We maintain our Neutral recommendation on Vale S.A (VALE).
Prior records, over the past five years, have shown that the demand for Brazil’s abundant minerals, notably iron ore and bauxite, has increased faster than the historic rate. Such acceleration is largely due to the rapid growth of the Chinese economy and other developing nations.
As the demand outstripped supply, the price of iron ore has quadrupled in the past five years. This is anticipated to bring in long-term growth for the company, on the back of rising spot prices of metals and minerals worldwide.
With time, Vale has grown into a strong contender in the iron ore market given the high ferrous (iron) content and low impurities of its iron ore reserves. Metal prices too are at an all time high. We believe Vale’s diversified iron ore product mix will allow the company to maximize the useful life of its mines and optimize its investment needs in the future.
Volume growth of bulk material, fuelled by larger shipments worldwide, is also expected to boost the company’s sales for the coming quarters. In addition, rapid consumption in the United States as well as recovery and urbanization in Japan may further help them steal the show. Rise in global stainless steel demand is also deemed as a positive for Vale’s nickel business.
However, Vale being a cyclical stock oscillates with the fluctuating worldwide demand for steel, which was largely influenced by economic activity at large. The international iron ore market, which is highly volatile with regard to price, quality and range of products, reliability, and transportation costs, has continued to impact the company’s financials while dampening sales.
Furthermore, the recent upsurge in oil prices, inflation in the emerging markets alongside significant fluctuations in currency prices cannot be overlooked. During the fourth quarter, the company’s earnings suffered a negative effect of currency depreciation of the Brazilian real against the US dollars.
Adding to the woe, taxation has become a serious issue for Vale. Income tax rates, mining tax rates and mining royalty rates levied on mining companies by various governments have significantly threatened its top-line results.
Mining companies, including Vale, find sustainable growth difficult given the major challenges facing the industry. The rise of resource nationalism is a major deterrent to growth for multinational miners. Miners are facing a politicized landscape, governmental delays on permits and tight environmental regulations and policies. These have interrupted operations and inflated costs.
Risks amplify, as the international iron ore market turns out to be highly competitive with global iron ore grades declining in quality. The improvement in grades essential to survive the competition is estimated to increase production costs. In this scenario, the mining companies throughout the world are trying to look for new mineral reserves to maintain growth and competitiveness.
Keeping this in mind, Vale has planned to spend about 11% of its $21.4 billion investment budget for 2012 on research and development, including the search for new mine reserves.
Mention may be made of the natural disasters and labor crisis, which are responsible for disrupting mining operations and destabilizing industrial infrastructure. Mining companies, like Vale, are also contending with a shortage of skilled workers and industrial infrastructure disruption, particularly in the developing markets, which have been impeding efficiency.
Even under such cloudy sky, future looks brighter as the company plans to diversify more into the areas of coal, copper and fertilizers, and at the same time strengthen its competitive position in iron ore and nickel. Moreover, Vale operates large logistics systems in Brazil, including railroads, maritime terminals, a port and a maritime freight portfolio, which are integrated with their mining operations, cutting down on the company’s transportation costs.
Brazil-based Vale S.A. is one of the world’s largest producers and exporters of iron ore and pellets. The company keeps improvising its competitiveness against rival companies like Rio Tinto plc (RIO) and BHP Billiton Ltd (BHP).
For FY11, the company reported total revenue of $60,389 million, up 29.9% y/y, primarily due to the effect of higher prices of metals and minerals. The company remains committed to returning value to shareholders thus optimizing allocation of its capital resources.
Vale has a Zacks #3 Rank, which translates into a short-term Hold rating (1-3 months).
To read this article on Zacks.com click here.
Zacks Investment Research
