According to Reuters, Vale S.A. (VALE) has signed an agreement with Hong Kong based Norsk Hydro ASA (NHY) to sell its aluminum business for $4.9 billion. According to the deal, Vale will receive $1.1 billion in cash and a 22% stake in Norsk Hydro, which is equivalent to $3.1 billion. Besides, $700 million is estimated as debt by the Hong Kong based company.
 
Norsk Hydro is a Norwegian firm whose main business is manufacture of aluminum products. Power is the major cost in producing aluminum, and Norsk Hydro has access to cheap power. Thus, any decrease in operating costs will automatically enhance shareholders’ value, which will also benefit Vale.
 
We also expect aluminum demand to increase over the next three years, outstripping supply growth. As a result, the aluminum market is likely to see a deficit for a prolonged period. This provides a backdrop supportive of high alumina and aluminum prices.
 
Moreover, a recent recovery in the global industrial production numbers is a positive sign as there is a positive correlation between global industrial production and Vale’s business. Global manufacturing PMI (Purchasing Managers’ Index) has been steadily improving over the last many months. Simultaneously, the new order inventory ratio, which usually leads manufacturing output growth by three months, has climbed to its highest level since April 2004.
 
Demand for iron ore products is usually related to worldwide demand for steel and the World Steel Association has forecasted a 10.7% increase in global steel demand in 2010 and 5.2% increase in 2011 compared with 2010 level. The increase will be driven by a strong growth in Chinese steel demand.
 
China’s steel use is expected to increase 6.7% to 579 million tons in 2010. China is expected to remain the largest consumer of metals in the future.
 
However, Vale’s strong exposure to international markets is a disadvantage on account of exchange rate fluctuations. Thus, we reiterate our Neutral recommendation.
Read the full analyst report on “VALE”
Read the full analyst report on “NHY”
Zacks Investment Research