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Summary

  • Chinese demand for high grade iron ore is increasing.
  • India is facing a production shortfall to satisfy local demand.
  • The iron ore industry can see a rebound on demand increase from China and India.

Vale SA (NYSE:VALE) is a Brazilian based company engaged in the production of iron ore. The company sold its stake in lower returning assets last year in order to increase investment in iron ore production. It sold a 26.5% stake in Logistics Company and an approximately 44% stake in Fosbrasil SA. Furthermore, the company signed a deal with a Franco-Belgian utility for the sale of 20% interest in two natural gas blocks. These sales indicate that the company will be focusing on iron ore as the emerging markets are expanding, providing more opportunities to iron ore miners to exploit higher returns.

We can see that China has been the main revenue generator for Vale but as the economic growth rate is slowing down, the demand for iron ore is expected to slow down as well. During 2013 the demand for iron ore by China increased by 10% y/y but has slowed down since then and is expected to grow by a meager 3.6% in 2014. This decline in demand driven growth has primarily been due to a major policy shift by the Chinese government and its focus on developing structural infrastructure as opposed to the earlier focus on economic growth.

Currently the steel mills are working under capacity because there are already huge stockpiles of iron ore lying in the ports due to previous agreements with the miners. Moreover, the demand is also shifting from low quality iron ore to a higher quality product. This is primarily driven by the government's efforts to control pollution which is primarily caused by low grade iron ore. Therefore, while there is an overall decline in the demand of iron ore we expect that Vale will witness a significant increase in demand for its high quality iron ore; more so than other miners because the company concentrates its production on high grade ore. High grade iron ore is commonly known as lumps or pellets in the industry and Vale increased its pellet production in the fourth quarter of 2013 by 7% quarter over quarter (11% compared to the fourth quarter of 2012), reporting 10.4 billion tonnes of pellet production.

(click to enlarge)

Source: Vale 4Q2013 Report

We believe that this shift in demand by China can increase the price of high grade iron ore which will support the iron ore price level to some extent and help Vale in increasing its market share in China.

Moreover, India is also increasing its steel capacity and by looking at the iron ore export figures that have reached 900 million tonnes we can see that the demand/supply gap is expected to widen in the future. Karnataka and Goa region in India produce around 35% of the total domestic production. This figure has gone down from 218 million tonnes in 2010 to a mere 135 million tonnes in 2013, primarily due to illegal mining.

This is the opportunity that Vale can capitalize on in order to capture more Asian market share in these two emerging economies. Both China and India portray a better future for Vale SA.

Analysis

Amounts in ($ Billions)

Market Capital

71.73

Long term Debt

50

Cash and Cash equivalents

(5.3)

Enterprise Value

116.43

According to our calculation the enterprise value of Vale is close to $116.4 billion which brings us to an EV per share of approximately $23 per share. According to our target price the shares are currently being sold at a 40% discount (current share price $13.92).

Furthermore, the company has recently announced opening of the Totten Mine which will increase production of copper, nickel and precious metals. It has a 20 year life span at a production capacity of 2,200 tonnes of ore per day. Vale has also started work on the Copper Cliff Mine, located in the same region as Totten.

Looking at the demand behavior of India and China for iron ore we believe that the two countries can prove to be a rebounding factor for the entire industry and, particularly, producers of high grade iron ore. Vale is trading at a huge discount at these price levels and is an attractive buy for capital appreciation and dividends.

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. Equity Flux is a team of analysts. This article was written by our Basic Material and Financial analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Consider Vale On Increased Demand Of High-Grade Iron Ore