Metinvest's 3Q14 production declines caused by Donbass conflict

Обзор облигаций 04.11.2014 In its 3Q14 production results released last Thursday, Metinvest reported unilateral production declines: crude steel dropped 42% QoQ to 1.7mt, iron ore concentrate declined 8% QoQ to 8.4mt, and coal concentrate was down 15% QoQ to 0.95mt. For 9M14, YoY production declines were as follows, crude steel by 21% to 7.5mt, iron ore concentrate by 5% to 26.5mt, and coal concentrate by 24% to 3.3mt. The significant drop in steel production was due to the conflict in Eastern Ukraine, which caused raw material supply constraints at Azovstal and Mariupil Ilyich Steel and the shutdown of production at Yenakieve Steel at the end of July and beginning of August. As a consequence, declining demand from the Metallurgical division negatively impacted the production of iron ore concentrate, which was also undermined by the equipment technical condition and repair works. The military conflict also had a detrimental effect on operations at Metinvest's East-Ukrainian coalmining asset, Krasnodon Coal, while coal production at Metinvest's US miners increased QoQ. Investment implications: We expect that the negative impact of the Donbass conflict on Metinvest's production will be more pronounced in 4Q14; for full-year 2014, the company may reduce its steel production by 26-29% to 8.9-9.2mt, iron ore concentrate by 6% to 34.4-34.7mt, and mined coal by 25-30% to 8-8.5mt. Railway deliveries of raw material supplies to Metinvest's steel mills remain the key issue, particularly for Yenakieve Steel which is located in territory not controlled by Ukrainian authorities. Repairs of damaged railway routes may require one to four weeks under the condition of a stable ceasefire which has not yet occurred. Even so, all production assets not materially affected by the conflict, including Avdiyiv Coke, Yenakieve Steel, and Kharstsyzsk Pipe, which were shut down since the beginning of August, are gradually restoring operations. As Metinvest is in process of rearranging its logistics and accumulating the required raw material inventories, it should ramp up capacity utilization, however below the targeted year-end 70% for Mariupil Ilyich Steel and Azovstal and 50% for Avdiivka Coke, Yenakieve Steel and Khartsyzsk Pipe. We also believe that the flow of the raw materials through the battlefront to Yenakieve Steel and Khartsyzsk Pipe should remain problematic.