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Summary

  • Vale has substantially cut costs and sold non-core assets to improve its cash position.
  • Despite an expected drop in iron ore prices this year, Vale’s performance should remain consistent.
  • Vale is also focusing on certain expansion projects that should deliver long-term value.

Brazilian mining giant Vale (NYSE:VALE) seems to have gained some strong momentum in the last 15 days with the share price up 15%. The year had started on a negative note for the mining giant, but things got better after Vale posted strong results for the fourth quarter a few weeks ago.

Higher sales volume and a slight increase in iron ore prices led to growth in Vale's revenue and helped it post better-than-expected operating profit. Now, going ahead, things should get even better as Vale is employing some attractive strategies to improve its bottom line. However, a headwind might come in the form of lower iron ore prices.

JPMorgan (NYSE:JPM) has lowered its 2014 iron ore price forecast by 6% to $118 per ton on the back of slower demand from China. However, JPMorgan still remains positive about Vale's prospects, believing that the company is capable of generating positive cash flow despite lower iron ore pricing.

Cost-cutting strategies have worked

It is quite possible that Vale's strategy of cost cutting has placed it in an ideal position to withstand the uncertainty in the iron ore market. Last year, Vale had sold $6 billion worth of assets, and in 2014, it plans more of the same. Vale is targeting a further 10% reduction in SG&A expenses in 2014. This comes after a 39% reduction in SG&A in 2013. In addition, the company had reduced its capital expenditure to $14.2 billion in 2013 from $16.2 billion in 2012.

But, Vale has reiterated its pledge to pay a minimum dividend of $4.2 billion in 2014, which currently equates to a dividend yield of 6%. Going forward, Vale will continue reducing costs and reallocate capital to the company's core business.

The company has made some good progress in this regard. Last September, Mitsui & Co. purchased Vale's stake in a cargo unit for $1.2 billion. Recently, Vale announced an agreement to sell its 20% stake in a couple of natural gas exploration blocks in Brazil's Parnaiba basin to GDF Suez. It also sold a stake in aluminum maker Norsk Hydro for $1.82 billion.

In order to boost profit margins and regain investors' confidence, Vale is continuously selling lower return assets, putting projects on hold, and focusing more on its iron-ore business. Driven by these improvements, Vale is in a solid position to withstand pressure from declining iron ore prices this year.

Strong operation performance

Vale is seeing good operational performance in Oman and the recovery from maintenance stoppage in the southeastern system has pushed its iron pellet production to 10.4 million tones. This is 11.1% higher than the production figure last year.

Also, the performance of the Australian mine of Carborough Downs has also improved remarkably, leading to a rise in coal production to 2.3 million tones, in comparison to 1.95 million tonnes in the year-ago quarter.

In addition, a forced shutdown of polluting facilities in China by the central government should benefit Vale, in case low-quality iron ore sources in steel mills in China are replaced by iron pellets and lumps.

Also, Vale is extremely committed and ambitious about its S11D project in Brazil. The company expects this project to start iron ore production in 2016. Vale has reported that 48% of the mining work is already complete and the rest is progressing according to schedule. The S11D project has an estimated capacity of 90 million tonnes of iron ore per annum and proven iron ore reserves of 4.2 billion tonnes. So, the S11D project will lead to an enhancement in the production capacity substantially once it starts in the second half of 2016 and ramps up to full capacity in 2018.

Conclusion

Vale has struggled so far this year, but the company is doing the right things by selling its non-core assets. JPMorgan expects a decline in price of iron ore this year, but despite this forecast, Vale seems to have positioned itself nicely in order to withstand the headwinds. The company is also investing in capacity expansion, so it should be able to report solid growth once again when iron ore prices increase.

Source: Vale: Sit Tight And Hold For Long-Term Gains