Vale Is Stuck Between Brazil And China

| About: Vale S.A. (VALE)


Vale's stock plunged by 18% in the past month.

The company's weakness is stemmed by soft demand for iron ore.

The economic weakness of China and Brazil have also driven down the company's stock.

The bearish market sentiment revolving around commodities and China has also initiated selloffs of shares of Vale (NYSE:VALE) that lost over 18% of their value over the past month. Moreover, Moody's downgraded again the company's credit rating to a notch above junk and a negative outlook. The company is stuck between the turmoil at home (Brazil) and weakness from aboard - mostly from China. And the direction of these two countries will largely determine where this company is heading.


The political and economic uncertainty around Brazil hasn't helped Vale's stock. The economy is expected to contract by 2.5% to 3% this year. All awhile Brazilian President Dilma Rousseff still faces possible impeachment in Congress. The President aims to draft an economic plan to prompt growth in Brazil in the hopes to ward off impeachment proceedings. And the unrest is also steering investors away from Brazilian companies including Vale. The only silver lining is that the weaker Real, which was substantially devalued against the U.S. dollar, helped cut down its production costs. Back in Q3 2015, C1 cash cost FOB fell to 12.7 per ton a fall of 20%, sequentially. Even with lower cash costs, however, the main problem will remain the direction of demand for its prime commodity - iron ore.


But Vale's problems don't end with Brazil's geopolitical troubles; the concerns over China have also contributed to the descent of Vale's stock. China is the world's leading iron ore consumer. And if China's economy, which is expected to present another year of around 6.5% growth in GDP, starts to slowdown this could also translate to softer demand for Vale's metals. After all, back in Q3, the Asian market accounted for 53.6% of Vale's total sales and China alone - nearly 39%.

Over the past several decades, China's economic growth relied on investments. But as the country's debt burden continues to build up to staggering proportions - it's currently at 240% or $25 trillion U.S. dollar - and savings rates can't seem to go much higher than their current elevated level - around 50% of GDP - the economy isn't likely to sustain high growth levels much longer. This could suggest that the demand for iron ore will decline, which will only further pressure down prices.


Given the expected weaker demand for base metals and iron ore - most notably from China - the outlook for their prices remains grim. Based on the IMF's recent commodities outlook from back in mid-December 2015, iron ore, which has roughly 50% stake of Vale's sales, is expected to be in 2016, on an average, 36% lower than the average price in 2015. Copper and nickel - base metals that account for another 20% of total revenue - are expected to be 17% and 27%, respectively, lower in 2016 than in 2015. With such low prices, Vale is likely to present even lower profits than it did back in 2015. One way to offset this downfall is by cutting down production costs and selling assets that require additional capital to develop or have high production costs. Vale has turned in this direction: It recently sold to ICBC four large ore carriers of 400,000 tons deadweight for $423 million in cash.

In terms of production, during 2015 (first nine months) the company increased production by close to 5%, year on year. The higher yield mostly came from Carajás Serra Sul S11D - it reached 33.9 Mt in Q3 2015 - the highest quarterly production for this project so far. And it doesn't mean as if the company plans to slow down its production growth.


Vale faces too many problems from home and aboard. These factors all weigh on the stock that lost a lot of its value and is likely to keep doing so in the coming months. Sticking to its plan of ramping up output may not prove to be the right move if prices continue to fall and company spent valuable resources on developing mines that may not - at least in the near term - yield a positive return. The company may have to resort to more drastic moves by selling additional assets, reaching more streaming contracts, and cutting production on costly mines. For more see: What's Up Ahead for Copper?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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Tagged: , Steel & Iron, Brazil
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