Why Vale Still Is Overvalued And What The Iron Ore Market Weakness Means

May.13.13 | About: Vale S.A. (VALE)

Vale SA (NYSE:VALE) still appears overvalued and we believe it has further to run down more. We believe the issues are macro in nature, and that the Brazilian Stock Market may likely continue to underperform others. Recently, CEO Murilo Ferreira made comments which led us to believe there is more negative in store for this stock:

"His remarks at a gathering of executives and government officials sponsored by a Brazilian magazine underscored eroding corporate profitability in Brazil amid the fastest cost inflation and wage growth in years. More than 40 percent of Brazilian companies polled by Thomson Reuters reported lower profit margins in the first quarter, mainly due to rising labor costs and operating expenses."

On the other hand, the CEO also announced plans to attempt to sell more into the USA market, but analysts on that announcement were quite skeptical:

"About 3 percent of Vale's sales went to the United States last year, less than a tenth of its sales to China, and some analysts question how eager the U.S. market will be for foreign iron ore. Currently, the North American iron ore market is nearly self sufficient, with mines located close to rail and water links that can ship the ore cheaply and efficiently to mills."

We also believe Vale is making overly optimistic statements about the rapid increase in certain commodities which may not materialize:

"Vale expects the price of nickel, which has fallen nearly 50% in two years, to rise this year, said Peter Poppinga, the company's base metals chief. ... Poppinga also sees the long-term outlook for copper to be good, despite copper prices recently falling to seven-month lows."

BHP Billiton (NYSE:BHP) made comments recently which we believe are more realistic about the potential of iron ore prices to drastically lower profits of Vale:

"Global iron ore supplies will expand faster than demand over the long term, potentially lowering prices and reducing volatility of the raw material used to make steel, according to BHP Billiton. New seaborne cargoes will gradually displace more expensive output, mainly in China, Alan Chirgwin, general manager of iron ore marketing at the world's largest mining company, told an industry conference in Singapore today. He didn't give price forecasts or define long term."

We are starting to hear murmurs from China about decreased demand for iron ore imports:

"Last week, Wang Liqun, deputy secretary-general of the China Iron & Steel Association, announced that although Chinese iron ore imports grew last year, this year they are expected to drop considerably. "Significant low-cost supply, mainly from Australia and Brazil, will eventually meet and exceed incremental Chinese demand."

Finally is the issue of rising wages in Brazil and how this impacts a very large employer in Brazil is quite important:

"... most families' incomes are still rising fast. Unemployment is close to record lows and pay rises are comfortably outstripping inflation, partly because of big hikes to the minimum wage, but also because of that tight jobs market."

We see very little reason to be owning VALE right now, and lots of downside not realized by the market yet. If the CEO is issuing warnings about the macro picture, we have learned it is best to listen to them while they are speaking.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in VALE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.