Most of its problems are being caused by low prices and slowing demand for iron ore which have been eroding profits for quite some time now. Discussions with Chinese authorities about allowing the giant Valemax ships seem to be going nowhere. This has made it difficult for the Brazilian miner to compete effectively with rivals like BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) that are geographically closer to China. To further add to its troubles, its Simandou project in Guinea is going nowhere due to the fickle nature of government policies. As a result, Vale has been forced to suspend projects, including Simandou, resulting in a drastically reduced capital expenditure target for next year.
In order to reduce costs, increase efficiency, and allocate scare capital more judiciously, Vale has embarked on a program to sell a number of non-core assets. With its core business of iron ore giving it enough trouble already, the company doesn’t seem to have the bandwidth to make huge upfront investments in businesses like oil and gas. Despite the huge cutbacks planned by Vale, some experts feel that it isn’t going far enough in letting go of new mining projects. They contend that the company would be better off in investing to increase production from its existing assets.
Why Is Iron Ore Giving Vale Nightmares?
Weak iron ore prices and a slump in demand have been attributed to a slowdown in China, the world’s biggest consumer of iron ore. Vale is the world’s largest producer and exporter of iron ore, and accounts for more than a quarter of the world’s seaborne iron ore exports. While it is also a major producer of nickel, copper and fertilizers, about 90% of its profits come from iron ore. It is thus natural that if its biggest customer sneezes, Vale will catch a cold.
Vale’s iron ore sales outlook for 2013 is down by 1.9% to 306 million tonnes from its original 2012 estimate of 312 million tonnes.
You can project your own iron ore shipment figures for Vale by using our interactive graph below:
Vale’s iron ore business constitutes about 65% of its Trefis price estimate.
The Endless Valemax Saga
Valemax vessels are the world’s largest iron ore vessels with a capacity of 400,000 deadweight tons. These were ordered to be built by Vale to reduce shipping costs to the Asia Pacific region, so it could compete better with Rio Tinto and BHP Billiton. The latter two enjoy a cost advantage over Vale due to the geographical proximity of Asia-Pacific countries to Australia from where they primarily ship iron ore. Thirty-five ships, each costing about $110 million, were ordered and all of them were expected to be in service by 2013. The company’s plan, however, went into a tailspin as China refused to allow these ships to dock at its ports.
While since then preliminary work at the Ningbo-Zoushan port has begun to prepare for Valemax docking, the permission granted is not final and agencies with the final authority have not yet acquiesced.
Valemax ships can save the company $6 per tonne in shipping costs compared with currently used ships of 180,000 to 200,000 tonnes, which allow cost saving only of $3 to $4 a tonne. Right now, Vale has to use smaller ships for the last leg of a voyage into the ports which is not optimal. Any saving on costs amid low iron ore prices and stiff competition can meaningfully bolster Vale’s profits. Recent reports suggests that there could be progress on this front, but nothing has been confirmed so far.
The Simandou Headache
Simandou in Guinea holds enormous high-quality iron ore reserves but faces major political, commercial, and transportation hurdles. There is a pervasive atmosphere of policy uncertainty in Guinea. The government keeps locking horns with mining firms over control, ownership, and financing of projects.
Vale has finally decided to shelve this project. It had already stopped work on its part of the deposit in spring. While Vale has conveyed that it is still interested in the project, it won’t proceed until there is clarity on government’s policies. Among other things, the Guinea government has been shifting its stance on the export route for Vale’s iron ore produce which has the potential to cause costs to balloon. This project is not being factored into Vale’s capital expenditure budget for the next year.
Reduced Capital Expenditure And Asset Sales
According to a recent regulatory filing, Vale plans to invest $16.3 billion in 2013, down from the $21.4 billion budgeted this year. This amount is the lowest after 2010. Almost 47% of the spending will be on iron ore. Approximately $10.1 billion will be spent on new projects, $1.1 billion on research and development and $5.1 billion on maintenance of existing mines and plants. Apart from Simandou, other projects scrapped from the spending plan include the Lubambe copper mine in Zambia and the Samarco IV pellet plant in Brazil. The reduction in spending is driven primarily by expectations of a slower expansion in demand next year.
The assets being considered for sale include Vale’s oil and gas division which had it had bought as a hedge against rising energy costs. However, with other businesses straining its cash resources, investing in this capital intensive business is not feasible for Vale at this point. The company is also considering selling its 22% stake in the Norwegian aluminum group Norsk Hydro which had been acquired when it sold its aluminum business to Norsk in 2010. There is also the possibility that Vale may sell 50-70% of its new logistics company VLI SA. This is far more than the 33% it had originally planned on selling. VLI will be a player in the non-mining-related general cargo business.
Vale seems to be doing all it can to keep its head above water in globally weak economic conditions. Unfortunately, some things like government policies are beyond its control. Until the time the global economy starts looking up, Vale should maintain focus on cutting costs, improving efficiency and getting rid of assets that may not generate good returns. This will help the company to keep its powder dry when good times return and iron ore demand resumes its upward trajectory.
We recently revised the Trefis price estimate for Vale to $20 after the third quarter earnings results.
Disclosure: No positions