Vale S.A. (VALE), with its headquarters in Brazil, is among other things, one of the largest producers of iron ore and nickel in the world and has more than 85,000 employees. In addition, the company also produces other minerals such as bauxite, potash, alumina and coal. It is also known for its network of integrated logistics such as railroads, ports and terminals, which account for approximately 7% of its total revenues.
2013 first-quarter financials
With increases in operating income, margins and earnings, Vale turned in a solid performance for the quarter. Operating income of $4.2 billion grew by over 41% and operating margin rose to 38%, which was an increase of 14% when compared with the preceding quarter. Earnings rose by $1.2 billion to $3.8 billion while cash generation (EBITDA) was 18% higher touching $5.2 billion. This was the best performance from the company since the first quarter of 2011 when prices for the major products all peaked together. It should also be pointed out that its gold streaming transaction with Silver Wheaton Corp (SLW) revealed hidden values in its base metal operations and of the $1.9 billion cash received in 2013, only $244 million was reckoned in the earnings because of accounting regulations. Improvements in costs and expenses added to the bottom line for the first time in years and were the result of important cost reduction initiatives. Despite the strong quarter and cost reductions, there remains a long way for Vale to go to enhance shareholder value by reducing the cyclical effect on the business.
Operating revenues for the quarter were $11.2 billion - a decline of 10.7% over the preceding quarter mainly due to the effect of lower volumes. Underlying earnings of $3.2 billion, were equal to an EPS of $0.62 per share on a fully diluted basis, compared to $2 billion in the preceding quarter. Higher tax payments and unfavorable foreign exchange rates were the main reasons for the decrease in underlying earnings. Capital expenditures excluding acquisitions were $4 billion in the quarter, 8.4% more than the same quarter of the preceding year. Investments in corporate social responsibility initiatives were $210 million of which $163 million of which was earmarked for environmental protection and conservation. The company continues to emphasize the maintenance of a strong balance sheet with low leverage (measured by total debt/LTM adjusted EBITDA) of 1.6 times, long average maturity of 10 years and low average cost of 4.6% per year as of March 31, 2013.
The iron ore market outlook
With no improvement in global growth and the increasing evidence that the slowdown in China is permanent, iron ore prices are already down by 8% this year to date and prices are likely to remain under pressure. The expectation is that global supply will exceed demand in the long term, which could result in lower prices but a far more stable and less volatile market. The company is addressing the problem in two different ways. The first is to expand volume to offset the lower price realization by the expansion of projects at Carajas Norte, Conceicao Itabiritos and Vargem Grande. The company is expected to realize the benefits of this expansion in 2014. The second is to aggressively cut costs while maintaining its balance sheet strength and low leverage.
The problems with coal
At a time when the company needs revenues from every single source in order to offset the decline in the core businesses of iron ore and nickel, it has been forced to cut back its coal export target for 2013 from Mozambique by around 30%. This follows on the heels of a temporary disruption at the Sena railroad operations. The reason for the lower export from Mozambique is because heavy flooding has closed the railroad used for transportation. Infrastructure problems in Mozambique have prevented the company from achieving its production and export targets for 2012. Moreover, the prices of coking coal, used for making steel, are declining because of increased supplies from South Africa and Mongolia as well as a reduction in the growth of steel production globally. Coal revenues, at around $1 billion annually, are a useful addition to the revenues from the core businesses.
The bottom line
At the current trading price of $14.40, the stock is trading near its 52-week low and could well represent an attractive entry point into commodity stocks if you believe that the global recovery and an upturn in commodity demand is around the corner. There is a dividend yield of around 3% plus a potential upside of around 15% to sweeten your investment.