Vale (NYSE: VALE) is a Brazilian multinational corporation that is engaged in metals and mining and is one of the largest mining operators in Brazil. The company is one of the largest logistics companies in Brazil operating a large network of railroads, ships, ports, and hydroelectricity plants to transport its products. The company is also the largest nickel and iron producer in the world.
Vale like all other major commodity companies reliant on iron ore prices has had a difficult time recently. The company watched its stock price drop from just over $36 per share at the peak of iron ore prices in 2011 all the way down to just over $2 per share in January 2016. However, since then, the company's share price has almost tripled to present prices of just under $6 per share.
Vale recently reported strong second quarter 2016 results. The company's values have continued to remain strong with strong growths in production from several key areas. This quarter resulted in the company's strongest financial performance in almost two years as the company begins to find a balance between exploration costs and profits. More importantly, the picture for demand for the company's key production products remains strong and should help the company in the long term.
Let us begin by discussing Vale's operational performance.
The above image shows Vale's production volumes over the past two years. As you can see, over the past two years, Vale's largest source of earnings, its iron ore production has remained strong. Compared to two years ago, Vale's iron ore production is up roughly 10%. And while the company's iron ore production has declined by a few percent over the past year, we can see that mid-2015 was a time of abnormally high iron ore production for the company.
The company's other major source of production, its nickel production, has remained very strong. Over the past two years, Vale's nickel production has gone up roughly 30% and the company's nickel production has gone up almost 20% over the past year. And the most recent quarter represents the company's second highest quarterly performance just a few percent below the company's previous 4Q 2015 high.
In the next major regions of production, pellets, copper, and gold, the company's production volumes remain incredibly strong. These three production volumes are just a few percent below the most recent quarter, and it is disappointing to see a quarter over quarter drop. However, the company's production volumes remain incredibly strong compared to a year or two ago.
Vale Production Changes - Vale Investor Presentation
Now that we have discussed the company's production volumes, it is now time to discuss the changes in the company's sales volumes. The company's iron ore sales volumes have increased by 2.4% in the past year while the company's nickel sales volumes have gone up by 14.9%. Out of the company's five major production products, four of them have seen an increase in sale volumes over the past year, three of them almost or double-digit increases.
Only pellets have seen their sale volumes decline by a more modest 6.9%. More importantly, look at the quantity of the volume decline in iron ore pellet sales. This decline in volume is 0.8 million tons of pellets per year. In contrast, iron ore sales have gone up by 1.7 million tons per year. As a result, even with the 6.9% decline in pellet sales, the company's total iron sales still went up by a respectable 0.9 million tons.
Now that we have discussed the company's operational performance, namely the changes in the company's production, it is now time to discuss the company's financial performance.
Vale EBITDA and Margins - Vale Investor Presentation
This next image shows several important terms for Vale's 2Q 2016 financial performance. The orange line shows iron ore prices for the quarter in $ / ton. The bar graph on the bottom shows the company's EBITDA for the quarter. And the black circles with the numbers in between shows the company's EBITDA margin for the quarter. These numbers show a number of exciting highlights for Vale's financial performance.
Vale's 2Q 2016 EBITDA was the highest it has had since 3Q 2014. This is inspite of the fact that iron ore prices have fallen by almost 30% since this time from $74.3 per ton to $55.7 per ton. The fact that the company's EBITDA has gone up by almost 10% during this time when its biggest source of income, iron ore prices, have gone down by 30%. This shows the improvement in Vale's efficiency and how it's decreasing its costs which should help its long-term earnings.
Vale Costs and Expenses - Vale Investor Presentation
The following image shows Vale's costs and expenses. Over the past year, Vale's costs have come down by 8.7% and the company's expenses have gone down by 31.9%. These changes in expenses have saved the company hundreds of millions of dollars each year and should significantly help it's earnings. These increases in earnings will help Vale's earnings to grow over the long-term as Vale figures out how to cut these costs further.
Now that we have discussed Vale's financial performance, it is now time to discuss the prices that the company has received.
Vale Realized Iron Ore Prices - Vale Investor Presentation
Vale saw its realized price 13.3% below the overall spot prices for the quarter. These decreases came from adjustments to the company's FOB sales along with a decrease in prices due to the moisture content of the iron ore. Assuming these ratios stay constant, that means Vale has huge potential to gain should iron ore prices recover to their 2Q 2014 levels (a double in prices) or to their 2011 highs which would involve a quadrupling of Vale's earnings.
While iron ore prices might never recover to their 2011 or 2014 highs, it is clear that January represented the bottom of the iron ore price cycle. January represented the bottom of the price cycle for oil and a number of other important commodities and it is likely that prices will not fall down to that level again (as we will discuss later when we discuss the overall macro pricing environment). That means Vale's profits will likely grow from here on out.
Now that we have discussed the company's operational performance including the increasing production of its key productions and the company's financial performance including how its earnings have been growing and can be expected to continue growing, it is now time to discuss the company's capital expenditures. While companies tend to cut spending during downturns, capital expenditures are essential to both maintaining production and achieving continued growth. Cutting capital expenditures too much can hurt a company's long-term prospects.
Vale Capex Expenditures - Vale Investor Presentation
The above image shows the change in the company's capital spending over the past year. As you can see the company has done an impressive job of cutting its capital expenditures. Impressively, the company managed to decrease its sustaining capex, that is the capex necessary to maintain its current projects by 30%. However, another big part of the company's capex cuts was roughly $0.5 billion in spending cuts on growth projects. This decreased spending means that the company's production growth will be smaller. On the bright side, the cash saved will help the company now. And it is clear the company is continuing to invest in necessary capex.
Vale Project Spending - Vale Investor Presentation
And what's even more impressive are the company's project startups. The company has three projects that it plans on starting up someone in the next year or so. All of these projects are projects with a multi-billion dollar capex that have significant capex with the largest of the three having at least 230 million tons per year of capacity.
Now that we have discussed the company's capex expenditures it is now time to finish up by discussing its financial strength before we finish up by discussing the long-term market forces.
Vale Gross and Net Debt - Vale Investor Presentation
Vale currently has $27.5 billion in net debt which has been continuing to increase in recent quarters. For a company with a $26 billion market cap, this is a very significant amount of the debt, the majority of the company's enterprise value is in debt. The company has $4.3 billion in net cash meaning that the company overall has $23.2 billion in net debt (slightly less than half its enterprise value).
As we saw in the most recent quarter the company had $2.4 billion in EBITDA. On $23.2 billion in net debt, we can expect that the company's annual interest payments are roughly $1 billion eating up just over half its EBITDA. The company's quarterly capex is roughly $1.4 billion eating up effectively the company's entire EBITDA. However, let's assume for a moment the company cancels is growth capex and sticks with sustaining capex. That means the company will be able to pay off its debt in 20 quarters or roughly 5 years.
Now that we have fully discussed Vale as a company, it is now time to discuss the macroenvironment that will help Vale's future earnings grow.
As we saw above, iron ore is clearly the largest source of Vale's earnings. The above image shows the amount of iron ore exported from major economies. As you can see, the iron ore exports have been increasingly rapidly in recent years and that growth is expected to accelerate in the coming years. Brazil is expected to see its iron ore exports grow by 20% in the next 5 years and Australia is expected to see its iron ore exports grow by an even more impressive 30% in the next five years.
And much of that growth can be expected to be made up for from increasing supply. A number of companies, such as we saw above from Vale have new projects that are coming online. These projects should lead to increased iron ore production from the major economies. However, as we also saw, many of these companies are cutting capex. That capex coupled with rapidly increasing demand should lead to a supply shortfall leading to a rapid increase in iron prices.
This can already be seen with iron prices that have increased recently to a 3 month high of more than $60 per ton. That's an almost 50% increase from where prices were at the end of 2015. Such an increase in prices should help Vale's EBITDA and therefore its long-term earning prospects. That coupled with Vale's recent growth shows me a very pretty picture of the company's long-term earnings.
Vale has had a difficult time recently watching its stock price take a big hit as iron ore prices collapsed into January 2016. Since then, the company's stock price has almost tripled and the company has continued to report strong earnings. However, despite the rapid increase in the company's stock price, Vale still has a huge amount of potential ahead of it.
Vale's debt load continues to remain high. However, the company is now covering its entire capex and interest with its EBITDA. More importantly, should the company's earnings continue to grow, which can be expected from the macroeconomic factors of iron ore supply and demand, Vale should be able to start paying back its debt or investing more in growth projects. These things should help Vale's long-term prospects and make it a good investment at present prices.
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.