Investors are more likely to be drawn to a company that is efficient in converting assets and capital into profits. Thus, whenever I wish to make an investment, I closely monitor cash flows and cash conversion on a comparative basis. In this article, I apply this principle to mining giant Vale (VALE).
At the moment, Vale is the second largest metals, energy, logistics, raw material, food and mining company and a giant among the publicly traded companies of the world. Currently, the market capitalization of Vale is US $129 billion and it has more than 420,000 stockholders all over the world. Vale's history is marked by its capacity for transformation: not only the transformation of minerals, but also the transformation of issues into appropriate solutions and adversity into results.
Vale generates its major revenues from iron ore and pellets (68% in 2011), nickel (10% in 2011) and fertilizers (6% in 2011). Last year, other revenues included 3% from logistics, 3% from copper, 2% from coal, 1% from manganese and ferroalloys and 1% from other operations.
Cash Conversion over Zealousness
Taking into account the duration of the production cycle, the method I prefer to use is the Cash Conversion Cycle [CCC], which is a type of financial metric that estimates the time period required by a company to convert the capital [CASH] invested in the business to the cash received (because of business operations); that is equivalent to the average of the processing period of stock (inventory) and the average of collection period of receivables minus the average of payment period of payables. In other words, CCC is the hypothetical time period amongst the spending cash and receiving cash per individual sale, unit of operation, output, etc. of any company. CCC is used most of the time to calculate how long the cash is going to be tied to the "working capital." It is much more reliable than operating cycles or turnovers, because it can tell you the estimated time your money will be ready for re-investment and further profit generation.
As a rule of thumb, the provision of money for further investment depends on the frequency of repetition of the M-C-M cycle; with a consequent increase in sales and in turn, higher revenues. In short, this will ensure an efficient "profit engine." Specifically, Vale does not tie up much capital to the organization in the form of receivables and stock (inventory), thereby giving it greater capacity to make payments and clear its payables.
I made a comparative analysis of five major companies in the mining sector. I analyzed the CCC of each company and added the number of days from outstanding inventory payable to outstanding sales and then subtracted the number of days, outstanding payable of each company. Lower CCC means better relative performance.
When considering a company's score, you also need to consider two other things apart from the CCC. These are Net Margin and Asset Turnover Ratio. A higher net margin gives a company greater capacity to convert revenue into actual profit. The asset turnover ratio measures how efficiently a company uses its assets by converting it to turnover.
By comparison, Freeport-McMoRan (FCX) has TTM revenue of $20,328 billion and a TTM CCC was 83 days. Cliffs Natural Resources (CLF) has a TTM revenue of $5.138 billion and a TTM CCC of 60 days. Southern Copper (SCCO) has a TTM revenue of $50.372 billion and a TTM CCC of 78 days. Rio Tinto (RIO) has a TTM revenue of $56.576 billion and a TTM CCC of 76 days. This compares favorably with Vale, which has a TTM revenue of $57.599 billion and a TTM CCC of 61 days. Vale boasts an efficient CCC, and according to stock exchange analysis, it is not wrong in doing so, as its CCC has shown an improvement on the average. As of last year, the industry's basic materials average of CCC stood at 53 days and Vale stood at 54 days. When we compare the CCC of Freeport-McMoRan for successive quarters, quarter four 2011 and quarter one 2012, CCC dropped 19%.
Although CCC needs some tricky calculations, it is certainly worth calculating once every quarter, as it can serve to foretell future prospects and trends. It can also help you analyze the odds and discover "underappreciated" stocks that can give you the best returns.
Today's giant and the pride of Brazil, Vale, was incorporated by its government back in 1942. In 1997, it was privatized, which is when it started diversifying its portfolio of products and exhibited extensive growth. Currently it's working across five continents.
Last year, Boston Consulting Group, a leading consulting organization, reported that Vale was selected among the top 25 sustainable value creators in the world for its "extraordinary" performance over the past 10 years. The Total Shareholder Return [TSR] of Vale was 31.8% in 2011, which is highest among the global leaders of mining companies with Rio Tinto TSR, which was 14.4%. Vale has invested US $1.06 billion in many social projects in the last three years, focusing on education, culture, health, infrastructure and citizenship promotion; and US $2.41 billion alone in environment protection including pollution control, planting trees and protecting forests.
According to the growth trend of Vale, the company is expected to achieve gross revenues of around US $64 billion, and dividends are expected to be around $11 billion. Vale generates most of its revenue from Asia, which is around 51% at the moment, with 23% of its revenues from South America, 17% from Europe, 6% from North America, and the remaining 3% from RoW. This year, its plans to expand its operations to further parts of Asia and America, and is expected to yield two times its current revenues. All in all, at the moment, Vale is a safe and sound company to invest in.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.