2023-06-12 17:54:12 ET
Summary
- Vale's plan to separate its base metals operation from its iron ore unit is generating significant anticipation, especially in the context of the accelerating trend toward EVs.
- Below, I will analyze the asset portfolio of Vale Base Metals in order to provide insights into its risk-reward profile.
- Interested investors may consider gaining exposure to Vale Base Metals through Vale S.A., which currently pays dividends yielding 7.76%.
As we learned from Vale S.A. 's ( VALE ) 2022 Investor Day , the mining giant intends to separate its nickel and copper business from its iron ore operations by forming a new entity called Vale Base Metals. While an initial public offering of Vale Base Metals is currently not planned, a 10% stake will be sold to a partner.
Considering the inaccessibility of Norilsk Nickel ( OTC:NILSY ) to investors and the projected increase in demand for base metals in the electric vehicle industry, investors seeking pure-play exposure to base metals probably anticipate an opportunity to invest in Vale Base Metals once it becomes publicly available. Let's explore this prospect further below.
An Overview of Vale's Energy Transition Metals Operations
In addition to its extensive iron ore operations, Vale S.A. holds the position as the world's largest producer of nickel, as well as a significant producer of copper and PGM (platinum group metals). Vale owns various nickel mines, including sulfide nickel mines Sudbury, Thompson, and Voisey's Bay in Canada, laterite nickel mines PTVI and Onça Puma in Indonesia and Brazil, as well as the Sossego and Salobo iron oxide-copper-gold (IOCG) mines in Brazil. Additionally, Vale is involved in two pre-production projects, namely the Alemao IOCG deposit in Brazil and the Hu'u porphyry copper-gold deposit in Indonesia, both currently undergoing pre-feasibility studies. These details are presented in Table 1.
Table 1. Base metals projects of Vale S.A. (Laurentian Research for The Natural Resources Hub based on Vale financial reports)
In 2022, Vale generated $43.8 billion in revenue from its continuing operations. Out of the total revenue, approximately 79.6% came from its iron ore operations, while 19.2% was attributed to the Energy Transition Metals segment or the base metal operations. This breakdown is depicted in Figure 1.
Fig. 1. Revenue contribution of business segments of Vale S.A. (Laurentian Research for The Natural Resources Hub based on Vale financial reports)
The revenue contribution from the base metal operations has experienced a decline since the mid-2010s, despite the significant improvement in metal prices during that period, as depicted in Figure 2. One of the factors contributing to the decrease in revenue from the Energy Transition Metals segment is the shut-down of various mines including Frood in end-2012 and Stobie in 2018 and resultant decline in production since 2017, as illustrated in Figure 3.
Fig. 2. Implied revenue per tonne of nickel equivalent (Laurentian Research for The Natural Resources Hub based on Vale financial reports) Fig. 3. Metal production of the Energy Transition Metals segment of Vale S.A., in NiEq (Laurentian Research for The Natural Resources Hub based on Vale financial reports)
Despite the recent decline in base metal production, Vale has ambitious plans to reverse the downtrend and achieve significant growth in its base metal operations in the coming years. The company expects nickel production to reach 230-245 ktpa in the medium term and exceed 300 ktpa starting in 2030. Additionally, Vale anticipates a tripling of copper production from current levels to approximately 900 ktpa by 2030, as illustrated in Figure 3.
Rationale Behind Separating the Energy Transition Metals Unit
In order to realize the ambitious vision mentioned above, the Energy Transition Metals segment would need to compete with the vast iron ore operations for capital if it remains a part of Vale. The primary reason for separating the base metals and iron ore operations, I believe, is to position the base metals for aggressive capital investment in the coming years.
The base metals segment achieved $2,493 million in adjusted EBITDA in 2022. Based on Vale S.A.'s EV/EBITDA multiple as of June 9, 2023 (4.65X), the market valuation of the base metals unit stands at $11.6 billion. However, Vale already received binding offers for a 10% stake in its base metals unit, valued at $2.5 billion. If Teck Resources ( TECK ), the Canadian mining company, successfully sells its metallurgical coal business to Glencore Plc ( OTCPK:GLCNF ), it may even bid for Vale's entire base metals unit, given its potential bloated wallet. These offers indicate a potential valuation of the base metals operations at approximately $25 billion, implying an EV/EBITDA multiple of 10.0X. Consequently, separating the base metal operations in preparation for a future IPO could potentially unlock around $13.4 billion of hidden value that is currently unrecognized by the market.
Additionally, as an independent entity, Vale Base Metals will no longer be associated with environmental disasters including the Samarco dam disaster (2015) and Brumadinho dam disaster (2019). Furthermore, Vale Base Metals will have a well-diversified jurisdictional footprint, with operations in Canada, Brazil, and Indonesia.
What now?
Investors who are considering waiting for the IPO of Vale Base Metals should be aware of the assets they will be exposed to. Firstly, they will acquire a portfolio of depleting mines, which have experienced a decline in production since 2017 and may continue to do so (see Figure 3). Secondly, while Vale has plans to reverse the production decline in response to the expected increase in demand for nickel and copper, there are limited options available, particularly for meaningfully-sized nickel sulfide projects. The copper development projects, Alemão and Hu'u, are still several years away from production. Thirdly, achieving the company's ambitious goals will require substantial capital investment. While the sale of a 10% stake in the base metals unit will provide $2.5 billion in cash, it is likely that a significant amount of debt will be added to the balance sheet. Consequently, concerns about the quality of the balance sheet may arise.
Investors who are not deterred by the aforementioned precautions may consider entering into Vale Base Metals by investing in Vale S.A. now (Figure 4). Currently, Vale trades at an attractive valuation with an EV/EBITDA multiple of 4.65X and a price/cash flow multiple of 5.0X, both on a trailing twelve-month basis. The separation of the base metals unit could potentially unlock hidden value amounting to $13.4 billion, representing an implied upside of 22% above the current market cap. The company also offers variable dividends , which currently yield 7.76% and are well covered, with a payout ratio of 31%. This means that investors receive dividends that outpace inflation while waiting for Vale to prepare the base metals operation for public listing.
Fig. 4. Stock chart of Vale S.A., dividends back-adjusted, in comparison with iron ore 62% Fe CFR spot price (modified from Barchart and Seeking Alpha)
For further details see:
Vale In The Age Of EVs: Separating The Base Metal Business Could Unleash Tremendous Upside