There's a lot of confusion about Vale's (NYSE:VALE) surprising earnings release for 2Q15, and the stock behavior afterwards. Opening prices at NYSE after the release were at $5.9, only to drop all the way down for a close at $5.18.
Vale posted a strong second quarter, beating analysts' forecasts, but the market doesn't seem to care about that.
With better than expected results, massive cash cost reductions and the first profit after 3 consecutive losses, analysts doesn't understand the behavior of Vale's stock. Investors seem to have focused on the sale of a minority stake of MBR, a subsidiary almost fully owned by Vale for R$4 billion, or $1.2 billion.
Vale released a statement explaining the sale:
"MBR owns assets for production, transportation and port shipment of iron ore, among which the mines and/or industrial plants of Vargem Grande (Capitão do Mato and Tamanduá), Abóboras, Pico, Mutuca (Capão Xavier), Mar Azul and Jangada, which accounted for the production of approximately 65Mt of iron ore in 2014. Among the assets owned by MBR, we also include the Ilha Guaíba maritime terminal and a participation of 32.9% in MRS Logística S.A. (MRS)."
MBR assets are located in the "southern system", but doesn't count for all of the assets in the system. In 2014 MBR accounted for the production of 65Mt of iron ore, the stake subject to the sale accounts for a yearly production of 23Mt of iron ore. The southern system is Vale´s least competitive asset in iron ore, due to the lower grade of ores and the high silica content. There is no new growth projects scheduled for that area.
As a part of the agreement with Vale, MBR has to do its own sustaining investment, pay the regular taxes, and retain its profits. Under the current conditions, as explained by Luciano Siani on the last conference call, Vale would pay to MBR, in the form of lease payments, a value of R$ 30.1 or $8.85 per wet metric ton -WMT- produced out of the MBR assets.
After providing the sustaining capex and paying taxes, the new partner of Vale will receive, with iron ore prices at $55, nearly $115 million a year, roughly a 10% yield, and will assume the iron ore price and equity risks.
Is Vale selling iron ore assets to invest the proceeds in the development of other iron ore assets?
It could seem so, as I look at it, Vale is reducing its risk exposure to a collapse in the iron ore prices in the near term, while getting the funds needed for the completion of its premium S11D mine, which will bring costs of iron ore landed in China to the lower $30 handle.
Selling a high-cost, low-quality asset, to complete the development of a low-cost, high-quality project, doesn't look bad.
The MBR shares were sold very close to the book value of the assets, that doesn't looks like a company in distress, more like a positive change in the priorities of Vale.
Vale isn't selling the crown jewels, just a little stake of its iron ore production, and will hold a call option on the shares of MBR sold. On the call option, Siani said:
"The call option, it's exercisable between the 3rd and the 10th year and the price, we cannot disclose the exact terms. But we can say that it's pretty much close to the sale price for a wide range of iron ore prices. But if iron ore prices climb high enough then there is kicker and there the spot price increase a little bit. So that's what we can say."
After the good results posted, I think Vale is better positioned to withstand the low commodity prices; this sale of assets is a strategic move towards a better free cash flow, and once completely understood, is a good move.
Vale is, now more than ever, a reliable, low cost provider of iron ore and base metals, showing impressive earnings amidst this ugly scenario, and will continue to do so.
Among all of the world's iron ore producers, I see Vale as the better risk/return opportunity in the medium term, and maintain my buy recommendation.
As Jesse Livermore said:
"After spending many years in Wall Street, and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting."
Disclosure: I am/we are long VALE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.