Vale (NYSE:VALE), the world's largest iron ore mining company, will announce its third quarter earnings on October 24. We expect low iron ore prices to have a significant impact on its earnings for the quarter since iron ore constitutes the majority of its business. We expect Vale to record a heavy decline in revenue on a year-over-year basis. Prices of iron ore and base metals are well below prices realized in Q3 2012. Apart from iron ore, Vale's product portfolio encompasses copper, nickel, aluminum, precious gems, and fertilizers.
The company released its production report for the quarter a few days back. It reported iron ore production of 83.9 million tonnes, which is 4.6% lower on a year-over-year basis. Production at its Carajas iron-ore mine, the world's largest, dropped almost 11% year-over-year to 27.6 million tonnes in the third quarter. The suspension of projects, asset sales worth $1.2 billion, and a reduction in output of premium pellet products due to decreased demand from Europe and China reduced its share of the global sea-borne iron-ore market. The quality of the ore produced this quarter also emerged as a worrying factor. Vale attributed it to environmental licensing issues. 
As a result of economic conditions in the Eurozone and a slowdown in demand from China, iron ore is trading at significantly lower prices than in the corresponding quarter last year. In addition, copper and nickel, by virtue of their heavy industrial usage, have yet to recover to 2011 levels. Iron ore, which accounts for about 90% of Vale's earnings before items, slumped to $86.70 a tonne on September 5. This is its lowest price since October 2009. Fertilizers, largely immune to recessions, may offer some support as agriculture is one of the fastest growing industries in Brazil.
Vale's iron-ore production declined by 2.2% in the first nine months of 2012 to 234.5 million metric tonnes. In the same period, rivals Rio Tinto (RIO) and BHP Billiton (BHP) grew their output by 4%,5% and 9.5%, respectively. While Rio Tinto's quarterly iron-ore production rose to 52.6 million metric tonnes, BHP's output stood at 39.8 million tonnes. Vale's output of pellets, a processed form of iron ore used by steelmakers, rose by 2.1% to reach 14.5 million tonnes this quarter. The production of nickel declined by 16% to 49,000 tonnes, copper production dropped 20% to 68,000 tonnes, coal production increased by 91% to 1.73 million tonnes and that of potash fell by 15% to 141,000 tonnes.
Vale is now pinning its hopes on Chinese infrastructure investment spending to revive an uptrend in iron ore prices. As far as nickel is concerned, Vale expects its Canadian mines to return to production from scheduled maintenance shutdowns. It also expects the New Caledonia operations to restart production in the fourth quarter, but the Onca Puma project in Brazil remains shut down with no forecast for when it might return to production.
Vale has also been hit by higher costs and declining output as delays in obtaining environmental licenses have hobbled the development of the company's ore reserves. Licensing issues have forced the company to continue producing from its older, less productive pits such as those in Carajas. The company has admitted that it is suffering from depletion in quality across its Brazilian ore deposits. The problems have been compounded by production delays caused due to heavy rains. 
Bullish On Long-Term Prospects
While Vale continues to face short-term headwinds, we are bullish on its long-term prospects. The company does have high-quality reserves such as those at its $19.5 billion Serra Sul project in Brazil which is expected to contain 90 million tonnes of iron. Vale also has reserves in Guinea at Simandou, which contain one of the highest-quality untapped iron ore resources in the world. The company has been unable to tap these so far due to difficulties it is currently facing with Guinea's operating environment. Vale still aims to boost its iron output to 460 million metric tons by 2017. That would mean a 40% increase, if successful. Even at a price of $100 a ton, that will give Vale revenues from iron ore of around $46 billion. Its total current revenues stand at $54.28 billion. 
You can project your own iron ore shipment figures for Vale by using our interactive graph below:
The company has also finally received permission to dock its giant Valemax ships at a port in China. These ships were built to enable Vale to compete effectively with rivals Rio Tinto and BHP Billiton. Rio and BHP currently enjoy a cost advantage due to the geographical proximity of their Australian operations to China compared to Vale's Brazilian operations. Valemax ships will reduce the company's shipment costs. The bad news here is that it will take the Ningbo-Zoushan port two to three years to be ready to receive Valemax ships, so any benefits will accrue only in the long term.
Vale's iron ore business constitutes 64% of its Trefis price estimate.
We recently revised the Trefis price estimate for Vale to $19, which is in-line with its market price.
- Vale Losing to Rio Tinto as Iron Output Drops: Corporate Brazil, Bloomberg
- Brazil Miner Vale Quarterly Profit May Stumble on Ore Prices, Fox Business
- Vale: Don't Skip This Metals Value Play, Seeking Alpha
Disclosure: No positions