RTNTF - Vale: Inexpensive Again And Offering A Hefty Yield

2023-07-05 07:39:55 ET

Summary

• Vale S.A., a major mining company, has seen its share price fall significantly in recent months, making it an inexpensive investment option despite political risks. The company also offers a high dividend yield of around 8%.
• Vale's current valuation is at 3.8x this year's expected EBITDA, which is in line with the 3-year median multiple, but significantly below the 5-year and 7-year median EBITDA multiple. Even with potential macro uncertainties, Vale still has potential.
• Vale has consistently paid large sums to its shareholders over the years. Over the last three years, Vale's total return was 80%, or around 22% per year, making it a compelling investment option.

Article Thesis

Vale S.A. ( VALE ) is a major mining company that has seen its share price pull back substantially in recent months. This has made Vale pretty inexpensive again, even when we consider the political risks. On top of that, investors also get a pretty high dividend yield of around 8%, considering the payments the company has made over the last year.

Vale: Cheap Again

As a mining company, Vale's results can be cyclical. And sometimes it seems that its stock is experiencing even wider swings to the upside and the downside, depending on investors' sentiment. Not too long ago, in early 2023, Vale was trading for more than $19 per share. Today, however, Vale is valued at just $13.50, down by 30% from the 52-week high. It currently trades around 7% north of the 2023 low, meaning we can say that Vale is trading close to the bottom of the recent trading range. Of course, buying shares in a company when they are out of favor or unloved is a good idea, as long as the fundamentals remain healthy. By doing so, investors can increase the likelihood of benefitting from a total return boost due to multiple expansion, whereas buying when shares are expensive and hyped up makes it less likely that investors will benefit from multiple expansion -- multiple compression is more likely in that scenario. Also, buying when shares are trading at the bottom of the trading range results in a higher dividend yield on cost, all else equal -- those that bought Vale at $19 will get around 30% less income compared to those that buy Vale at the current price, on a fixed dollar amount (e.g. a $1000 investment).

Looking at Vale's valuation, we see the following:

Today, Vale trades at 3.8x this year's expected EBITDA, looking at the company's enterprise value, where debt and cash held on the balance sheet are accounted for. That's pretty much in line with the 3-year median multiple, but considerably below the 5-year and 7-year median EBITDA multiple. If one thinks that the 3-year median EBITDA multiple is the most important, then Vale is pretty fairly valued right now. But due to the abnormally high profits during the pandemic, one can argue that the 3-year EBITDA multiple is not the best metric to estimate a fair value for Vale. Relative to the 5-year and 7-year median multiples, Vale has around 80% upside. Averaging the 3-year, 5-year, and 7-year median EBITDA multiples, we get to a 5.6x EBITDA target, which would represent an upside potential of around 45% to 50% from the current level. Even when we assume that the valuation should be lower due to macro uncertainties on the horizon, such as a potential recession in the US, and we subtract 20% from the 5.6x EBITDA target in order to get to a new 4.5x EBITDA target, Vale would have upside potential of around 18%.

All in all, we can thus summarize that the recent share price underperformance has made Vale S.A. quite inexpensive again. Shares trade at a low valuation in absolute terms, and also in relative terms, compared to how the company was valued in the past and compared to how its peers are valued: Rio Tinto Group ( RIO ) trades at 4.7x this year's expected EBITDA and BHP Group Limited ( BHP ) trades at 5.5x this year's expected EBITDA right now. One can argue that a discount is warranted due to Vale being domiciled in a somewhat more risky country, but with Vale trading at a discount of more than 30%, the political risks seem to be accounted for, I believe.

A Hefty Shareholder Yield

Many basic materials and commodity companies are seen as income investments, and rightfully so. The industry is not growing overly fast (thus there is no need to invest at a rapid pace), and the companies in this space oftentimes generate strong cash flows, which, in combination, allows for high shareholder returns in many cases.

This also holds true for Vale, which has paid out vast sums of money to its owners in recent years. A comparison between Vale's share price return and its total return showcases this pretty well:

Over the last three years, Vale's share price rose by a little over 30% -- which isn't bad, but not overly strong, either. The total return over that time frame, however, was 80% -- or around 22% per year, which is highly compelling.

We see that Vale's dividends have been a major driver (or, one could argue, the major driver) of total returns in the past. And thanks to a clean balance sheet and a shareholder return policy that sees the company paying out substantial dividends still, it seems likely that dividends will remain highly important in the future.

Over the last year, Vale has made several dividend payments . In US Dollars, they looked like this:

- $0.38 per share was paid out in September

- $0.28 per share was paid out in September ((IOC))

- $0.06 was paid out in March ((IOC))

- $0.35 was paid out in March

Combined, that makes for a dividend payout of $1.07 over the last year, which translates into a dividend yield of 7.8% with Vale trading at $13.80 right now. That's a pretty high dividend yield, but looking at Vale's past dividend payments, prior to the trailing twelve months period, dividends could be even higher in the future. In late 2021, for example, Vale made a single dividend payment that was around one and a half times as high as the four payments Vale made over the last year -- and that was not Vale's only dividend payment in 2021. When profits climb, investors can thus expect even higher dividends compared to the already pretty nice payout Vale offers today.

What's Vale's Outlook?

Vale's business is cyclical, and that will likely always remain the case. Commodity prices move up and down, depending on the state of the economy, macro news, but also investors' fears and hopes.

In the long run, commodity drives are largely driven by supply and demand, however. The underlying outlook for many of the commodities Vale produces is positive, I believe. Iron ore is needed to produce steel, and global demand for steel should remain strong or get even stronger in the future. There's a lot of aging infrastructure in Western countries such as the US, which will require replacement spending for bridges, electricity transmission infrastructure, and so on. In higher-growth countries such as China and India, new infrastructure is being built in order to fuel economic growth and to allow for a higher standard of living for a population that becomes wealthier and wealthier. At the same time, green investments require substantial amounts of commodities as well: New transmission lines (and their supporting infrastructure) require steel, windmills require steel, and copper is required for everything from electric vehicles to electrical grid infrastructure. All in all, the demand picture for the basic materials that Vale produces is thus positive. At the same time, it does not look like there will be a lot of supply coming online in the near term -- building new mines has become quite expensive, and regulation has become tougher over the years. Due to ESG mandates and other factors, greenfield projects are hard to pursue, and even when new mines are brought online, that does not necessarily result in more overall output, as some older mines are closing down when they aren't profitable any longer. I thus believe that the overall mining and basic materials industry could benefit from a positive macro picture in the coming years and possibly decades, and Vale should be among the companies to benefit from this development.

Between a high dividend yield, an inexpensive valuation, and a positive longer-term business growth outlook due to a supportive supply-demand picture, I believe that Vale has a good chance of delivering attractive total returns going forward. Shares trading near the 52-week low look like they could be a good long-term investment.

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