MITSY - Vale: An 8.58% Dividend While Awaiting Value Unlock

Summary

• Vale S.A. is in talks to sell a stake in its future-oriented battery metals business.
• I wouldn't be surprised if a stake sale will be followed by an IPO or a spinoff of the segment.
• Vale seems to be in full sales mode for the segment that could reportedly bring in 25% of its market cap in value.
• Meanwhile, it only represents 15% of its EBITDA.

Iron ore prices are really strong recently hitting new highs, at $133 per metric ton, since July 2022. That's with China shutting down one of its largest steel manufacturers last week.

Vale S.A. ( VALE ) is the largest iron ore miner in the world. It is making gobs of money right now. I think Vale continues to be a fine hold, given its ability to generate a ton of free cash flow, and it also appears to continue to allocate capital in a mindful way(buybacks, dividends, and minor investments). But what I'm really watching out for is the separation of its base metals business.

In my last article , I speculated Vale would sell a stake in its battery metals business to Tesla, Inc. ( TSLA ). However, it now appears more likely it's going to be General Motors Corporation ( GM ), Mitsui & Co., Ltd. (MITSF), or Saudi Arabia's Public Investment Fund.

It has to be said Vale is making a lot of progress. The business has been segmented into an Iron Solutions and Energy Materials Transition segments. Vale appointed an ex-Tesla exec at the latter segment as a director, and that side of the business will be operating out of the U.K. Per the earnings call :

I'm also very happy to announce the appointment of Jérôme Guillen as our first Independent Director for our Energy Transition Materials business, in line with the new management model that we had laid out during Vale Day.

Jérôme is a former President of Tesla Automotive and has played a key role in developing the EV market as we know today. He is a very innovative and purpose-driven individual that will certainly add tremendous value to our energy transition materials strategy. As well, we continue to make substantial progress on the minority sale, and expect to share additional details with you still in the first half of this year.

It gives me the impression (but this isn't substantiated by the company's communication) that a stake sale could be a precursor to an IPO of the latter segment. It all (the segment's name, Tesla director, and the presentation materials) seems like it is being set up to be sold in a roadshow of some sort to European ESG investors. A stake sale of 10% or so could set a nice benchmark for an IPO. Per the Bloomberg report, Vale is looking for around $2 billion for a 10% stake.

Another reason I think the stake sale could be a precursor to a spin-off/IPO is a comment on the last earnings call about the difference in the base metals business vs the iron ore business in terms of capital requirements:

That's the next reason why we're doing that, because if you understand the needs of cash for this business, we are talking huge amount of money. We're talking $20 billion. And I think Vale's iron solutions shareholder eventually wouldn't like that as well. So why not have this option in the near future, if you are executing well?

The iron ore business is throwing off tremendous cash, but here the CEO suggests investments on the base metal side could require $20 billion. Incidentally, 10x $2 billion gets you $20 billion. An IPO would solve the capital requirements. It would also solve the problem that if you put a growth business inside a legacy production business, they often both get a terrible multiple. An IPO could unlock some of the value within the business.

I pulled up a valuation table of the large mining conglomerates off Seeking Alpha.

Vale trades at 4.4x forward EV/EBITDA or 6x forward earnings. All the large mining companies appear to trade at modest valuations, but Vale trades at the lower end of the range.

Vale's energy transition materials segment generates around 15% of its EBITDA. If the company succeeds in selling it for $20 billion that represents around 25% of its market cap in value. Implying it is trading at an even lower multiple pro-forma for a full separation. In addition, these multiples are for a company with only $2 billion in net debt.

I think Vale S.A. continues to be an excellent hold. If nothing happens, the 8.58% dividend yield makes up for a lot of aggravation. If that's not enough, there are the not-insignificant buybacks, with Vale S.A. having bought back ~13% of shares since April 2021.

I'm not going to buy Vale S.A. yet. I don't think the stake sale is likely to result in a re-rate. I'd expect that to come if it is indeed followed up by an IPO of the future-oriented growth business. At this point, that's still quite speculative.

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