Vale Downgraded – Analyst Blog

We downgrade our recommendation on Brazil-based Vale S.A. (VALE) from “Outperform” to “Neutral” due to the instability in the Chinese market based on price concerns attributable to the new iron-ore pricing system, which gives a price hike of approximately 30%.

 

Vale has switched from an annual pricing system of iron ore to a quarterly one. The quarterly price is based on a three-month average of price indices for the period ending one month before the onset of the new quarter. The new system will secure the shareholders’ sentiments and will help tackle daily volatility in the spot prices of iron ore to a greater extent.

 

We also expect a recovery in global steel demand in 2010 and beyond. The global steel demand is expected to climb 10.7% in 2010 and 5.2% in 2011. Lastly, the recovery in the emerging markets is always greater than in the developed economies of the world, which is encouraging.

 

Vale has been benefiting from a chain of small acquisitions, which are expected to bring potential synergies. Recently, it acquired Corumbá iron ore mining operations from Rio Tinto plc (RTP) for $750 million in cash, and mines at Simandou, site of a large underdeveloped high quality iron ore deposit, at a low price. Simandou will help Vale produce 450 million tons of iron ore by 2014.

 

The 22% stake in Norsk Hydro will be accretive to earnings owing to its access to cheap power, a major cost component for producing aluminum. Moreover, aluminum prices are expected to increase driven by higher demand.

 

However, strong exposure to international markets puts it at a disadvantage in terms of exchange rate fluctuations.

 

Vale also faces intense competition from Australia-based BHP Billiton Ltd. (BHP) and the Rio Tinto Group comprising the UK-based Rio Tinto plc and Rio Tinto Limited based in Australia. The transportation costs of delivering iron ore from Australia to Asian customers are generally low as a result of Australia’s geographical proximity. However, Rio’s competitive advantage in the Asian market stems from low impurity levels in its iron ore, which generally requires lower processing costs.