Is Vale SA A Wise Investment?

| About: Vale S.A. (VALE)
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Metal and mining industry has been facing problems.

Vale SA has lost considerable value and profits in the past three years.

Lower iron ore prices will create problems for Vale.

Vale is not a wise investment.

Vale SA (NYSE:VALE) is a metal and mining company that produces and supplies nickel, iron ore, manganese ore, iron ore pellets, ferroalloys, coal, copper, phosphates, potash, cobalt, and other metals. Vale SA has been continually losing its share price value and has lost approximately 63% since 2011. Year-to-date, the stock lost around 13.8%, and has decreased about 0.23% in the past month alone. This is particularly due to the decline in commodity prices, which further resulted in lower revenues and a significant fall in earnings per share. Since 2011, its earnings per share fell from $4.33 per share to $0.11 per share at the end of 2013.

Over the past three years, most of the metals and minerals it supplied have been facing falling prices and imbalance between supply and demand. Iron ore prices are falling along with potash, phosphate, and coal prices. Recently, Morgan Stanley and Deutsche Bank have predicted that iron ore prices will fall significantly in the coming days, which I believe will further impact Vale's revenue and earnings. Vale has reshuffled its growth strategy and has reduced its capital investment while only targeting high-value growth assets. It is looking to expand its production from existing assets while disposing of non-core assets. Furthermore, it is lowering its costs and expenses.

Based on the new business plan, the company has sold around $6 billion of non-core assets in 2013. The company continued with its plan in the first quarter of 2014, as it sold its 36% stake in the logistics unit, VLI, and a 22% stake in Norsk Hydro (OTCQX:NHYDY) for $1.82 billion. On the other hand, Vale has completed projects like Conceição Itabiritos, Plant 2, and CLN 150, which will grow iron ore production in the coming years. Furthermore, the company cut its capital expenditure by 26% compared to the past year quarter and is looking to lower its capital investments. On the cost management side, the company has lowered SG&A by 20%, R&D by 15%, and pre-operating and stoppage expenses by 33%. Vale management is looking to lower its cost of operations while enhancing operational efficiencies.

Expanding production from existing assets is the key aspect of its new working business plan. In the past quarter, it has generated a record level of production of iron ore and pellets (305.6 Mt), copper (353,000 t), gold (297,000 oz), and coal (8.1 Mt). In the first quarter of this year, iron ore production reached a record of 71.1 Mt, coal production reached 1.8 Mt, and nickel production reached the record level of 67500 t. But still, its revenue growth remains low due to lower commodity prices particularly iron, copper, and coal prices. However, with the cost-cutting efforts and efficient management, sequentially, Vale has been able to generate growth in earnings but profits are still down on a year-after-year basis.

On the cash side, Vale looks to be in a good position. The company has generated a lot of cash from the sale of non-core assets, which has strengthened its cash position. Furthermore, the company has lowered its capital investments to give a boost to free cash flows. This plan has worked for Vale, as it has generated $1.6 billion of free cash flows in the past quarter, which allowed them to pay a special dividend of $0.32 per share.

In Conclusion

Going forward, we can expect iron prices to continue to fall based on Morgan Stanley and Deutsche Bank's estimates, and thus, its ferrous minerals segment will contribute to even lower profits. The ferrous minerals segment is the largest revenue contributing segment for the company, and this segment's profits are directly related to the iron ore prices. Even though its fertilizer business segment has generated growth in the past quarter on the back of nitrogen sales, potash and phosphate prices are expected to remain depressed in the short-term due to the supply and demand dynamics. Overall, we can say that Vale's main product line has been facing problems. However, Vale has taken a number of steps to reduce the impact of expected damages. It is efficiently cutting costs, enhancing production from existing assets and only targeting high-value and high-growth assets. Its timely move in its business strategy put it in a stable position compared to the Cliffs Natural Resources (NYSE:CLF). In my recent article on CLF titled, "Is it Wise to Invest in Cliffs Natural Resources," I made a negative vote to invest in CLF based on iron ore prices, problems in top management, and its business strategies. In the case of Vale, it is in a better position than CLF due to the move it has made in its business strategy, its diversified business model, and its efficient management. However, having the philosophy of a defensive investor, I still do not suggest picking Vale as its main product line is facing headwinds, which are significantly lowering its profits, and it is expected that commodity prices, particularly iron ore price, will fall more in the coming days.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.