) and the recent license trouble," says Thompson. In a recent disclosure, Mechel reported an increase in core shareholder Igor Zyuzin's stake pledged as security for the company's debt from 34.4% to 37%. This could be another sign of creditors' declining confidence in the company's prospects, as relative strength in the stock price makes margin calls unlikely.

According to Michael Thompson, "The threat of license revocation is very real, given that violations now appear to be part of a pattern of doing business at Mechel Mining and how serious some of them are. Mechel's hopes for special treatment could be misplaced, as the Russian Subsoil Agency may not provide additional time for remedial action. The high debt burden also makes investment in remedial action harder for Mechel." 

"We see Mechel as overbought at the current levels – the stock has gained 5.7% YTD despite its regulatory troubles and substantial debt burden and seems ripe for a correction, unless Mechel management can come up with a credible plan to address license violations soon," Thompson also said.

RUXX Index, which tracks Russian equities, including Mechel OAO, fell 10.62% in the last month.

Michael Thompson
Senior Analyst
917-475-6452
[email protected]

SOURCE RUXX Index