Evraz, Severstal Clawing Against Debts, Weak Prices, Markets

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Russia’s two largest steel producer groups have recorded poor results for the first half of 2013 as the mills, Evraz and Severstal, continue to battle weak steel prices amid falling demand for the commodity in Europe and China and a glut of supply on the market, according to the FT.

Export volumes from Russia have held up relatively well, with data reported by the ISSB suggesting export volumes increased 8% between 2011 and 2012 from 24.6 to 26.5 million tons, even as exports from Ukraine and Kazakhstan fell. The EU remains Russia’s most important export market, but weak demand in Europe coupled with rising low-cost imports from China have depressed prices for Russian mills.

In addition, growth in the domestic market has slowed sharply with fears the economy could even slip into a recession in the second half of this year. Evraz reported a net loss of $122 million in the first half of the year after revenue fell 9% year-on-year, while Severstal reported a 9% decline in sales for the same period, with a downward trend – after making $44 million in the first quarter, it lost the same amount in the second.

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Goldman Sachs’ Net Debt Forecast for Evraz

Both companies are saddled with huge debt in spite of heroic efforts to sell off unwanted or peripheral businesses and pay it down. Goldman Sachs forecast the Evraz group net debt to reach $7.1 billion by the end of the year, or 4.5 times operating earnings, and although the firm holds sufficient cash to cover short-term repayments, Merrill Lynch has put a 52p target on the stock which currently languishes at about 95p after a 70% slide since its listing in London in November 2011.

Not surprisingly, Evraz has postponed any dividend payments mid-year, but Severstal will be recommending a small dividend as the firm slashes costs from capital expenditure programs and sells loss-making assets. Both firms went on a buying spree during the last decade and are now paying the price for debt taken on to buy overpriced assets, but their poor results underline a deeper malaise in the Russian steel industry.

How Raw Materials Costs Factor In

The country had assumed itself largely immune from the effects of the 2008 crisis – for example, steel exports dropped only slightly in 2009 and then rebounded. Energy prices have been below Western levels, enabling steelmakers to compete on energy costs even if iron ore costs have been less advantageous; but most importantly, the domestic construction market has been robust, fueled by a high oil price and a relatively (compared to the Western markets) fast-growing economy.

As the oil price has eased and global demand has failed to recover, domestic growth has slowed and the resulting overcapacity is not finding ready export markets in the face of low-cost Chinese material. Neither producer is expecting the situation to improve anytime soon, and both continue to cut costs, reduce planned capital expenditure and sell off assts to pay down debt.

If interest rates rise, they will need to re-double their efforts – saddled with such large debt positions, they are especially vulnerable to interest payments and rates.

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