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Summary

  • Vale will be hunting for a turnaround when it releases its second-quarter earnings report on July 31.
  • Vale has been beaten down as a result of weak iron ore pricing, but analysts are upbeat about a recovery.
  • Vale's valuation looks attractive, but a high debt and earnings erosion are concerns.

Judgment day is coming up for Vale (NYSE:VALE). The mining giant is expected to come out with its second-quarter earnings on July 31, and it will be desperately hunting for a turnaround. Vale's shares have lost around 4% of their value so far this year, as the company has struggled due to weakness in iron ore pricing. However, it is trying to initiate a comeback. Let's take a look at what's expected of Vale and if it can turn the business around.

What's expected

Analysts expect Vale to post revenue of $10.6 billion, down 3.6% from the year-ago quarter. Its earnings are expected to take a massive hit, declining to $0.45 per share from last year's $0.64 a share. Hence, Vale's performance in the second quarter is expected to be weak, just like the first quarter.

In the first quarter, Vale had reported an 11% decline in revenue to $9.5 billion, missing the $11.2 billion analyst estimate compiled by Bloomberg. In addition, its net income declined to $2.52 billion from $3.11 billion in the prior-year period, primarily due to lower iron ore prices. Thus, there seems to be no turnaround in sight for Vale as of now.

Positive moves

But Vale remains positive about a turnaround. In April, Moody's changed its rating outlook from neutral to positive on Vale. Moody's believes that Vale management has done well to steer the company despite a difficult environment. The company is now focusing on increasing production. In fact, Vale had turned in record production in the first quarter since 2008. Looking ahead, the company is working to make its production more efficient.

For example, its distribution center in Malaysia is expected to allow it to blend different quality ores in the near future, and improve its cash flow generation. Nova Caledônia produced 5,600 tons in the first quarter, of which almost 3,000 tons were produced in March alone, exhibiting the increase in speed.

Vale is progressing well on the Nacala Corridor in line with its plans. It has achieved physical progress of 62% in the greenfield section. Now, it aims to launch the first train at the Nacala Corridor by the last quarter of this year.

Vale had saved approximately $166 million in the first quarter of 2014 as compared to the fourth quarter of last year, and the moves discussed above should allow it to improve further.

Improvement in the cards?

Moreover, analysts are optimistic about Vale's performance. According to Nomura Securities (as reported by Barron's):

"Vale's core iron ore and pellet projects are tracking in-line with or better than expectations. Carajás Plant 2 (formerly +40Mtpa) should achieve full capacity next year, while the Itabiritos projects are on schedule with Conceição Itabiritos already operating at 25% and Tubarão VIII and Vargem Grande expected to come online within the next year to add 16Mtpa of processing capacity in the lower grade Southern and Southeastern systems.

Vale's base metals business generated adj. EBITDA of $549mm in 1Q-14, up 21% y/y and +126% q/q, driven mainly by lower startup and stoppage costs at VNC and Long Harbour. We see nickel production growth of 13% in 2014 and 2016 coupled with higher realizations (we model nickel at $19,840/t in 2015) resulting in nickel EBITDA of $3.7bn in 2015 relative to $1.1bn in 2013."

Moreover, it is expected that iron ore prices will increase going forward. According to Cowen:

"High cost marginal producers, especially in China, are likely producing ore at a loss at sub $110/mt prices, therefore, there is a built in support near this level. This theory is also supported by the fact that over the past two years prices have rarely traded below the $110/mt level and quickly spike higher after falling under that price level. Therefore, we see current prices of ~$105.5/mt as short-lived and expect 2014 prices to average above current spot prices."

Impressive valuation, but huge debt

Thus, it is likely that Vale can emerge stronger after its upcoming earnings report. Moreover, another attractive thing about Vale is its solid valuation. Its forward P/E ratio of 8 is lower than the industry's average of almost 10. Its current ratio of 2.57 represents strong short-term liquidity. However, there are certain negative points that investors should not ignore.

First, Vale has a massive debt of $33.73 billion, which is way greater than its cash position of $7.5 billion. Next, its bottom line is expected to decline at a CAGR of 16.7% over the next five years, which is a remarkable drop from the growth of 12.5% seen in the last five years. But, at the same time, Vale has generated strong operating cash flow of $15 billion in the last year, so it should not have much difficulty in sustaining its operations going forward.

Hence, with the pricing and demand situation expected to get better, Vale might be able to stage a comeback after earnings.

Source: Earnings Preview: Vale