Vale (VALE), the world’s largest iron ore mining company, will announce its fourth quarter and annual earnings results on February 27. We expect low iron ore prices to have a significantly negative impact on its earnings for the whole year since iron ore constitutes the majority of its business.
While iron ore production in the fourth quarter grew year-over-year, it wasn’t sufficient to offset the overall decline in production. Production in 2012 stood at 320 metric tonnes a 0.8% year-over-year decline. The slight production decline was mainly due to abnormally heavy rainfall in the Brazilian states of Minas Gerais, Rio de Janeiro and Espirito Santo, which seriously constrained mining and logistics activity. With average iron ore prices in 2012 being much lower than the previous year, we expect an overall decline in revenues. 
The company is likely to report an overall loss for the fourth quarter due to impairments and additional tax charges announced in December. It will book a $4.2 billion fourth-quarter pretax charge after lowering the valuation of a nickel mine and its stake in aluminum producer Norsk Hydro ASA (OTCPK:NKSJY). It will also take tax losses of nearly $483 million relating to cases in Brazil and Switzerland. Of this, $451 million will be booked on the balance sheet for Q4 and the rest of the amount will be adjusted in the next financial year. 
Low Prices And Production Reduction To Hurt
As a result of economic conditions in the eurozone and a slowdown in demand from China, iron ore traded at significantly lower prices for much of 2012. Prices recovered spectacularly in the last quarter but the late rally will not be enough to offset the negative impact of low prices in the first three quarters.
While Vale’s iron ore production showed a 0.8% year-over-year decline to reach 320 million tonnes, rival Rio Tinto (RIO) increased its output by 3.7% to 199 million tonnes. Vale’s lead over Rio Tinto thus narrowed to 121 million tons, the smallest in three years. Not just that, Vale forecasts a further drop in iron ore production for 2013. Excluding its stake in a joint venture with BHP Billiton (BHP), it expects iron ore production to stand at 306 million tonnes. On the other hand, Rio expects to produce 290 million tonnes next year, a 21% expansion in production from current levels. The expected production decline this year is largely due to aging of some of the companies’ mines in southeastern Brazil. 
The production of nickel declined from 242 million tonnes to 237 million tonnes and that of copper from 302 million tonnes to 292 million tonnes. The production of these two metals was affected mainly by a longer than expected temporary suspension of mining operations in Sudbury during the first quarter.
The production of coal, however, rose spectacularly by nearly 84% from 3.7 million tonnes in 2011 to 7.1 million tonnes. This was attributed to ramp-up of production at the Moatize mine in Mozambique and a significant improvement in the performance of Integra Coal and other mines in Australia. Nevertheless, lower prices of coal witnessed in 2012 will temper the gains accrued to Vale.
Impairments And Additional Tax Charges
Vale will take a $2.85 billion pretax writedown on its Brazilian nickel project Onca Puma, which had been producing far below expected levels due to processing problems. The operations here finally had to be shut down temporarily after problems were detected in the furnaces.
In addition to nickel, Vale also said that it will recognize a $1.3 billion pretax impairment on its 20% stake in Oslo-based Norsk Hydro, an aluminum producer. The company blamed the impairment on downward volatility in aluminum prices and macroeconomic uncertainties in the European economy.
In addition to these impairment charges, Vale announced the settlement of two major tax disputes at a considerably higher cost than originally envisaged. It settled a dispute with Swiss tax authorities over differences in interpretation of the federal tax breaks granted to Vale’s international business in 2006 and the consequent tax liability figure. While the company had already set aside $37 million for the Swiss claim, it said it would now have to pay $232 million, which is almost six times that amount. 
Vale settled another tax dispute over unpaid sales taxes in the state of Minas Gerais, Brazil’s traditional mining hub. Here also while Vale had provisioned $64 million for the case, its eventual liability would actually be five times higher at $317 million.
We will be paying attention to Vale’s comments on how it plans to achieve its iron ore production expansion targets beyond 2013 since it has stated its aim of producing 402 million tonnes by 2017. Also, we will be looking out for any hints about the sale of non-core assets. The company has slashed its investment spending target for 2013 to $16.3 billion, the lowest level in three years. 
We have a Trefis price estimate for Vale of $20, which will be revised after the fourth quarter earnings results.
- Vale Q4 2012 Production Report, Vale Press Release
- Vale to Book $4.2 Billion Charge for Nickel, Aluminum Assets, Bloomberg
- Vale Lead Over Rio Narrowing on Slowing Output: Corporate Brazil, Bloomberg
- For Vale, the taxman cometh, Financial Times
- Vale Capex 2013, Vale Press Release
Disclosure: No positions