Chinese Steelmakers Warming Up: Vale Well Positioned

Includes: BHP, RIO, VALE
by: Paul Harper

Companhia Vale do Rio Doce (Vale) (NYSE:RIO) has recently been climbing back from lows caused by the severe drop in demand for its principle feedstock, iron ore. However, there are signs that the Brazilian mining giant may be turning the corner, as the Baltic Dry Index (BDI) has begun to show some activity off the back of speculation that the steel industry is picking up, particularly in Asia.

Vale said steel output across Asia declined by only 8.9% in the first quarter, despite the Japanese recession. This would indicate continuing strength in Chinese demand, compared to North American steel output falling by 52% and European output declining by 44%. Furthermore, Vale said its first-quarter copper output was unchanged year-on-year, aided by Chinese consumer demand for durable goods.

Steel demand is set to stabilize in the latter part of 2009, leading to “mild” recovery in 2010, according to the World Steel Association. German car registrations in March rose to the highest since 1992 after the government began paying owners to trade in old vehicles for new models. Sales in China of cars, minivans and multipurpose vehicles rose to a record in April. Car makers are the fourth-biggest steel consuming indutry, according to the association.

“The first-half will be pretty poor, but by the third or fourth quarter demand will improve,” said Peter Fish an analyst at UK based metals consulting company MEPS International Ltd. “The time is approaching when so-called destocking, in which customers use up inventories, ends and new orders will be made.”

China’s imports of iron ore also spiked dramatically in February and March, as larger iron ore producers such as Vale and Rio Tinto (RTP) have been selling their iron ore to Chinese customers at a discount. Based on comments from the China Iron and Steel Association, it’s possible that small Chinese steel mills are taking advantage of the opportunity to buy higher-grade imported ore at attractive prices. Previously, imported ore was only available to large mills.

A recent report in Tradewinds shows that Vale chartered 25 Capesize vessels last month for chinese delivery, which should point to flows of iron ore resuming, although a base price for 2009 has still not been agreed with Chinese steelmakers. At present, iron ore is being sold on the spot market at roughly 20-40% discount from 2008 highs of $200 per tonne, by Rio Tinto and BHP Billiton. Valke on the other hand has dropped production and delivery in step with falling demand and has maintained last year's benchmark pricing.

Chinese negotiators from Bao Steel had tried to force prices down to 60% of last year's benchmark, however it would seem that Vale’s stance regards shipment may have forced China’s hand, as demand for steel is growing. Vale finished trading on Friday at $17.42 off of a YTD low of $11.90 on heavier than normal buying activity.

For me, Vale is in a much more enviable position than its two main competitors, Rio Tinto (RTP) and BHP, as they have expended a lot of energy in last year's failed takeover bid. Rio Tinto in particular is saddled with huge amounts of debt and no doubt is coming under a lot of political pressure form its would be Chinese bail out “sugar daddy”. I firmly belive that Vale will be able to add at least 50% to its stock price this year and is one of the best value buys in the commodities sector right now.