Bloomberg News

Estar Default Risk Weighs on Mechel Debt, Rating: Russia Credit

August 21, 2012

Bondholders are demanding higher yield premiums from OAO Mechel (MTL:US) relative to other Russian metals and mining companies on concern its debt load will soar with the takeover of a smaller steel producer.

Billionaire Igor Zyuzin’s coal company, which agreed on new covenants under its international debt less than four months ago, will seize control of the indebted Estar Group if the Moscow-based company can’t repay a $945 million bank loan guaranteed by Mechel’s units by the end of September, according to the debt agreement. Moody’s Investors Service downgraded Mechel last week partly on concern Estar is likely to default, adding as much as $800 million to Mechel’s $9.2 billion of debt.

“Such a move may put Mechel at a risk of technical default and breaching newly agreed covenants,” George Buzhenitsa, a Moscow-based analyst at Deutsche Bank AG, said in an Aug. 20 phone interview.

The yield on Mechel’s 5 billion rubles ($157 million) of bonds with put options in 2014 climbed 337 basis points, or 3.37 percentage points, this year to 14.9 percent, widening the premium over similar-maturity debt of OAO Magnitogorsk Iron & Steel to 590 basis points from as little as 97 basis points in January, according to data compiled by Bloomberg. OAO Koks, a smaller coal producer with the same B2 rating from Moody’s as Mechel, has bonds due in 2014 that yield 11.76 percent.

The rising costs may complicate Mechel’s plans to lengthen the maturity of its debt.

Extending Maturities

Mechel is looking to push out maturities without inflating its borrowing costs, Chief Financial Officer Stanislav Ploschenko said in an e-mailed message from Moscow on Aug. 17. Extending the tenor “may probably entail certain refinancing, including in foreign currency,” he said.

The plan will be scrapped if it becomes too expensive in “tight” international capital markets, Ploschenko said.

International lenders aren’t likely to call in Mechel’s loan if it risks breaching the current terms because they has approved the potential acquisition of Estar, Buzhenitsa said. They may agree on new covenants with Mechel before a breach is recognized, he said.

Net debt may advance as high as $10.5 billion if Mechel completes Estar’s consolidation, according to Deutsche Bank estimates.

International lenders holding $2 billion of debt raised the ceiling on Mechel’s net debt to earnings before interest, taxes, depreciation and amortization to 5.5 this year and 4.4 for the second half of next year, the company said May 10.

Maria Kolmogorova, a spokeswoman for Mechel (MTLR), declined to comment for the story.

Coal Slump

Mechel has to repay about $1.4 billion in bonds and loans by the end of the year and $1.9 billion in 2013, according to a June 20 presentation. First-quarter revenue was little changed at $2.95 billion, while profit slumped 29 percent from a year earlier to $218 million as coal prices dropped and mines were halted for safety checks, the producer said at the time.

Domestic coking coal prices tumbled 34 percent from a November peak while export prices lost more than 50 percent in the same period, according to Morgan Stanley (MS:US)’s data.

Mechel will be able to rely on funding from state banks to avoid a default, Andrey Kulakov, Uralsib Capital analyst said in the report Aug. 20. About 40 percent of Mechel’s total debt are loans from state banks, while 20 percent are domestic bonds, he said.

Putin Support

Russia will not leave its miners without support as the global economic crisis damps demand, President Vladimir Putin said Aug. 20 at a meeting with coal-industry workers, noting the success Mechel has had developing its Elga deposit.

State-owned VTB Group approved a three-year extension for Mechel on 13.6 billion rubles ($459 million) of loans while OAO Gazprombank (GZPR) extended 22 billion rubles of credit lines by three to five years earlier this year.

The ruble appreciated 1.1 percent to 31.7159 per dollar by the 7:00 p.m. close in Moscow. Non-deliverable forwards, which provide a guide to expectations of currency movements, showed the ruble at 32.2048 per dollar in three months.

The yield on the government’s domestic ruble bonds due in June 2017 fell 11 basis point to 7.62 percent. A gain in Russia’s dollar bonds due in April 2020 pushed yields down three basis points. The yield on Russia’s international ruble bond due in March 2018 was little changed at 6.408 percent.

Extra Yield

The extra yield investors demand to hold Russian government bonds rather than U.S. Treasuries fell eight basis point to 211, according to JPMorgan Chase & Co.’s EMBIG indexes. The difference compares with 160 basis points for debt of similarly- rated Mexico and 161 basis points for Brazil, rated one step lower. Russia is rated Baa1 by Moody’s Investors Service, the third-lowest investment grade.

The cost of protecting Russian debt against non-payment five years using credit-default swaps fell eight basis points to 162, according to data compiled by Bloomberg. The swaps cost 15 basis points less than contracts for Turkey, which is rated three levels lower at Ba1 by Moody’s.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Russia’s government won’t abandon Mechel, which is a large employer and is seen as a strategic company, said Fedor Naumov, head of research at Moscow-based Kapital Asset Management, which manages about $7 billion in assets. The majority of Mechel’s bonds are held by state banks after investors sold them as the global financial crisis reduced the appetite for risk, he said.

A bond sale on the open market will be too expensive for Mechel, given the company’s debt and effect of the possible Estar consolidation, Deutsche Bank’s Buzhenitsa said.

“We recommend to avoid investing in Mechel’s bonds” due to the high risks, UralSib’s Kulakov said.

To contact the reporter on this story: Yuliya Fedorinova in Moscow at

To contact the editor responsible for this story: John Viljoen at

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