An Overview of Vale - The World's Largest Iron Ore Company - Market Realist

Positioning Vale SA in the lower prices and lower costs scenario (Part 1 of 10)

Iron ore miners price performance

Vales (VALE) share price was down ~44% in 2014. This mirrored the ~48% decline in iron ore prices. Other companiesBHP Billiton (BHP)and Rio Tinto (RIO)are also down. However, their decline isnt as steep as Vales decline.

Rio Tinto performed the best among all of the iron ore producers. It was only down 13.5% in 2014. Meanwhile, BHP was down 23.7%.However, the fall isnt just due to the decline in iron ore prices. Its also due to the recent slump in oil prices.

The pure plays and midcapslike Fortescue Metals Group (FSUGY) and Cliffs Natural Resources (CLF)are down 53.1% and 70.2%,respectively.

ETFslike the SPDR S&P Metals and Mining ETF (XME)are a good way to gain exposure to this sector without picking individual companystocks.

Vales downfall continues

Vales decline in stock price continues into 2015 as well. Citigroup reduced its target for iron ore in 2015 and 2016 to $58 per ton and $62 perton. Previously, the target was $65 per ton. This impacted Vales stock price. Its stock price was down ~6% after the report was released.

As well discuss later in this series, iron ore prices have been revised down due to the impact of oil and foreign exchange. These factors willhelp Vale reduce its costs as well.

Series overview

In this series, well talk discuss Vales price decline. Well see how its cost position changedcompared to other companies. Well discuss howits cost position changed due to the recent oil price decline and the Brazilian real depreciation versus the Australian dollar. Well do a costanalysis of major seaborne iron ore players.

Well also discuss Vales recent developmentslike the potential bid on its nickel assets and the sale of its Fosbrasil assets in Brazil. In the

Positioning Vale SA in the lower prices and lower costs scenario

Vales price performance compared to other iron ore playersBy Annie Gilroy

Jan 22, 2015 4:28 pm EDT

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Company overview

Vale (VALE) is a Brazilian multinational diversified metals and mining company. Its the worlds largest producer of iron ore and iron ore pellets.Its the worlds second largest nickel producer. It also produces manganese ore, ferroalloys, coal, copper, PGMs (platinum group metals),gold, silver, cobalt, potash, phosphates, and other fertilizer nutrients.

Vale has mineral exploration operations in 11 countries around the globe. It operates infrastructure systems in Brazil and other regions of theworld. Its infrastructure systems include railroads, maritime terminals, and ports that are integrated with its mining operations.

Operations

Its main operations are divided into four main lines of business:

Bulk materials iron ore, iron ore pellets, manganese, ferroalloys, and coalBase metals nickel, cobalt, copper, PGMs, and other precious metalsFertilizer nutrients potash, phosphate, and nitrogen fertilizersLogistics infrastructure railroads, maritime terminals, distribution centers, and ports

The bulk of Vales earnings come from iron ore. Other companies in seaborne iron ore trade include Rio Tinto (RIO), BHP Billiton (BHP),Fortescue Metals Group (FSUGY), and Cliffs Natural Resources (CLF) Australian division. Together with Vale, these companies accountfor more than 70% of the seaborne iron ore supply.

Investors can also consider investing in ETFs that invest in the metals and mining sectorlike the SPDR S&P Metals and Mining ETF (XME).

An overview of Valethe worlds largest iron ore companyBy Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Locational disadvantage

Vale (VALE) has always been at a disadvantage to other iron ore companiesincluding BHP Billiton (BHP) and Rio Tinto (RIO)because of itsgeographic location. Asia, particularly China, is the largest single consumer for these seaborne iron ore players. Brazil, where Vale operates, isthree times as far from China as Australia. This leads to repercussions for Vale in terms of a significant difference in freight costs. As a result,it places BHP and Rio Tinto lower down on the global iron ore cost curvecompared to Vale.

The bulk of Cliffs Natural Resources (CLF) volumes are only for the US. So, the changes in freight rates shouldnt impact it much.

To learn more about the cost curve, read Must know: An overview of the iron ore industry.

Decline in freight costs

With the recent decline in the freight rate, this seems to be changing. It used to cost $21 per ton to ship from Brazil to Chinacompared to$9$11 per ton from Australia to China in 2014. Freight costs declined dramatically in the last six to eight months. The costs declined mainlydue to a drop in the price of bunker fuela type of oil used to power large ships.

This brings some cheer to Vale. For Vale, this led to a decline of ~$11 per ton of freight cost. Now, it hovers around $10 per ton. There wasa decline of $4 per ton for its Australian peers. In Australia, the freight costs are around $5$6 per ton. This makes the incremental cost ofshipping from Brazil to China only $5$6 per ton highercompared to the previous difference of $12$15 per ton.

However, this wont be the exact impact on Vales costs. Vale isnt fully exposed to spot freight. Also, it has long-term contracts or leases withthe shipping companies. It also own Valemax ships. It will benefit from declining bunker fuel costs.

The SPDR S&P Metals and Mining ETF (XME) invests in the stocks mentioned above. It provides diversified exposure to this sector.

To learn more about Valemax ships and its strategic importance for Vale, read Valemax ships sail Vale SA to cost-effective distribution.

Why lower freight costs impact iron ore miners differentlyBy Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Freight and FX savings

Lower freight costs will lower the CFR (cost and freight) for seaborne iron ore producers. It will have implications beyond just reducing thecosts for the miners. Now, well discuss the implications of freight and FX savings on Vale and other companies in the iron ore industry.

Cost curve reordering

While the savings from freight costs decrease, oil savings and FX depreciation will benefit all of the players engaged in seaborne iron oretradeincluding BHP Billiton (BHP), Rio Tinto (RIO), Vale (VALE), Cliffs Natural Resources (CLF), and Fortescue Metals Group (FSUGY).There are some differences that could lead to a reordering in the cost curve.

First, a decrease in freight cost isnt impacting all of the miners at the same rate. Brazil is getting proportionately more of a benefitcomparedto the Australian players.

Second, freight differences wont benefit domestic iron ore producers muchespecially the Chinese domestic producers. This will helpexporters become more competitive. Considering the first point, the Brazilian exporters are still more competitive.

As far as FX gains are concerned, they arent distributed evenly across miners. The Brazilian real is depreciating faster than the Australiandollar. This will benefit Vale more than BHP, Rio Tinto, or Fortescue Metals Group.

Downside

Lower input costs are good for miners. This has positive results for other marginal and high-cost producers. Smaller iron ore players involvedin seaborne iron ore trade will also benefit from the lower freight costs. They would get a new lease on life for a longer period oftimeuntil the iron ore prices tumble to a new low. Then, sustaining with these lower costs would be difficult.

This definitely isnt good news for big, low-cost producers. These players increased capacity to displace these high-cost, marginal suppliersout of the market.

The SPDR S&P Metals and Mining ETF (XME) invests in the stocks mentioned above.

Freight and FX savings impact Vale and the iron ore industryBy Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Vales cost position

In this part of the series, well discuss how Vales (VALE) cost position compares to other iron ore companies in Australiaincluding BHPBilliton (BHP), Rio Tinto (RIO), and Fortescue Metals Group (FSUGY).

The costs include mining, processing, and administration. They dont include royalties, exploration, sustaining capital, depreciation andamortization, interest, and taxes.

Cash costs

Vale is a low-cost producer. Its cash costs are $22 per toncompared to $20.40 per ton for Rio Tinto and $26$27 per ton for BHP.

Fortescue lowered its cost per ton significantly. It invested in infrastructure and operational improvements. This caused its cash costs to fall~23% to around $32$34 per ton. However, it attracts a significant discount to the benchmark 62% iron content. Its grade is inferior at57%58%. It has lots of moisture content. It doesnt even produce any premium lump product to offset this discount. Its still highdebtcompared to its overall position. This makes it a distant fourth when it comes to big, low-cost global iron ore miners.

The only cost that differentiates Vale from the other Australian companies is the freight cost. On average, it used to cost $23 per ton to movecargo from Brazil to Chinacompared to only $9$10 per ton from Australia to China. This creates a huge difference of $13 per ton betweenVale and the other Australian companies. To provide iron ore at similar costs to Chinese steelmakers, Vale would have to discount the iron oreper ton by $13. This reduces its realized price.

In contrast, Cliffs Natural Resources (CLF) sells most of its produce locally. As a result, freight costs dont impact its core business much.

Investors can also consider investing in ETFs that invest in the metals and mining sectorlike the SPDR S&P Metals and Mining ETF (XME).

So, weve seen that Vale isnt a high-cost producer. Why is its stock more sensitive to moves in iron ore prices? Well discuss this in the nextpart of this series.

Whats Vales cost position compared to other iron ore companies?By Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Why Vale is more sensitive to iron ore prices

So, it isnt the cost position thats the real deal breaker for Vale (VALE). We already discussed that freight rates are declining. Vale should beable to compete with the other Australian seaborne companiesBHP Billiton (BHP) and Rio Tinto (RIO).

Huge debt position

There are two reasons why Vale is more sensitive to iron ore prices. One is the huge debt it accumulated over the years. Most of the debt isdenominated in the US dollar, or USD. Vale took the debt in USD to take advantage of the lower interest rates. However, with the localcurrency depreciation and USD strengthening, this advantage is going away.

The main debt repayments start becoming due in 2016. The market isnt doubting Vales ability to repay its debt obligations. Its the interestservice charges that are putting pressure on its margins. The commodity price scenario is already weak. This is worrying for investors.

Cliffs Natural Resources (CLF) is a North American iron ore producer. It has a huge debt position. For some time now, the debt position hasbeen a major overhang on its shares.

Ambitious capex plans

The second reason that Vale is more sensitive to iron or prices is its ambitious capital expenditure, or capex, plans. Its capex plans are morestretched out than Rio Tinto and BHPs plans. While BHP and Rio Tinto plan to complete their iron ore expansion plans by 2017, Vale isplanning to complete its full expansion by 2019.

Vale still has a huge expansion capex budget in place for this targeted capacity increase. So, the cash flow it earns demands debt servicingand capex. Vale has the weakest balance sheet and the highest debt among the three major players. This makes Vales share price moresensitive to any moves in iron ore prices.

There are other reasons why Vale is more sensitive. Vale is less diversified. Also, theres more government interference in Vales affairsthanin BHP and Rio Tintos affairs.

Investors can consider investing in ETFs that invest in the metals and mining sectorlike the SPDR S&P Metals and Mining ETF (XME).

Why is Vale more sensitive to iron ore prices than BHP and RIO?By Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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A potential bid for Vales nickel assets

Bloomberg reported a potential bid for Vales (VALE) nickel assets. Well briefly analyze the potential consequences if the bid goes through.Right now, the bid seems to be far-fetched.

Potential X2 bid

Bloomberg reported that Mick Davis, Xstratas former CEO, is considering a bid for Vales nickel assets. Hes considering the bid through hisnew companyX2 Resources. Its reported that this investment vehicle values Vales nickel assets at $5$7 billion.

Xstrata was acquired by its largest shareholder Glencore plc (GLNCY) in a $30 billion deal in 2012. Since then, Davis raised about $4.8 billionfrom equity investors. Hes hunting for assets to buy from the worlds largest minerslike Vale, BHP Billiton (BHP), and Anglo American plc(AAUKY).

There hasnt been an official confirmation from either side. However, $5$7 billion implies a valuation of close to 2.25x EV/EBITDA (enterprisevalue to earnings before interest, tax, depreciation, and amortization)based on annualized 3Q14 adjusted EBITDA for nickel, withoutconsidering debt. This is quite low for Vale to consider. Even if it gets an offer, this price might not be enough for Vale to part with the assets.

Nickel business

Vales key competitive strengths in nickel include its long-life mines and low-cash costs of productioncompared to other nickel producers. Italso benefits from its sophisticated exploration and processing technologies and its diversified portfolio of products.

To learn more about Vales nickel assets, please read Nickel plays an important role in the future of Vale SA.

Vale and other iron ore companiesincluding Norilsk Nickel, Jinchuan Nonferrous Metals Corporation, Glencore Xstrata (XSRAY), and BHPBillitonaccount for ~47% of global refined primary nickel production.

Investors can also consider the SPDR S&P Metals and Mining ETF (XME) to get exposure to this sector.

What does X2s potential bid for Vales nickel assets mean?By Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Stake sale

On December 9, Vale (VALE) announced that it entered into an agreement with Mitsui & Co. According to the agreement, it will sell Mitsui 15%of its 95% stake in the Moatize mine. It will also sell Mitsui 50% of its 70% stake in the Nacala Logistics Corridor, or NLC. To learn more aboutVales coal operations, please read Vale SA coal mining operations.

After the transaction is complete, Vale will indirectly own 81% of the Moatize mine. It will own ~35% of the NLC. It will share its control withMitsui.

Moatize mine

The value attributed to Mitsuis 15% stake in Vale Mozambique, or VM, is $450 million. Mitsui will also be responsible for funding future capexto complete the Moatize mine expansion. This will be pro-rata to its equity participation of 15%estimated at $188 million. As a result ofearnout and clawback clauses, the final value attributed to VMs 15% stake could range from $330$480 million. The transaction amounts willbe used to fund the capex of the Moatize mine expansion.

NLC

Mitsui will make an upfront payment of $313 million for 50% of Vales 70% stake in the NLC. In addition, Vale and Mitsui are negotiating for upto $2.7 billion in non-recourse project financing that will be used to fund future capex. It will also be used to repay about $1 billion inshareholder loans to Vale. It will be used to repay Vales spending on the project from the end of 2Q14 to the close of the deal.

Strategic importance

With these transactions, Vale avoided a total cash outflow of $3.6 billion. The transaction is essential to continue its investment in Mozambiqueand Malawi. It provides the funding to complete the Moatize project. It also provides funding for the NLC. It supports Vales strategy ofoperating world class assets. It improves Vales balance sheet and eliminates future funding needs. It also reduces Vales exposure to theproject risk.

Other iron ore companiesincluding BHP Billiton (BHP), Rio Tinto (RIO), and Cliffs Natural Resources (CLF)are also going for stake sale orcomplete divestments. The companies want to improve their free cash flow profile and operate effectively in this low commodity priceenvironment.


Why is the equity partnership with Mitsui strategically important?By Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Fosbrasil stake sale

Vale (VALE) completed the 44.25% stake sale in Fosbrasila Brazil-based producer of purified phosphoric acid in Cajatito ICL Brasil Ltda,or ICL, for $52 million. Vale announced the stake sale, subject to regulatory approval, in December 2013.

While the transaction is immaterial to the overall company, its a step towards the companys policy of divesting non-core assets. Vale has agoal of raising $10$15 billion in cash through restructuring and asset sales over the next 12 months.

Cost-cutting initiatives

In the currently subdued commodity price environment, Vale took many other initiatives to preserve margins and conserve cash.

In 2013, the company sold assets worth $6 billion. Its also looking to spin off part of its base metals business. It could be worth up to $14billion.

It significantly reduced its capital expenditure, or capex. Now, its focusing on a small project pipeline that will generate more value forshareholders. Vales capex fell from $16.2 billion in 2012 to $14.2 billion in 2013. Its budgeted to be $12 billion in 2014.

In 2014, Vale achieved $1.2 billion in recurrent savings. The selling, general, and administrative, or SG&A, expenses were mainly responsible.They fell by ~23%. Pre-operating and stoppage expenses were cut by ~46%. Research and development expenses were also reduced thisyearcompared to previous years.

Other iron ore companiesincluding BHP Billiton (BHP), Rio Tinto (RIO), and Cliffs Natural Resources (CLF)also embarked on cost-cuttingand restructuring initiatives to remain profitable.


Understanding the completion of stake sale in FosbrasilBy Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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Wheres Vale placed in the iron ore industry?

Vale (VALE) is the largest iron ore producer with high-quality assets in Brazil. The development of the S11D project will reduce its costs more.It will also increase its production volumes. Going forward, Vales revenue should also get some support from nickel and copper. Theproduction is increasing for these base metals.

Iron ores contribution

However, iron ore contributes to most of Vales revenue and earnings. Iron ore contributes 62% towards Vales revenue. It contributes ~80%towards its EBITDA (earnings before interest, tax, depreciation, and amortization). As a result, iron ores volume and price outlookwill determine Vales position in the iron ore industry.

Demand and supply

Vale is highly leveraged to iron ore prices. Iron ore prices have been depressed in recent months. They slid ~49% in 2014. The main causes ofthe iron ore market woes are oversupply from major iron ore producerslike BHP Billiton (BHP), Rio Tinto (RIO), and Fortescue Metals Group(FSUGY)and weak demand growth from China. China consumes two-thirds of seaborne iron ore.

There was an overall policy shift in China from investment to consumption-led growth. This might not be good for the steel, iron ore, andcoking coal sectors.

This means Vale isnt going to get much help from iron ore prices. High debt on its balance sheet isnt helping Vale either. Its cost-cuttingefforts, non-core asset divestment, and FX and freight costs might bring some relief in the short term.

The SPDR S&P Metals and Mining ETF (XME) invests in the stocks mentioned above.

For the latest updates and industry news, visit Market Realists Iron Ore page.

Must-know: Vales placement in the iron ore industryBy Annie Gilroy

Jan 22, 2015 4:29 pm EDT


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An Overview of Vale - The World's Largest Iron Ore Company - Market Realist