An Unsustainable Debt Burden
Mechel's net debt, at around $9.2 billion, equals 10.8 times its 2014 expected EBITDA, which is an unsustainable level, even when 60% of such amount is owed to three state-controlled banks (Sberbank, VTB and Gazprombank). Hence, I am sure Mechel will need to keep restructuring its debt, selling assets and issuing new equity until the company lowers its debt down to more usual industry ratios. Other highly indebted companies such as Arcelor Mittal (NYSE:MT) or AK Steel (NYSE:AKS) - one of the most leveraged American steel companies - have net debt to EBITDA ratios of 2.5 times and 6.2 times, respectively.
With the European (and international) steel market still oversupplied, prices for steel and steel related products (including coking coal) will remain low for at least the next one or two years. This means that Mechel's top line, at around $9.5 billion for 2013, will not soar in the short term.
Not Cheap but There Is Future for the Company
Apart from its huge debt pile, Mechel has significant challenges ahead. First of all, the company will need a high capex investment in order to launch the coking coal Elga deposit. On the other hand, the company will need to decide what to do about its high cost steel segment. That said, Mechel is the largest coking coal producer and one of the largest steel producers in a high growth emerging market. Besides, its coal operations are extremely cost efficient, which gives the company huge value even if you do not take into account the extremely valuable Elga coal deposit – Credit Suisse's analysts give the Elga deposit a value of $2.5 per share.
I believe there is a future for Mechel but right now is not the right time to go long on the company's equity. Mechel needs to restructure its debt and its operations before being a sustainable business. Moreover, selling for 2014 10.5 times EV/EBITDA, Mechel looks expensive compared to Arcelor Mittal, which trades at 2014 5 times EV/EBITDA. AK Steel is selling for even higher multiples but the company is an extremely leveraged play into the American steel industry – which is recovering thanks to the housing recovery.
In the past, great investors such as George Soros have been among Mechel's investors but they are not buying shares, at least for now. As soon as those investors start accumulating shares you might also want to do the same. Right now its still time to wait and see.