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By Ishtiaq Ahmed

The recent slump in commodity prices has hit mining and energy companies. Several mining companies have experienced declining revenues due to low prices. Vale S.A. (VALE) has also been adversely affected by the slowing global economy, with the price of the stock suffering heavily. Since the start of 2011, the Vale stock has lost almost half of its value. The stock was trading at around $36 at the start of 2011. It closed at $18.11 on October 19, 2012.

China is the most important customer for Vale, as most of its ore is shipped to China and Asia. The good news for Vale is that the Chinese economy looks to be recovering, and the demand for iron ore is increasing. Recently, the Chinese government approved infrastructure projects of worth one trillion yuan. As a result, the commodities market experienced an increase in prices. Since early September, iron ore spot prices for China delivery have surged nearly 30%. Although, the Chinese economy is not likely to reach double-digit growth periods anytime soon, it has started to grow between 7% and 8%.

Recent Production Report

Third quarter production for Vale was 83.9 million metric tons, showing an increase of 4.2 percent from the second quarter production. Over the last twelve months, the output for Vale reached 317.4 million metric tons. However, iron ore output dropped 4.6 percent from a year earlier. Production at Vale's Carajas iron-ore mine dropped 11 percent to 27.6 million tons in the third quarter. As a result, the company had to continue mining older, less productive pits.

Vale also reported that its output of pellets rose 2.1 percent to 14.5 million tons in the quarter. Nickel production slumped 16 percent to 49,000 tons, and copper dropped 20 percent to 68,000 tons. Moreover, coal increased 91 percent to 1.73 million tons, and Potash fell 15 percent to 141,000 tons. Vale said that the company will halt operations at Frood copper and Nickel mine and will make up the lost production from other mines in the Sudbury basin.

Earnings Expectations

Iron ore prices have been falling gradually as the global economy slowed and the eurozone crisis undercut metal prices. As a result, Vale is expected to post considerably lower profit from the same period last year. Iron ore prices have been significantly lower than the same quarter prices last year. Average price per metric ton for the previous year was $175.90, which came down to $112.10 for the current quarter. Analysts expect Vale to report $1.8 billion in profit for the quarter, showing a decrease of over 60% from the same quarter of last year. Further, net revenue of the company is expected to fall by 36% to $10.4 billion, while EBITDA is expected to hit $4.2 billion.

Competition

Vale's main competitors for Vale are Cliffs Natural Resources (CLF), BHP Billiton (BHP) and Rio Tinto (RIO). Cliffs Natural rivals Vale primarily in the production of pellets, whereas the other two companies are also Vale's competitors in metal and mining. At the moment, Vale is facing the danger of losing market share to its competitors due to production and supply issues.

BHP Billiton increased its market share from 14% to 15% during the first half of the year. Vale's competitors have a proximity advantage over Vale. BHP's mines are closer to the Asian markets, which gives it better and faster reach to customers. On the other hand, Vale faces its own problems on the supply side. The company has failed to receive permission from the Chinese government to dock its mega ships (Valemax). At present, the company is docking ships at Malaysia and Philippines.

However, Vale is hopeful that pressure from local steel manufacturers will play in its favor, and the government will allow it access to ports soon. As a result of slowing production and supply issues, Vale's market share declined to 26%, from 28% a year ago. Vale's iron-ore production declined 2.2 percent in the first nine months of 2012, to 234.5 million metric tons.

On the other hand, Rio Tinto's company filings show that production grew 4.5 percent to 146.9 million tons. BHP expanded its steelmaking raw material output by 9.5 percent in the past nine months.

Summary

It is unlikely that we will again see commodity prices sky rocketing any time soon. Instead, BHP CEO Marius Kloppers suggested in his speech at the company's earnings announcement that iron ore demand was likely to normalize. This makes sense, as the Chinese economy will grow at a steadier pace, and the eurozone will also take some time to recover. As a result, mining companies will be able to manage their production and supply efficiently, and capital expenditures may decline.

It is clear that demand levels for iron ore are not expected to reach past levels any time soon, but the recovery is in progress. I believe the commodities market will recover over the next year, providing Vale with an opportunity to grow at a steady rate.

Source: Vale: A Smart Pick To Play A Global Recovery