Mechel (MTL) Profits Appear to be Coming Under Scrutiny

Ah, the joys of investing in non capitalist societies. It appears there is a movement afoot in mother Russia as Mechel (MTL) seems to be printing too much money. In-country steel makers (Mechel's peers) are getting the short end of the stick and the government wants to fix that. Just replace the term "steel makers" with "financials" and you can see the United States is not very different from Russia. ;) Only Russia dresses up the actions in much more flamboyant ways.

An interesting story out this week below, certainly could go a long way in explaining the weakness of late - although all the metal companies have been mugged of late.

• The Mechel group -- Russia's leading specialty steelmaker and one of the leading producers of coking coal in the world -- has lost 5% off its Moscow-listed share price on Thursday, following the public announcement two days earlier that it is under Russian government investigation for price-rigging and other anti-trust violations.
• Russia's Federal Anti-Monopoly Service (FAS) announced on July 15 that it has opened an inquiry into price-rigging and other anti-trust violations by the Mechel Group's coal division. The move is the first ever taken by Russia's anti-trust watchdog against coking coal suppliers to the Russian steel industry. (how convenient)
• Mechel is very sensitive to signals from the federal government, as the steel division has been a takeover target for two years past. For the time being, Mechel is claiming it knows of no complaints from clients regarding its coking coal supply or price policy. The company spokesman has also announced that "we haven't received any official documents about the case."
• The FAS action may, however, be the prelude to intensifying pressure on Mechel to limit its coking coal exports, and restrain share-listing ambitions for the coal and iron-ore division, and possibly for the ferroalloys division also.
• The last major problem Mechel had with a federal government agency in Moscow occurred in late 2004, when agents of the Interior Ministry raided the offices of a Mechel trading subsidiary in Moscow, searching for documents related to what appeared at the time to be a tax investigation. No charges or administrative proceedings followed, however.
• Company sources said at the time that the raid was intended to deter Mechel, which held a 17.1% stake in rival steelmaker Magnitogorsk Metallurgical Combine (MMK), from bidding for the 17.8% state stake on auction later that month. Mechel then sold its stake to controlling MMK shareholder, Victor Rashnikov, who went on to bid successfully for the state stake. (Russia at its best)
• FAS Russia, being concerned with possible price increase for coking coal and coal concentrate on the Russian market, sent enquiries to all main producers of coking coal and coal concentrate in order to study the level of coal supplies to domestic market, pricing procedures and price behaviour, as well as the planned level of supplies and prices for the year 2008."
• The FAS action may be a harbinger of the warning that Mechel's good fortune must now be shared with the rest of the domestic steel sector, and the state as well. (not good)
  
• Russian law provides that price-fixing violations are punishable by a fine of 1% to 15% of a company's profits gained from those sales. It is not clear, however, for how long the alleged price-fixing has been going on.
• A report by MDM Bank analyst James Lewis warns that "perhaps more important than the possible consequences for Mechel, though, are those for the industry: We view the allegations as possibly the latest in a string of recent measures to control rising coal prices and, in turn, steel prices. These started with discussions of export taxes on steel back in May (in which the FAS was also involved) and continued earlier this month with consideration of restrictions on coking coal exports. Now, rather going after the industry as a whole (efforts that have so far resulted in no immediate relief to rising coal and steel prices), it is possible that the government could be targeting individual producers. Whether or not Mechel was indeed engaged in price-fixing, we believe that such individually targeted measures could be more effective in convincing all major Russian coal producers (Mechel, Raspadskaya) to tread more carefully in their pricing policies."

So quite an interesting situation. This also plays into another them of mine, the long term protectionism of resources. We've talked about this in agriculture extensively this past winter. This appears to be a power play to protect the domestic steel industry by trying to keep (a) Mechel exports low; keep product in country and (b) restrict prices on domestic metallurgical coal so Russia's steel makers won't suffer. Neither is good for an investor. Ironically Mechel itself is a steel maker and is getting punished for it's forward thinking vertical integration!

This is too bad; obviously it is impossible to predict the outcome but these sort of actions and/or the restriction of the mining IPO would not make us happy campers. We've been waiting for that IPO for a long time. [Dec 12: Mechel Reports Earnings, Considers Mining IPO]

Long Mechel in fund; no personal position