- The metals and minerals industry is facing headwinds.
- Vale has adopted the right path to prosper in the challenging environment.
- Vale is not a good match for defensive investors.
Vale S.A. (NYSE:VALE) has been performing well in front of the strong headwinds in its main product line in terms of price stability. It has lost considerable sales and earnings in the past three years and cash flows came down considerably and the company has reduced its dividends. All this happened only due to the fall in commodity prices including iron ore, copper, potash, and coal. This shirked investors' confidence and the share price dropped consistently in the past three years. However, the company has developed a smart strategy to adapt to the challenging business environment. The strategy has worked for the company in the past few quarters and led it to reduce losses.
Vale's plan is simple and straight forward; Vale is looking to go forward with high value and high growth assets, and is only making targeted investments in growth opportunities. It is focusing on its existing assets to expand its production in an efficient way; this is helping the company's cash flows to pay dividend and reduce debt level. The company is further supporting its margins by reducing cost and expenses. Amid this, outlook for the metal and minerals is not stabilizing as the commodity prices are still in volatility. Lowering spending and more saving will allow the company to prosper.
Based on the new business plan, the company has sold around $6B worth of non-core assets in 2013. The company continued with its plan in the first quarter of 2014, as it sold its 36% stake in the logistics unit, VLI, and a 22% stake in Norsk Hydro (OTCQX:NHYDY) for $1.82B. On the other hand, it is making its capital investments in a more disciplined way in order to give a boost to cash flows and only targeting high-growth high-Vale assets. In the first half of this year, Vale has reduced capital expenditure to around $5B compared to the past year of $7.1B. It has completed projects like Conceição Itabiritos and Plant 2, which are both growing its iron ore production.
In addition, the company is focusing more on its existing assets to expand its production. This strategy is not only reducing cost for the company, but also enhancing its production level. At the end of the recent quarter, Vale has generated record production of iron ore around 79.4 Mt led by its focus on enhancing production from existing assets and the additional Plant 2 in Carajás and the fresh Conceição Itabiritos plant. Whereas phosphate, coal, and pallet production increased substantially compared to the past quarter. With the massive increase in production, the company has been able to post higher sales but EBITDA remains flat compared to the past quarter due to lower margins though Vale has been saving SG&A expanses to give support to margins. And its net income went down due to the impairment charges.
However, its cash position came back to a stable level after the company's implementation of the new strategy. Its strategy involves lowering capital expenditure to give a boost to cash flows. At the moment, Vale's operating cash flows are covering its capital investments and dividend payments after its initiative of lowering capital expenditure. In the first half of 2014, its operating cash flows came in at $8.6B when capital expenditure was at $5B and thus free cash flows stands at $3.9B. This reduces any risk of insolvency and the company's potential of paying dividends as it is now generating a healthy amount in free cash flows.
Vale has adopted the right strategy at the right time compared to the other industry peers, particularly Cliff Natural Resources (NYSE:CLF), which remains slow in responding to the changing business environment. Thus, Vale has been able to reduce losses and risk associated with its business. Though Vale is doing good business in a difficult time, I still do not recommend Vale for defensive investors as the company has been facing problems in its main product line which are expected to continue in the coming days based on forecasts presented by the two big banks. I am also expecting the company to keep reducing losses with its new business strategy, but I do not see that Vale is outperforming in the short term. I think defensive investors can find a number of other stocks in the market which are offering consistent dividend growth with steady price appreciation at low risk.