Vale (VALE) is the main Brazilian mining company and the global leader in iron ore. The company is specialized in low cost ore and is mainly present in emerging markets, representing a good way to get exposure and long-term orientation. And right now, the mining company looks undervalued.
Vale showed strong results in 2011, expected to increase in 2012
Vale showed very strong results in 2011 with operating revenues reaching $60.4 billion, operating profit reaching $30.1 billion (with an operating profit margin at 49.9%), and net earnings reaching $22.9 billion.
Revenues mainly come from the sale of iron ore with a price that hit a record high last year. Despite the recession in Europe and a decrease in demand, Vale was able to maintain its position in emerging markets such as China, Eastern Asia and the Middle East. We expect prices to stabilize over the next months and slightly decrease in the future but with raised forecasts.
Raising prices are going to increase the demand for cheap ore and drive the demand over the next years even in case of slight slowdown.
Vale generated negative FCF in 2011 compared with 2010 because of strong investments in mines (Capex/revenues = 36.2% in 2011) and higher dividends paid to shareholders ($3 to $9 billion), but that's expected to increase in 2012, according to the company.
Vale is well positioned internationally and more profitable than its competitors
The Brazilian mining company is well diversified geographically with its main assets in Brazil and a strong position in emerging markets. Vale is the largest iron ore company and second in Nickel. Being a low cost producer, Vale can generate cash relatively easily and relies less on the commodity prices.
|2011||Vale||Rio Tinto||BHP Billiton||Anglo American|
|Net Profit ($Mil.)||22652||5826||23648||6169|
|EBITDA margin (%)||52.9||44.0||52.6||38.9|
|FCF Margin (%)||-1.0||20.4||19.8||3.9|
|Total Debt/EBITDA x||0.7||0.8||0.4||1.6|
Source: annual reports
The comparison shows a better EBITDA margin and a positioning among the leaders in terms of revenues for Vale but a riskier profile due to a high Capex. The key is to generate positive free cash flow as soon as possible.
Diversification in fertilizers, a good growth opportunity
Vale's strategy is clearly oriented towards diversification with increasing activities in rare earths and especially fertilizers. The operating revenues from fertilizers products reached $846m in 2011 with 193% growth. Fertilizer products represent now 1.4% of the operating income and a good growth opportunity as Brazil is the fourth largest consumer of fertilizer products. Vale invested heavily in this sector in 2010 with the acquisition of BPI.
More product diversification would be seen as positive. Vale's competitors are currently expanding their activities in diamonds.
Government interference to watch carefully
The last events in Argentina made us consider more carefully government interference in national champions such as Vale. The government owns 12 golden shares of Vale that give veto power on certain items and the Brazilian government pension fund has a 49% stake in the company. We don't expect any action against Vale (the Brazilian government is in fact supportive of Vale) but will watch any influence that could trigger a weaker capital structure or limit the company's growth. Those factors will be taken into consideration in the DCF model consequently (in the next article).
Slowdown of China and emerging markets should not affect Vale dramatically
China represented 32.4% of Vale's revenues in 2011 and is its main customer before Brazil (18.4% of revenues). And a slowdown in China and emerging markets could impact drastically Vale's performance. Even an 8% growth in China should not impact Vale's sales too much due to its low cost positioning.
Moreover, Vale's Chief Executive Officer Murilo Ferreira said last week that China's demand for iron ore should keep increasing in 2012 after a 6% increase in the Asian nation's consumption in the first quarter.
Low risk profile
Diversification and positioning on the cost curve being two factors that improve the risk profile, Vale has a strong capital structure and low leverage. The mining company has a strong balance sheet with $23.1 billion of total debt (-8.7% compared with YE 2010) and $3.5 billion of cash. We can compare those figures to a $35.3 billion LTM EBITDA, which shows a very manageable amortization. The leverage ratios are consequently very low with a total debt/EBITDA at 0.7.
Because of many investments, the level of cash decreased in 2011 and FCF should be watched carefully during the first quarter of 2013. However a strong capital structure should compensate the potential volatility of earnings due to uncertainty in demand.
Revenues from Asia grew by 6% during the first quarter with iron ore prices hitting $150. Vale could surprise investors this year.
Could it be the right moment to buy?
For the growth opportunity
Vale is quoting today at $22.52, which accounts for EPS at 3.83 and a PER at 5.87. Compared with its competitors, Vale is looking cheap given the growth opportunities and the technical analysis shows that Vale is trading at the support level of 22.5 (the next support should be 20.5). The next resistance at 24 could be broken in case of good 1Q results and Vale could easily trade between 24 and 26.5 at medium term.
For the dividend
Vale distributed a dividend of 1.5 per share last year and clearly oriented its policy towards shareholders. The dividend yield is consequently 5.10%, much better than the competitors.
|2011||Vale||Rio Tinto||BHP Billiton||Anglo American|
|Est P/E||6.5 (12/12)||7.8 (12/12)||13.8 (06/12)||7.9 (12/12)|
|Dividend yield (%)||5.1||3.3||3.0||2.4|
Source: Yahoo Finance