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Summary

  • Bad quarterly performance wasn't a one time thing.
  • Over-reliance on iron-ore has put Vale in a torrid condition.
  • Iron-ore prices may fall as much as $80 per ton, which will hurt Vale's prospects.
  • Vale will have a tough time balancing the excess supplies and the constantly depreciating prices of iron ore.
  • Investors should stay away.

Iron ore miner Vale (NYSE:VALE) is finding it difficult to execute a comeback. The stock has declined 8% in 2014, primarily because of weak results that it reported last time. In fact, Vale suffered a decline in both revenue as well as earnings.

Its revenue of $9.5 billion was way less than the consensus estimate of $11.4 billion. This led to a consequential fall in earnings as well. Earnings lagged analysts' estimate of $0.52 by $0.12. This translated into a 33.9% drop in earnings year over year.

This weak outcome is chiefly due to a steep fall in the selling price of ores that can be attributed to several reasons. On the bright side, Vale is delivering solid production figures. The company attained its highest production of iron ore in the quarter since 2008. However, it doesn't look like Vale's fortunes are going to change any time soon.

Difficult times ahead

Vale is not finding the going easy. This is a contrast with the previous year when the company was seeing strong demand for its ores. China, the biggest consumer of seaborne iron ore, is switching away from exports and is sticking with domestic consumption. China is focusing on sustainable economic practices, and is laying more emphasis on its own resources and enterprises.

China was a major customer of Vale, and as a result of this, the demand for iron ore is suddenly facing an abrupt decline. As a general rule of merchandise, prices are determined on the basis of demand and supply in the market. Consequently, this deceleration of demand will continue to hurt the prices. The combination of higher supplies and lower prices will lead to margin pressure.

Vale is not well-diversified, as it is highly dependent on iron ore. The surplus supply and easing demand from China may prove to be catastrophic for Vale.

It can get worse from here

Moreover, analysts expect iron ore prices to plunge further as miners continue to expand production, overlooking the weak demand. By 2015, analysts expect prices will fall down to $80 per ton. Moreover, Citigroup expects iron ore surplus to skyrocket to 67 million tons this year, as compared to 2 million tons in the previous year. The large supply growth will certainly hurt iron ore prices, which are already very low.

As per Barclays' statement, a slump of just 10% in prices will affect Vale's earnings by 32%. Analysts said that Vale ranks toward the bottom in its industry on all key metrics including production growth, FCF generation, earnings growth, gearing, ROE and ROIC.

Until now, iron ore prices have descended below $90 per ton, which accounts for a massive decline. The major hurdle before Vale is to balance between the excess supplies and the constantly depreciating prices, however it doesn't look likely. Morgan Stanley (NYSE:MS) recently downgraded Vale as the firm thinks Vale will struggle due to the excessive supplies. The analysts at the firm said:

"The global seaborne iron ore market has enjoyed an impressive period of tight or undersupplied market conditions since the China-driven commodity 'supercycle' began in 2005. China's crude steel consumption and production grew much faster than expected, and the global mining community was left unprepared. Iron ore is not a rare commodity, but it is a difficult one to mine, process, and transport at a reasonable cost. As the supply shortfall continued to increase and price increased, global miners (especially in Australia and Brazil) began to respond in full force. Today, we are seeing the manifestation of that response, and the global seaborne iron ore market is set to enter into a new period characterized by oversupply."

The analysts also added, "Cut 2014-17e EBITDA by 25-38%, or 30% below consensus, as lower iron ore prices more than offset an improving base metals business."

Conclusion

Vale is in trouble. The company is facing difficult dynamics in the end market. So, it is advisable to stay away from Vale as a turnaround looks unlikely.

Source: Vale's Turnaround Is A Pipe Dream