Vale: Tax Settlement, Capital Discipline And $4 Billion Dividend Offer Upside

Dec. 4.13 | About: Vale S.A. (VALE)

Based in Rio de Janeiro, Brazil, Vale S.A. (NYSE:VALE) is the world's largest producer of iron ore and the second largest producer of nickel. The company recently hosted its annual investor day in New York. The mining giant achieved a number of important milestones in 2013 including tax litigation, assets divestitures, costs reductions and environmental licensing. Moreover, the company's strategy remains clear to continue to deliver value to investors in 2014 and beyond.

Vale's strategic priorities are a disciplined capital allocation, cost competitiveness, a strong balance sheet, delivering growth in iron ore volumes, and unlocking value from non-iron ore assets by improving EBITDA and selling stakes.

Portfolio Management

The mining giant is focused on iron ore, nickel, copper, coal, and fertilizers businesses. However, the company plans to sell its non-core assets. Vale expects to sell minority stakes in several coal and fertilizer projects, as well as in the Nacala corridor. Reducing ownership of the Nacala corridor should be positive for the project's IRR. Moreover, reducing exposure to the marginal Australian coal business is also positive for Vale. The company is also looking for partners to buy into its existing fertilizers business and growth projects, which should materialize during 2014. Vale's strategy makes sense given the business is capital constrained from growing and has relatively low NPV. Nickel needs to be fixed before it is a candidate.

Cost Reduction And Dividend

Vale is also focused on its cost cutting initiatives and is targeting a 10% decline in SG&A expenses and a 50% fall in pre-operating and stoppage expenses in 2014. The mining giant will focus its cost and expense reduction efforts in areas like procurement, exploration activities, administrative and sales organizational structures. Moreover, the company is also committed to return additional cash to shareholders and has set the minimum dividend of $4.0 billion for 2014, which is again better than expectations.

Tax Settlement Removes A long-Running Overhang

The world's largest producer of iron ore settled its decade long (2003-12) tax dispute with the Brazilian government related to foreign profits. The company agreed to pay R$22.3 ($9.6 billion), which is at the low end of most sell-side estimates. Vale will make an upfront payment of R$6.0 billion and the remainder will be paid over a period of 15 years. It is worth noting here the company had an estimated liability of R$45.0 billion related to the historical tax disputes. The company estimates the NPV of the tax payments at R$14.4 billion, which was again below market expectations.

As mentioned earlier total tax contingencies of R$22.3 billion are lower than the market expectations, and the main reason for that is the company's decision to make upfront payment for 2003, 2004 and 2006 (years with the largest amounts of interest and fines). Moreover the company didn't include 2002 and 2013 in the government's tax refinance program, which means that the legal process for these years is still ongoing and a final decision rests with the Supreme Court.

The company also retained a legal option on its case against the government. If Brazil's Supreme Court eventually ruled in favor of Vale, another company or industry group on this topic, Vale could stop paying and request a reimbursement of payments already made, claiming that the government never had the right to collect it. We think this better than expected settlement is positive for Vale, as it removes a long-running uncertainty associated with the size of the liability.


We have a buy rating on Vale. Disciplined capital expenditures, lower SG&A expenses, sale of non-core assets, growth in iron-ore volumes, minimum dividend of $4.0 billion, and a tax-settlement with the Brazilian government, these are all significant positives for Vale. The company's total capex guidance of $14.8 billion for 2014 represents the third consecutive year of reduction in capex and by 2016 the company could reduce it to $10 billion if no new projects are approved.

On the iron ore front, the combination of the Beijing's goal to reduce pollution and increase the share of poorer quality ore in the seaborne market has increased demand for Vale's higher quality ore and the company's iron ore quality premium has increased. The biggest iron ore producer highlighted that pellet premium reached $40 per ton and that the company has been securing contracts with Chinese steel companies with $10 per ton premium for Carajas ore on top of an adjusted Platts 65% Fe price. We also think the market is overly cautious about iron ore prices. Vale is also financially secure with low-cost mines and a strong balance sheet and is committed to return excess cash to shareholders. Finally, we think the better than expected tax-settlement is positive for Vale, as it removes a long-running uncertainty associated with the size of the liability.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.