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Arch Coal Inc (ACI), Mechel OAO (ADR) (MTL): Can You Take Risks With an Undervalued Miner?

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Usually, one wouldn’t want to tread into the territory of Russian stocks. The precise reason being stocks based in Russia tend to be volatile because of governmental interference, political situations and influential people like (who else?) Vladimir Putin. On the upside, certain Russian stocks provide an opportunity for discerning investors to purchase under-priced stocks if they are willing to take risks.

Arch Coal Inc (NYSE:ACI)

One company that particularly interests me is Mechel OAO (ADR) (NYSE:MTL), which produces coal, iron ore, steel, nickel, electric power and thermal energy. In this article, I shall briefly describe what makes Mechel interesting even though it is in an unenviable position.

Why you must consider Mechel OAO (ADR) (NYSE:MTL)

Mechel is one of the foremost metal and mining companies in Russia and was incorporated as recently as 2003. It operates in Russia, the United States Steel Corporation (NYSE:X) States, Lithuania, Kazakhstan, Bulgaria, the United Kingdom and Ukraine. Russia holds immense amounts of natural resources and very few companies have access to them. Most companies that operate in Russia are Russian like Mechel OAO (ADR) (NYSE:MTL). The vastness and potentially substantial wealth of resources in Russia can make any company that operates there truly profitable.

However, as we can see from Mechel OAO (ADR) (NYSE:MTL)’s numbers, that is clearly not the case. Mechel OAO (ADR) (NYSE:MTL) has a market cap of $1.24 billion and an enterprise value of $11 billion. With a profit margin of -20.39% and an operating margin of -3.85%, things are certainly not going too well in the company. Mechel OAO (ADR) (NYSE:MTL)’s return on equity was -46.40%, which clearly shows that the company is not able to make use of money invested by investors and return a profit. The company’s total debt of almost $10 billion makes things worse in the eyes of possible investors.

Still, I take a kinder approach to this company because of these 5 reasons:

1. Mechel has access to Russian resources, metals and energy.

2. Though Vladimir Putin famously criticized Mechel for using foreign subsidiaries to avoid taxes, last minute negotiations by senior Russian politicians helped Mechel to bounce back.

3. Coal and thermal markets are doing very badly, but China, India and other emerging economies still need sources of energy and often depend on thermal energy and coal. Though Chinese demand has drastically fallen, increased constructions in the hinterlands of the country will create sufficient market for companies like Mechel, which have always depended on China for sales.

4. Mechel has presence in energy-rich countries that are business friendly, unlike Russia. In the same breath, we must note that Russia has often taken a kinder approach toward Mechel in spite of rhetoric against the company that made its shares fall.

5. Mechel’s PEG ratio is 0.07, which shows that it is greatly undervalued. It currently trades at $3 but the fact that it is so grossly undervalued makes it an interesting buy for those who are willing to take the risks.

Negatively valued peers

If you do not want to take risks and would like to invest in lucrative American mining companies for the sake of safety and stability, you can look at Arch Coal Inc (NYSE:ACI) and the larger United States Steel Corporation (NYSE:X).

Arch Coal Inc (NYSE:ACI) is the 2nd largest coal supplier only next to Peabody energy. With 32 active mines and more than 5.5 billion tons of proven coal reserves, Arch Coal Inc (NYSE:ACI) is a good long term choice.

Like Mechel, Arch Coal Inc (NYSE:ACI) is undervalued. In fact, with a PEG ratio of -0.60, Arch Coal Inc (NYSE:ACI) is negatively valued. A negative PEG ratio is usually considered a bad sign but it is not always so. When a company’s free cash flow is still improving, its earnings will not grow. Thus, a negative PEG ratio can only considered to be a bad sign when a business will likely not make any earnings in the future.

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