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Summary

  • Weak iron ore pricing has hurt Vale, and the trend is expected to continue.
  • Vale might continue to write down assets.
  • Vale's balance sheet is weak, and the company's bottom line is expected to diminish going forward.

Vale (NYSE:VALE), the Brazilian mining giant, missed estimates on both top and bottom lines in the second quarter as the company continues to remain challenged by a weak end-market environment for iron ore. In fact, Vale missed the bottom line forecast by a whopping $0.17 per share, and its revenue of $9.9 billion was way below the $10.63 billion revenue expectation due to weak iron ore pricing.

Weak iron ore pricing will continue hurting

Vale suffered as iron ore pricing dropped to its lowest level in four years. However, the company did see an improvement in iron ore volumes, which rose 13% year-over-year to 79.4 million metric tons. Now, if the price of iron ore improves going forward, there is a possibility that Vale's performance could improve. But, that looks like a far-fetched idea.

Steel giant ArcelorMittal (NYSE:MT) was forced to cut its earnings forecast for the full year when it reported its second-quarter results. This surprised investors, as ArcelorMittal reported its first quarterly profit in two years, and even then, it issued a glum forecast. The reason behind ArcelorMittal's weakness was an expected drop in iron ore prices, which will weigh on the company's performance even though it is seeing a rebound in steel demand in the U.S.

As reported by The Wall Street Journal:

One part of ArcelorMittal that saw its profits decline was its iron ore mining business, which suffered from an expected decline in average iron ore price to $105 a ton from $135 a ton last year. That caused the company to cut its full-year forecast for earnings before taxes and other costs to "more than $7 billion" from $8 billion.

More write-downs can be expected

Hence, the weakness in iron ore pricing is expected to continue, which will continue taking a toll on Vale's performance. Moreover, Vale has been forced to write off billions in assets due to the weakness in the mining industry. In fact, the company has written off a massive $7.1 billion by way of asset write-downs in the last two years.

In the previous quarter as well, Vale wrote down $774 million worth of assets. It took an impairment charge of $500 million in Guinea after the government there cancelled Vale's license to develop an iron ore mine, as WSJ reports. Since Vale calls this write down as partial, more can be expected going forward.

In addition, Vale has also written down $274 million from its loss-making coal mine in Australia, known as Integra. The downturn in the commodity market has hurt Vale tremendously, and the end-market indicators suggest that there might not be a turnaround any time soon. Iron ore prices dropped 18% year over year in the previous quarter. Looking ahead, the tumble is set to continue. According to a report, iron ore prices are expected to drop another 7.6% in 2015, averaging $97 per tonne. In the long run, iron ore price will drop to around $90 a tonne, according to Morningstar.

Hence, there will be no respite for Vale going forward.

Weak fundamentals

On top of that, Vale has a pretty weak balance sheet. Its debt stands at a whopping $33.3 billion. The cash position is rather small in comparison at just $7.4 billion. Vale's debt-equity ratio has risen tremendously in the past couple of years, and as the company engages in more write-downs, it can go up further.

The drop in iron ore prices will keep hurting Vale. In fact, over the next five years, its bottom line is expected to erode at an annual rate of almost 17%, which is way worse than the growth of 12.5% seen in the last five years.

Hence, even though Vale expects iron ore demand to improve on the back of better steel demand, it will be a wise idea to stay away from the stock. The company carries a massive dividend yield of 6.10%, but since its bottom line is diminishing and revenue is dropping, it might be forced to cut the dividend going forward.

All in all, Vale looks like a risky investment. The stock has dropped 8% this year, and more downside cannot be ruled out.

Source: 3 Reasons Why Vale's Turnaround Isn't Likely