Vale (VALE), the Brazilian mining giant which is the largest iron ore producer in the world, reported its results for the third quarter of 2012. As expected, the main financial indicators were softer than the same quarter of the previous year as a result of the downward price volatility caused by the global economic weakness. The company pointed out the fact that the cyclical nature of the mining industry means that it is vulnerable to price volatility and, in view of the future economic prospects for more moderate growth; it would focus on higher productivity and cost control in order to do well in a highly competitive global industry. The focus will be on capital efficiency and investments in highest quality assets while selling off less productive and profitable assets.
The competitiveness of the iron ore business is being improved through initiatives to cut costs, increase productivity and improve quality. The most significant initiatives are the execution of projects related to the high quality reserves of Carajás and the use of technology to counteract the effects of aging in the Southern/Southeastern Systems reserves. In 2012, the company obtained a total of 52 licenses critical to the running of the mining and logistics operations in Brazil. Moreover, preliminary licenses were received for Serra Sul S11D, a critical project for the future supply of iron ore, as well as the operating license for the N5 South mine, at Carajás which has s 1.025 billion metric tons of proven and probable reserves and an average Fe content of 67.1%.The four Itabiritos projects - Conceição, Conceição II,Cauê and Vargem Grande - will replace lost capacity and expand net capacity with a rise in Fe content to over 65% and a sharp reduction in the silica content. An estimated fleet of 20 Valemax vessels will be deployed by the end of the year leading to improved global distribution. The size and performance of our coal business will be significantly enhanced with the development of the mining and logistics operations in Mozambique, The base metals business is seeking lower costs and higher productivity, and will benefit from the expansion of capacity in copper - Salobo I & II and Lubambe while the loss-making nickel mines in Canada will be closed.
For the third quarter, gross revenues at $10.963 billion were 9.8% lower than the $12.150 billion in the second quarter of 2012. The decline was windy because of lower prices of iron ore and pellets, $1.513 billion which was partially offset by greater sales volumes of iron ore, which added US$ 333 million to revenues. Revenues generated from the shipments of bulk materials - iron ore, pellets, manganese ore, ferroalloys, metallurgical and thermal coal - were just under 70% of operating decreasing from 73.5% in the second quarter. The share of base metals increased from 14.7% in the second quarter to 16.1% in the third quarter to 16.1% from 14.7% in the previous quarter. Shipments to Asia accounted for 52.3% of total revenues, slightly more than the 51.3% figure for the second quarter while the Americas rose from 26.4% to 27.2% because of increased sales in Brazil. Europe declined to 18% from just over 19% in the second quarter. On a country basis, the share of sales to China of total revenues amounted to 32% in the quarter while the share of Brazil was just over 21% and that of Japan was just over 11%.
Operating income declined to $2.647 billion from $3.923 billion in the preceding quarter. Excluding the effect of the one-time provision related to mining royalties (CFEM) adjusted EBIT (Earnings before Interest and Tax) was $3.189 billion for the quarter The decrease of $1.276 billion in adjusted EBIT was primarily caused by lower prices, $1.497 billion and the provision for mining royalties, $542 million. This was partially offset by higher sales volumes which added $272 million to operating income. The adjusted EBIT margin in 3Q12 was 24.7%, or 29.7% after excluding non-recurring items, down from 33.0% in the preceding quarter. Net earnings were US$ 1.669 billion in 3Q12 which was an EPS of US$ 0.32 per share. Cash generation, as measured by adjusted EBITDA, totaled $3.738 billion in quarter, 27.0% lower than the preceding quarter. Excluding the effect of non-recurring items, cash generation would be $4.280 billion.
Analysts were pleasantly surprised by the better-than-expected third quarter EBIDTA of $3.7 billion because of stronger iron ore sales volume and higher realized iron ore prices. However, Credit Suisse analyst I. Westin maintained his cautious view on the stock because of the uncertainty economic growth prospects while Citi's (C) Alex Hacking was more bullish saying that this was the best quarter since 2008 because of the better-than-expected prices and costs. He has a buy rating on the stock. The company's ADRs rose 4.5% in early trade after the results announcement.
BHP Billiton (BHP), Rio Tinto (RIO), Barrick (ABX) and Freeport-McMoRan (FCX) are the diversified miners that can be compared to Vale S.A. Vale's price/earnings ratio is around 5.7 times earnings, price/sales ratio is approximately 1.68 times sales and the price/book ratio is 1.12 times its book value. These are the lowest price ratios among this group of mining companies and only Rio Tinto's 1.62 price-to-sales ratio is lower than Vale. Vale is therefore trading at a substantial discount to its peers and the strong third quarter results suggest that the stock is undervalued. The World Steel Association expects a 3.6% increase in global steel usage in 2012 down from 5.6% in 2011 and usage in China is expected to increase by 4%. Increased construction activity in China, South Korea and India is expected to boost steel demand as is Chinese economic growth stimulus and the slow recovery in the US housing markets. If this materializes, Vale is one of the mining companies that stand to gain the most. If you are bullish about the prospect of this recovery, I would strongly recommend that you buy the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.