On Jun 11, we issued an updated research report on VALE S.A. VALE. The consequences of the Brumadinho tailing dam failure remains a headwinds. Nevertheless, the company will gain from focus on delivering improved margins in iron ore operations and higher iron ore prices. Investment in projects, efforts to ramp up its coal business and transform base metals business will also act as catalysts.
Manifold Impact of the Brumadinho Dam Disaster
On Jan 25, 2019, a tailings dam failed at Vale’s Córrego do Feijão mine, in the city of Brumadinho, state of Minas Gerais, leading to 300 casualties and extensive property and environmental damage. Various Brazilian courts have ordered freezes, attachments, deposits and similar measures affecting an aggregate of R$17.6 billion ($4.5 billion) of Vale’s financial assets to secure the payment of damages. The company suspended dividend and stopped all share buybacks. It also eliminated executive bonuses.
Following this, Vale suspended various operations, either voluntarily or as a result of revocation of licenses or court orders. This impacted the company’s iron ore annualized production by about 92.8 Mt. The company is taking legal and technical measures to restart these operations but timing is uncertain. The financial impact of the disaster has not been quantified yet. Vale reported a loss of $1.6 billion or 32 cents per share in first-quarter 2019 — its first quarterly loss since the third quarter of 2015. This can primarily be attributed to the impact of the Brumadinho dam rupture.
Revenues in fiscal 2019 will be lower owing to suspended operations. Further, as a result of the suspended operations, Vale may have to purchase iron ore and iron ore pellets in the market to meet its obligations under existing commercial contracts, which may lead to higher costs. The company may have to make investments or adjustments in the operations not impacted by the dam failure to increase production, mitigate the impact of suspended operations or comply with additional safety requirements. It may also have to utilize alternative disposal methods to continue operating certain of its mines and plants, particularly those that rely on tailings dams. These alternative methods may be more expensive or require significant capital investments in mines and plants. As a result, costs are expected to increase, which may have a material adverse effect on margins.
The company will write off assets of the Córrego do Feijão mine and those related to the upstream dams in Brazil that will result in a loss of $124 million in 2019. Additional impairments, write-off or write-down of assets may be recognized in 2019. The company also has to make provisions for costs of decommissioning, and further remediation and legal proceedings.
Vale’s “Value over Volume” Approach to Mitigate Impact
The company is focusing on maintaining its ‘”value over volume” approach for the iron ore business. Despite the production constraints, Vale remains committed to delivering the highest possible margins, by managing extensive supply chain and flexible product portfolio. The company strives for better price realization, based on adjustments to product portfolio according to market demand and supply chain optimization. The company is also focusing on improving quality and productivity, controlling costs, strengthening logistics infrastructure.
The Brumadinho dam breach and the consequent capacity closures, and Cyclone Veronica in Australia negatively impacted iron ore supply. This led to fears of a supply crunch, which in turn aided the surge in iron ore prices. Although Vale’s production has gone down owing to the disaster, it will eventually benefit from rising iron ore prices.
Focus on Investment to Spur Growth
The investment budget for 2019 approved by Vale’s Board of Directors is $703 million for project execution, and $3.731 billion for sustaining existing operations and replacement projects. Major portion (96%) of the capital expenditures budget for project execution will be invested in Brazil. The company is developing a focused organic growth portfolio with fewer projects but with higher expected rates of return. Its main initiative, S11D, accounts for 44.2% of the $703 million budgeted for project execution in 2019.
Ramping up Coal Business, Efforts to Transform Base Metals Business
Vale is focused on increasing coal production, primarily through the ramp-up of the Moatize operations and the Nacala Logistics Corridor (NLC) in Mozambique and Malawi, where it has entered into a strategic partnership with Mitsui. As it completes the ramp-up in Moatize and the NLC, the company expects reduced costs which will boost margins. Other key initiatives, such as knowledge transfer from its iron ore operations, opening of new mine sections and preparation of selected mining pits for future disposals are expected to lead to higher capacity utilization, mine productivity and yields for the coal business.
The company is also focused on transforming its base metals business into a significant cash generator. Vale is focusing on nickel business through supply chain integration, operational excellence and digital transformation. It is also being aided by consistent review asset utilization and optimizing operations in order to increase productivity and improve returns, while maintaining capacity for growth to capitalize on prospects for an electric vehicle revolution.
Share Price Performance
Over the past year, Vale's shares have dropped 5.0 compared with the industry’s decline of 4.9%.
Zacks Rank & Stocks to Consider
Vale currently carries a Zacks Rank #3 (Hold).
Some better-ranked stocks in the basic materials space are AngloGold Ashanti Limited AU, Arconic Inc. ARNC and Materion Corporation MTRN. All these stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
AngloGold Ashanti Limited has an expected earnings growth rate of 90.57% for 2019. The company’s shares have appreciated 67.2% in the past year.
Arconic has a projected earnings growth rate of 31.99% for the current year. The company’s shares have appreciated 28% in a year’s time.
Materion Corporation has an estimated earnings growth rate of 27.1% for 2019. Its shares have rallied 16s.7% over the past year.
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