Vale Day - Capex, Iron Ore Market, Partnerships & Cost Cuts_04Dez13_BBD

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(BRL mn) 2012A 2013E 2014E 2015E

Key Figures 4-Dec-13

EPS (R$) 4.14 5.95 5.91 4.65

Local price 32.39

Net earnings 21,126 30,388 30,180 23,747

ADR 14.76

EBITDA 36,048 50,446 48,195 45,087

Price range - 52 weeks (BRL) 25.52-43.09

Shareholders' equity 166,101 185,853 205,470 220,905

Shares outstanding (mn) 5,102.90

ROE% 12.72% 16.35% 14.69% 10.75%

3-month ADTV (R$mn) 469.5

P/E 7.82 5.44 5.48 6.96

Market cap (R$mn) 165,283

EV/EBITDA 6.11 4.37 4.57 4.89

EV (R$mn) 220,315

P/BV 1.00 0.89 0.80 0.75

Net debt (R$mn) 50,446

Dividend yield 6.96% 6.37% 6.33% 4.98%

Net debt/EBITDA (LTM) 1.17

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(BRL mn) Reported A/E QoQ % YoY %

Net Revenues

Vale Day: Capex, Iron Ore Market, Partnerships & Cost Cuts Vale hosted its Vale Day 2013 on Dec. 2 in NYC. Overall strategy, project developments and the company’s expectations regarding the various markets in which it operates were discussed in detail. Our main takeaways are: Strategy: Reducing uncertainties while keeping austerity

Settling a major tax dispute with large reduction in the liability (to R$22.3bn, from R$45bn) reduces uncertainties surrounding Vale.

Austerity and simplicity are guiding the overall decision-making process, with a conservative approach.

A strong balance sheet and maintenance of “A” credit rating are paramount to management, especially considering the company’s large capex needs.

Capex: Scaling back budget (US$14.8bn for 2014), with 3

rd consecutive reduction

The focus is still on the main projects: Carajás (35.3%), Moatize (27.7%), Itabiritos (11.5%), distribution network (4.7%) and Salobo II (3.6%).

R&D should remain stable in 2014, with feasibility studies expenses decreasing significantly (down US$192mn).

Sustaining capex budget was also reduced, to US$4.5bn from US$4.8bn, and there is potential for a further reduction of US$107mn related to a non-recurring ERP implementation project.

Iron ore market: Less volatility and healthier market ahead

Iron ore price volatility should decrease as the cap price is limited by new low-cost supply, while the floor is determined by quality deterioration and cost inflation at Chinese mines.

Vale believes 1/3 of new supply will be only filling the depletion gap.

Vale is continuously working on approval for docking Valemax ships in China.

Scrap is not an issue, as Chinese scrap has low quality and is difficult to collect.

Base metals: Rightsizing operations to increase efficiency

Closing of one furnace at Sudbury (two currently in operation) should help reduce sustaining capex by US$1bn, while productivity can be assured by operating the remaining furnace with greater capacity utilization.

Salobo: first quartile cash cost could generate US$1bn in annual cash flow.

Coal/Fertilizers: Partnership for Nacala and Kronau

Vale intends to sell half of its 70% stake in the Nacala corridor, and believes it could also be used to transport grain, boosting domestic agriculture.

Vale could sign a MOU for the Kronau project in the coming weeks.

Caves: S11D project approved already meeting cave legislation requirements

Vale obtained the environmental permit for S11D already complying with cave legislation, therefore not representing an unplanned risk for the project.

(…continued on following pages…)

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Vale FLASH NOTE

BBI Equity Research

Wednesday, December 4, 2013

Vale (VALE5, VALE US) Mining

Outperform Target Price: R$54.00, US$25.00 Upside: 66.7%, 67.6%

Alan Glezer, CFA - 55 11 2178 5466

[email protected]

Arthur Suelotto, CFA - 55 11 2178 6104

[email protected]

Bradesco Corretora – Av. Paulista, 1.450 – 7th

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Ibovespa Vale PNA

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COMPANY REPORT BBI Equity Research – Wednesday, December 4, 2013

Strategy: Reducing uncertainties while keeping austerity

Capex downtrend with simultaneous asset divestments:

o The company will only deploy capital in world-class assets.

o Already disinvested US$6.4bn in non-core assets (US$4.5bn in 2013).

o Disinvestment trend may continue going forward (management will

analyze all possibilities involving its non-core assets, but taking a careful

and disciplined approach, avoiding mispricings at all costs).

o Currently searching partners in some businesses to leverage returns.

Important milestones to reduce uncertainties achieved in recent months:

o Several tax disputes solved with no major cash flow pressure:

ICMS tax in Minas Gerais successfully negotiated.

CNI claimed unconstitutionally of state inspection fees.

Tax liability claimed by Swiss government settled.

o REFIS settlement of income tax on non-Brazilian subsidiaries

20% upfront with a remaining 15-year refinancing.

50% discount.

Reduced tax exposure to R$22.3bn from R$45.0bn – NPV of

R$14.4bn tax exposure for 2002-2013 was not included.

If a court rules in favor of Vale, it will have the right to stop paying

installments and request a refund of payments made.

Uncertainties regarding cave regulation: In light of the technical work Vale has

been performing, it is optimistic about sorting out issues.

Structure of controlling group: Although a formal decision has yet to be made, the

chairman said there is no reason not to renew the shareholders agreement.

o Approval of the S11D project could be an early indicator of renewal of the

agreement, as cash flow generation will only happen after the

agreements expire, while investments will mostly occur before it.

Figure 1: Capex Plan for 2014

Source: Company

Capex: Scaling back budget (US$14.8bn for 2014), with 3rd consecutive reduction

Third consecutive year of capex reduction (-5% vs. 2013, -16% vs. 2012).

2014 budget: US$14.8bn (using average BRL/USD rate of 2.35).

o US$9.3bn in projects, highly concentrated in key ones:

Carajás (iron ore): US$3.3bn (35.3%).

Moatize II (coal): US$2.6bn (27.7%).

Itabiritos (iron ore): US$1.1bn (11.5%).

Iron ore distribution network: US$436mn (4.7%).

Salobo II (copper): US$332mn (3.6%).

o US$4.5bn in maintenance and sustaining current operations.

Fourth year of stability in sustaining investments.

o US$0.9bn in R&D.

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Guidance for 2015 and 2016: US$13.6bn and US$10.4bn, respectively, for

approved projects only.

Still investing US$107mn in ERP implementation – potential to lower future

sustaining capex.

R&D – Feasibility studies on a downtrend, as focus on key projects increases.

Strategy: Vale is on the path to becoming cost competitive.

o 2013: “low-hanging fruit” (COGS down 5% YoY, R&D down 47% YoY,

SG&A expenses down 39% YoY – 9M12 vs. 9M13).

o 2014: “efficiency and productivity” (simplification of organizational

structures – potential for additional 10% reduction in SG&A expenses).

o 2015: “structural changes”.

Growth – Divestitures and partnerships may allow for potential dividends and

lower leverage.

Figure 2: EBITDA Growth for 2014

Source: Company

Iron ore market: Lower volatility and healthier market ahead

Vale’s outlook: Iron ore seaborne market and steel production will continue to

enjoy healthy growth (+34% and +23%,respectively, between 2012 and 2020).

Scrap should not be an issue until 2023-2025.

o Scrap from construction in China is difficult to collect, and has low quality.

o China does not have a proper collection network.

o Electricity is scarce and expensive.

Vertical integration (iron ore production controlled by the steel industry)

decreased from 28% in 2004 to 23% in 2012 (increasing seaborne market).

Depletion will increase with lower prices.

o 1/3 of new capacity will replace depletion.

o Vale does not see an oversupplied market.

Figure 3: Iron Ore Supply

Source: Company

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Chinese steel consumption intensity: on a very steep path and still in the

beginning of an uptrend, still having a long way still to go.

Figure 4: Steel Intensity versus GDP

Source: WSA, IMF, Company

Prices should remain stable going forward, and volatility is decreasing as new

low-cost supply curbs the cap, while cost inflation/deterioration of Chinese

producers’ mines increases the price floor.

Strategy: 2CTS

o Continuous confidence in Asia/China.

o Cost curve and quality:

Being well positioned in the cost curve is essential.

Maintaining very high quality is also indispensable.

o Time to market.

o Tailored to market (focus on Asian growth).

Vale needs to adapt its strategy to maximize returns in the Asian

market.

o Safety and health.

o Sustainability.

o Delivering shareholder value by:

Keeping market leadership.

Keeping FOB cost parity.

Increasing quality advantage.

Reducing logistics costs.

Improving customer services.

Staying in the first quartile is indispensable:

o Vale believes the cost curve is not becoming flatter. On the contrary, it is

actually becoming steeper (costs of high-cost producers are growing).

Figure 5: Iron Ore Industry Cost Curve (Seaborne + China Domestic)

Source: Company

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The shift to Asia should continue, representing a key challenge for Vale, due to

the logistics challenge.

o VALEMAX has already transported 44mn tons.

o Vale already has 30 ships in operation, and should receive the remaining

5 ships in 2014.

The company believes it will be able to dock VALEMAX directly in China in the

near future:

o It has already made 121 shipments with this kind of vessel.

o China is becoming a more market-oriented economy, and as VALEMAX

reduces pollution by 25%, it is in line with the Chinese government’s

current strategy.

The company expects 215mtpy of additional capacity, vs. 65mtpy of depletion,

with net growth of 150mtpy.

Many iron ore projects are presently addressing the issue of quality in order to

improve overall iron ore quality.

2018 – expected capacity of 450mtpy with better quality:

o Increase in average iron ore content by 1%.

o Decrease in silica content by almost 2% – in China a smaller silica

premium is being priced in.

Figure 6: Vale’s Iron Ore Capacity

Source: Company

Third-party purchases should stay in the 6-10mtpy range, depending on iron ore’s

overall attractiveness.

Figure 7: Vale’s Total Iron Ore Supply Forecasts

Source: Company

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Base Metals: Rightsizing operations to increase efficiency

Strategy (i): Delivering positive cash flow results.

o Gold streaming transaction (US$1.9bn).

o Reduction of operating, SG&A and R&D expenses (US$800mn YTD

through 3Q13).

o Conclusion of ramp-up of new operations.

Strategy (ii): Value over volume in feed generation.

o Idling of unprofitable mines in short/medium term.

o Closing of one furnace in Sudbury.

Instead of using two simultaneously at 50% capacity.

Savings of US$1bn in sustaining capex.

o Synergies in Sudbury basin – concrete results in 1H14.

All assets are in 1st and 2nd quartiles of cost curve.

o All nickel assets’ cash cost below US$10,000/t.

o PTVI should shift from 2nd quartile to 1st soon.

Salobo: Ramp up of world-class asset.

o Phase 1 successfully ramping up and phase 2 to double production

(start-up in mid 2014).

o First quartile of production cash cost with potential to generate US$1bn in

annual cash flow.

o Based on current forecasts, Vale should be able to reach 224ktpy in

2018 (around 20% above previous guidance).

Long Harbor: Investment has to be made to satisfy government requirements.

Rightsizing operations in both Sudbury and Thompson:

o Sudbury: further capex reductions with completion of projects (Totten

and CORe – mill redesign).

New Caledonia:

o Proved that integrated process and new technology worked in 2013.

o Focus is now on improving availability of the plan.

o Issue in November: sub-marine effluent pipeline ruptured without any

environmental impact – unexpected stoppage.

o 40,000t remains the target for 2014.

Onça Puma: very satisfying results from new furnace (15,000t for 2014).

EBITDA:

o US$1.9bn in 2013 (without the gold transaction and other non-recurring

items, US$1.5bn).

o US$2.5bn in 2014.

o Vale’s medium-term expectation is US$4-6bn (If nickel prices are at

$26,000/t, it can reach US$6bn).

Figure 8: Base Metals EBITDA Trend (US$bn)

Source: Company

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Coal/Fertilizers: Partnership for Nacala and Kronau

Moatize coal:

o Chipanga (Moatize’s coal product) is already seen as premium hard

coking coal (HCC).

o Australian operations becoming cash positive (sustainable cost

reductions and improving efficiency); will be put together with global

assets (partnership could be considered).

o Moatize:

Cost of US$64/t and improving conditions of Sena-Beira railroad.

Great scalability, world-class project.

Moatize + Eagle Downs: key projects for coal.

Figure 9: 2023 Seaborne FOB Cash Cost Forecast for HCC (Hard Coking Coal)

Source: Wood Mackenzie, Moatize – Vale cost projection

Nacala corridor:

o Open access railroad line.

o Vale will remain in charge of operations but is considering reducing its

stake in the Nacala corridor from 70% to 34-35% (discussions have

already begun, and moving towards an MOU).

o The company expects to find partners to share usage (Northeast of

Mozambique, which features strong grain production).

Figure 10: Potential Partnership for Nacala

Source: Company

Vale has expertise in mining and excellent logistics that could be used to improve

the value of the fertilizer business.

o Bayovar is an example of optimizing distribution.

Potential to unlock hidden value: bringing partners at both the project level and in

the fertilizer business itself.

Advanced discussions to develop Kronau potash project in Canada (possibility of

signing an MOU in the coming weeks).

Caves & safety: S11D approved already meeting cave legislation requirements

Caves:

o As per Brazilian legislation, any underground cave accessible to a human

being is protected by the regulation.

It took 24 years for the rules to become clear (only in 2012).

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o Cave relevance studies normally take 1 year to be completed, as they

are executed in both the dry and rainy seasons.

o The company expects favorable results in 2013, as some studies were

submitted in 2012.

Successful example with S11D – project conceived complying with cave

legislation, already taking into consideration the existence of the caves.

o 137 caves were preserved.

Licensing is usually a complicated process, extending for long periods since each

step depends on conclusion of the previous step.

o Simpler for new projects.

o For actual operations, a compensation for existing caves is needed.

Vale has 200 caves and needs a one-year period to classify

them by relevance – those with greatest relevance should be

compensated.

Massive improvement in rate of accidents, with recordable injuries/million hours

worked falling from 3.33 in 2011 to 2.66 in 2013.

Vale is including contractors in health and safety projects.

Figure 11: Total Recordable Injuries Frequency Rate¹ (per million hours worked)

Source: Company (¹ Medical treatment, restricted work, fatalities and lost time. Includes employees and contractors.

Capital Projects: Discipline in the Development/Completion Phase Transaction

Pre-feasibility studies (FEL2) and feasibility studies (FEL3) are only being

approved after a complete and rigorous maturity assessment.

The company is striving to avoid, at all costs, changing suppliers and contractors

after the initiation of projects.

In addition, contractors are charging fees that are lower than they used to be,

since demand has decreased.

Key projects (delivered in 2013):

o Additional 40mtpy:

Start-up in 3Q13.

Capex of US$3.5bn.

Already produced almost 3mn tons.

Sinter feed with dry processing method.

Figure 12: Additional 40mtpy

Source: Company

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o CLN150 – railroad and port facilities:

Railroad capacity of 128mtpy (after 5 sections being delivered).

Port capacity is currently 150mtpy.

Capex of US$3.9bn, and development as expected.

Already shipped 6mn tons in 25 VALEMAX vessels.

o Conceição Itabiritos:

High-quality pellet feed.

Presently in ramp-up phase; should start up in 4Q13.

Being delivered on time and on budget – capex of US$1.2bn

Possible positive surprise for 2014.

Figure 13: Conceição Itabiritos

Source: Company

o Teluk Rubiah unloading facilities:

3 ship loaders already placed.

First VALEMAX to be unloaded in the coming weeks.

Next year will start the exportation facility.

Stockyard - 3.2mn tons of capacity.

Stackers and reclaimers installed.

Capex of US$1.4bn.

Start-up in 2H14.

o Long Harbour.

o Totten.

Projects under construction:

o S11D:

No problems even throughout the rainy season.

109 total modules, with 31 already finished.

47% of physical progress completed.

2-year ramp-up.

Transportation of first module over 48km and was very

satisfactory (important part of the project).

Main energy substation has been concluded.

Duplication of 8 sections out of the railroad’s 48 has already

started.

o Moatize II:

48% of physical progress completed.

Will be delivered in 2H15.

Capex of US$775mn.

13,000 workers working at the site.

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Greenfield portion of the railroad is progressing very well, and

whose satisfactory completion is vital for the schedule (should be

exporting in January 2015).

Figure 14: Moatize II

Source: Company

o Nacala corridor:

Railroad progress: 33%.

Start-up: 2H14.

Port progress: 36%.

Start-up: 1H15.

Capacity: 18mtpy.

Capex: US$4.4bn (executed: US$1.1bn).

o Salobo II:

Should be ready in 1H14.

Capex below budget (US$1.7bn budget vs. US$986mn

executed).

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The non-US research analysts are not associated persons of Bradesco Securities, Inc. and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on

communications w ith a subject company, public appearances and trading securities held by a research analyst account.

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regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that

statements regarding future prospects may not be realized.

Investors should note that income from securities or other investments, if any, referred to in this report may fluctuate and that price or value of such securities and investments

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Bradesco Corretora’s and its affiliates’ salespeople, traders and other professionals may provide oral or w ritten market commentary or trading strategies to their clients and

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From time to time, Bradesco Corretora or its aff iliates and officers, directors and employees, not including its analysts may, to the extent permitted by law , hold long or short

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Non-US research analysts w ho have prepared this report are not registered or qualif ied as research analysts w ith FINRA but instead have satisf ied the registration and

qualif ication requirements or other research-related standards of a non-US jurisdiction.

Bradesco Corretora Research Team

Dalton Gardimam 55 11 2178 4275 [email protected] Denis Blum 55 11 2178 4224 [email protected]

(Senior Economist)

Tarik Migliorini 55 11 2178 4230 [email protected]

Carlos Firetti, CFA 55 11 2178 5363 [email protected] Luis Azevedo 55 11 2178 5321 [email protected]

Tales Freire 55 11 2178 4527 [email protected]

Banking and Insurance

Carlos Firetti, CFA 55 11 2178 5363 [email protected] Education

Bruno Chemmer, CFA 55 11 2178 4903 [email protected] Luis Azevedo 55 11 2178 5321 [email protected]

Rafael Frade, CFA 55 11 2178 4056 [email protected] Tales Freire 55 11 2178 4527 [email protected]

Financial Services

Rafael Frade, CFA 55 11 2178 4056 [email protected]

Gabriel Gusan, CFA 55 11 2178 5329 [email protected] Ricardo Boiati 55 11 2178 5326 [email protected]

Carlos Firetti, CFA 55 11 2178 5363 [email protected] Pedro Bueno 55 11 2178 4272 [email protected]

Healthcare

Rafael Frade, CFA 55 11 2178 4056 [email protected]

Raquel Erzinian 55 11 2178 5319 [email protected] Auro Rozenbaum 55 11 2178 5315 [email protected]

Marcos Dong 55 11 2178 5469 [email protected]

Bruno Arruda 55 11 2178 5310 [email protected]

Alan Glezer, CFA 55 11 2178 5466 [email protected] Fixed Income

Arthur Suelotto, CFA 55 11 2178 6104 [email protected] Altair Pereira 55 11 2178 4279 [email protected]

Caio Lombardi 55 11 2178 4225 [email protected]

André Sonnervig 55 11 2178 5318 [email protected]

Edigimar Maximiliano Jr. 55 11 2178 5327 [email protected]

Luiz Peçanha 55 11 2178 5324 [email protected]

André Mazini 55 11 2178 5109 [email protected] Renata Cristovão 55 11 2178 4273 [email protected]

Leandro Fontanesi 55 11 2178 4274 [email protected]

Homebuilding

Luiz Mauricio Garcia 55 11 2178 4223 [email protected] Gabriel Lima 55 11 2178 5313 [email protected]

Alain Nicolau 55 11 2178 5316 [email protected] Rodrigo Coelho 55 11 2178 5317 [email protected]

Sales - 55 11 3556 3001

Juvenal Neves [email protected] Head of Trading

Tiago Valent [email protected] Orlando Cardoso [email protected]

Gustavo Paiva [email protected]

Catherine Menezes [email protected]

Traders

Fernanda Weber Bratz [email protected] Cássio Garcia cá[email protected]

Lucila Sakakura [email protected] Fábio Brisola [email protected]

Gustavo Ize [email protected]

Ingrid Amorim [email protected]

Rogério Queiroz [email protected] Julio Cesar Rossi [email protected]

Dauro Zaltman [email protected] Mauricio Sanchez [email protected]

Denise Chicuta [email protected] Peter Gil [email protected]

[email protected] Silene Zinhani [email protected]

Traders

Agnaldo Ishikava [email protected] Marcio Aguiar [email protected]

Douglas Vieira Corazza [email protected] Wilson Pereira [email protected]

Eduardo Tosin Bueno [email protected]

Joao Batista Tamassia Santos Junior joã[email protected]

Marcelo Matias Boneri [email protected]

Paulo Silva do Carmo [email protected]

Pedro Fonseca de Souza [email protected] José Lázaro Ferreira - Head [email protected]

Sandoval Marcos Iorio [email protected] [email protected]

Institutional Sales Team - USA, UK & HK

Marcelo Cabral [email protected] Luiz Fernando Silva [email protected]

Juan Briano [email protected] João Paulo Loyola jployo [email protected]

Randall Smalley [email protected]

DeWayne Shaw [email protected]

Bradesco Securities UK, Ltd

Sales – 44 207 382 0070

Shinichiro Fukui [email protected] Robert Hulme [email protected]

Brent Matson [email protected] Roland Campbell ro [email protected]

Robert Vespa [email protected] Sales - Fixed Income – 44 207

382 0074Christopher Barresi [email protected] Guilherme Zraick [email protected]

Sean Harte [email protected] Fernanda Jordan [email protected]

Economics & Research Director

Bradesco Corretora CTVM S.A. | São Paulo

Transportation, Logistics, Malls and Commercial Properties

Bradesco Securities, Inc. | New York (FINRA/SIPC Member) Bradesco Securities Hong Kong Ltd.

Head of Equity Research

Sales Trading - 55 11 3556 3001

Steel, Mining, Pulp & Paper

(Chief Economist)

Consumer Goods and Retail

Telecom, Media and Technology

Electric Utilities, Water & Sewage

Food & Beverage

Each analyst whose name is in bold print is the principal analyst responsible for the content of reports on the respective sector, as well as fulfillment of

the provisions of Art. 16 of CVM Instruction 483/10.

Stock Loans Desk - 55 11 3556 3001

Sales Trading – 01 212 888 9141

Sales - Fixed Income – 01 212 888 9141

Oil & Gas, Petrochemicals and Sugar & Ethanol

Sales – 01 212 888 9141

BM&F Trading Desk - 55 11 3556 3350

Lilian Osti - Commercial Manager

Sales - Local Fixed Income - 55 11 3556 3005

Patricia Cruz Bilezikjian, CFA

Sales – (852)2251 8716 or (852) 2251 8718

Sales - Fixed Income - 55 11 2178 6959

Av. Paulista, 1450 7º andar

CEP: 01310-917 São Paulo – SP

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