Is Vale Worth Digging?

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About: Vale S.A. (VALE)
by: JP Research
Summary

Brumadinho dam, operated by Vale S.A., collapsed at the end of January.

Public Prosecution Offices recommended executives' dismissal.

The board of directors subsequently appointed a new team.

We're neutral on the case, with a negative outlook on potential repercussions.

According to the company’s press release, earlier this month, Vale’s (VALE) Board of Directors received from the state and federal prosecutors a recommendation to consider the dismissal of some company executives and employees following the accident in Feijão dam.

The Board held meetings on the next day with the company’s executives, during which it immediately accepted requests by those same executives for temporary removal from office. The new executive team is regarded as experienced and will likely be well received by the market.

Vale is a profitable company with a strong cash flow generation profile and a solid asset base. However, there’s now more risk to the story emerging from potential liabilities occurring from the accident. With the lack of significant upside and catalysts, we prefer to stay on the sidelines.

Feijão dam disaster

The Feijão dam disaster occurred on 25 January 2019 when Córrego do Feijão iron ore mine's Dam I breached in Minas Gerais state. Vale owned the dam, and this is the second accident in less than four years in which the company is involved. In 2015, the Mariana dam disaster killed 19 people and destroyed the village of Bento Rodrigues.

The mudflow from the dam advanced over houses in a rural area. As a result, at least 186 people were confirmed dead, and 122 were considered missing. Most victims were Vale’s employees, said Fabio Schvartsman, Vale’s CEO, in a press conference.

Vale was fined R$250 million by The Brazilian Institute of Environment and Renewable Natural Resources, one day after the failure and judicial authorities have also frozen R$11 billion of Vale's assets.

The workday after the accident, Vale’s stock price fell 24%, losing R$71.3 billion (US$19 billion) in market capitalization, the biggest single-day loss in the history of the Brazilian stock market, surpassing the time when Petróbras lost more than R$47 billion, in May last year. Fitch Ratings downgraded Vale's debt to a rating of BBB-, on that same day.

Executives dismissal

The Federal and Minas Gerais state Public Prosecution Offices along with the Federal Police issued the recommendation No. 11/2019 with considerations on the dismissal of several of Vale’s executives and employees. After the announcement, Vale had ten days to deliver a decision.

Following the issue, Fábio Schvartsman (CEO), Gerd Peter Poppinga (Executive Director of Ferrous and Coal), Lucio Flavio Gallon Cavalli (Head of Planning and Development of Ferrous and Coal) and Silmar Magalhães Silva (Head of Operations of the Southeast Corridor) voluntarily requested their temporary removal from office, which the Board accepted immediately. Luciano Siani, CFO, remains in office.

As part of the interim succession plan, the Board appointed Eduardo de Salles Bartolomeo (currently Executive Director of Base Metals) as CEO, Claudio de Oliveira Alves (current Head of Pellet and Manganese) will hold the position of Executive Director of Ferrous and Coal and Mark Travers (Head of Legal, Institutional Relations and Sustainability of Base Metals) will be the new Executive Director of Base Metals.

It isn’t clear yet if Mr. Bartolomeo will be holding the position permanently since the board has hired recent CEOs from outside of the company. Mr. Bartolomeo is less familiar to the markets but is an experienced name in the industry. Having worked over a decade at Vale and previously holding several executive positions in other companies, he is the logical internal choice.

We expect Mr. Bartolomeo to be well received by the market and capital allocation strategy to remain unchanged.

Conclusion

While Vale remains a low leverage name with a quality asset base and a strong cash flow generation profile, the recent developments add uncertainties over Vale’s investment case. The Brumadinho tragedy should result in higher scrutiny from the government going forward, possible regulatory changes and potential liabilities. Additionally, we expect iron ore prices to remain low in the long-term.

In summary, we think: 1) Iron ore prices remain lower for longer, 2) strong cash generation offset by uncertainty around potential liabilities from the dam accident and higher capex, and 3) The current valuation discount could increase as we get more color around potential liabilities.

With that in mind, we consider there’s no significant upside to the stock at these levels that justifies taking a position with increased risk.

Potential risks to our view include China steel output growth surprising to the upside and leading to higher-than-expected IO prices, higher quality premiums on higher grade ores, Vale having to make lower than expected payments for the Feijão accident and BRL depreciation.

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.