2023-04-25 09:00:00 ET
Summary
- Vale is the world's largest iron ore miner, with increasing exposure to materials critical in the global energy transition.
- While cyclical headwinds persist, the company is in a good position to benefit from massive secular tailwinds in both iron ore and critical minerals.
- The company is already attractively valued and poised to move much higher the moment economic demand expectations bottom.
Introduction
It's time to talk about Brazil's largest mining company, the iron ore giant Vale S.A. (VALE) . In a recent article covering Anglo-Australian miner Rio Tinto ( RIO ), I got a lot of comments from people who didn't feel like buying a stock with high iron ore exposure. After all, when betting on accelerating mining demand related to net zero, investors want copper and rare earth exposure.
In this article, we'll dive into Vale, one of the largest companies tied to global steel production. This fascinating company is currently suffering from falling iron ore prices as pressure from cyclical demand weakness is mounting. While that's bearish for the time being, the company is in a great spot to recover well beyond its prior highs thanks to secular demand growth for high-quality iron ore and its related exposure to the energy transition.
In addition, the government of Brazil is progressively collaborating with China, which is the biggest purchaser of iron ore globally and a country that is actively seeking ways to decrease pollution caused by steel production.
So, let's get to it!
The World Needs Vale
Vale is the world's largest iron ore and nickel producer. It runs the Carajás mine, which is the largest mine in the world.
In 2022, roughly 80% of its revenue came from steel solutions. The remaining sales came from its Energy Transition Materials segment, which includes its nickel operations.
While iron ore isn't as rare as copper or other metals related to the energy transition, it's still a commodity that is expected to do tremendously well over the next few decades.
The company estimates that up to 200 million people will migrate from rural areas to urban areas in China. The steel penetration rate for housing in China is expected to rise from just 0.8% in 2018 to 6.0% by 2025. Growth in India is expected to be even stronger. Some experts have told me that India is reminding them of China in the 1990s. Hence, it's no surprise that Vale expects steel production to double in that region over the next few years.
On top of this, Brazil's President Lula is working closely with China , as China knows it needs Brazil as a strong trading partner for agriculture and industrial commodities. This South American nation currently supplies both.
China overtook the U.S. in 2009 as Brazil’s biggest trading partner, as the Latin American nation became the go-to supplier to feed the Asian nation’s rapidly-growing population and factories.
Brazilian exports to China totaled some $89.7 billion last year, of which 36% was soybeans, 20% iron ore and 18% crude oil, according to government data.
On top of that, and as seen in the PowerPoint slide above, steel plays a huge role in the energy transition. Vale estimates that by 2030 2030, annual demand for blast furnace feedstock will rise by 70 million tonnes. That number is 100 million tonnes for cleaner direct reduction production.
Furthermore, by 2030, more than 400 million tonnes of depleted iron ore capacity will have to be replaced.
These factors are expected to provide a healthy tailwind for high-quality iron ore demand and pricing.
The slide below further reinforces this.
According to the company :
We are seeing unprecedented opportunities for segmentation and demand growth for high-quality products. Quality is key for the decarbonization of steelmaking and a game-changing transformation for the high-quality suppliers like Vale. There is no other company like Vale, which combines volume and quality, innovative products and supply chain to deliver the decarbonization solutions that the steel industry needs.
Our iron solution strategy is designed precisely for this purpose. With those differentiators, we are a partner of choice for our clients. We are establishing partnership with steel mills to find new solutions to decarbonize the industry. We have signed with clients, representing almost 50% of our Scope 3 emissions.
Furthermore, the company announced that it is projecting higher average iron content in its iron ore portfolio starting this year. This is expected to result in a higher quality premium on prices, as each one percentage point increase in average iron content corresponds to around $550 million of incremental EBITDA.
In light of these estimates, the commissioning of higher production in the S11D and the Gelado project, along with increasing concentration processes, will help achieve a mix of higher growth, higher product quality, and better prices. Vale is also about to start up their first green briquette plant in the first half of 2023, with 6 million tonnes of production capacity as originally planned.
With regard to its energy transition material business, Vale believes it has the right assets in the right jurisdictions to deliver high-quality products to its customers.
Vale entered into strategic nickel supply agreements with Northvolt and General Motors ( GM ), in addition to a Memorandum of Understanding for nickel processing between PTVI, Huayou, and Ford Motor Company. Vale is developing a first-of-its-kind plant in Canada and North America to produce nickel sulfate from high-period low-carbon nickel from their Canadian refineries. Nickel production was boosted by 6% in 2022, and Vale is building client engagement and the supply chain to take them to the leadership of sustainable mining in the critical minerals world. That doesn't just sound ambitious, but I believe Vale has the tools to get it done.
With regard to copper, production declined by 15% in 2022 due to extended maintenance, but with maintenance completion and the startup of Salobo III, Vale's copper production is expected to grow significantly this year.
Related to this, Bloomberg reported this month that Vale is looking to expand its copper operations.
The mining giant has at least two very early-stage projects ongoing in the exploration stage after abandoning a third one in a copper-rich corner of southern Peru, the world’s second-largest producer. The two greenfield copper projects require a combined investment of $7 million, Peru’s Energy and Mines Ministry mineral exploration portfolio showed.
This move is likely going to help Vale grow its non-iron ore business, which it is looking to spin off at some point .
This Uptrend Isn't Happening Without Headwinds
So far, we have found a lot of good news for the company's future:
- Global steel production is expected to rise, driven by rapid demand in Southeast Asia.
- The demand for high-quality iron ore is expected to far outpace the demand for lower-quality iron ore.
- Rare earth metals are expected to be an increasingly big part of Vale's business.
Yet, VALE shares are 38% below their 2021 highs and down 16% year-to-date.
FINVIZ
The reason is cyclical. As good as the long-term (high-quality) iron ore bull case might look, the global economy isn't doing so well right now.
This is hurting iron ore demand. The chart below compares the VALE stock price to COMEX 62% iron ore futures.
TradingView (VALE vs. COMEX TIO)
As long as global manufacturing indices continue to decline, we can assume that cyclical demand will pressure iron ore futures.
As reported by Mining.com and according to Yu Chen, an analyst at consultancy Mysteel, the weaker-than-expected buying interest of Chinese mills in spot iron ore cargoes ahead of the upcoming holiday is causing a drop in spot prices and putting pressure on futures markets.
Inventories at 45 major Chinese ports rose by 1.23 million tonnes, or 1%, to 130.35 million tonnes in the week ending April 21. Pei Hao, an analyst at international brokerage firm FIS, made the case that the fall in iron ore prices was caused by several negative factors, including a worse-than-expected 19.2% year-on-year fall in new housing starts and sufficient supply from the top three suppliers.
According to Trading Economics :
Average new home prices in China's 70 major cities dropped by 0.8 percent year-on-year in March 2023, after a 1.2 percent fall in the previous month. This was the 11th straight month of decrease in new home prices but the softest pace since June 2022, amid efforts from Beijing since last year to speed up policy measures to support a recovery of the ailing property sector.
TradingEconomics (China Newly Built House Prices YoY Change)
So, what about the valuation?
Valuation
Vale has an enterprise value of roughly $72.6 billion, based on its $66.0 billion market cap and $6.6 billion in 2023E net debt.
This is roughly 3.3x 2023E EBITDA of $21.8 billion.
The company is expected to generate $7.8 billion in free cash flow this year, followed by a surge to $8.2 billion in 2024. Needless to say, these numbers are dependent on commodity prices and final customer demand. However, for now, we're dealing with a price/free cash flow ratio of 8.5x.
Both these valuation metrics are attractive, especially if considering that Vale boosted its CapEx by almost $1 billion since 2021.
Moreover, the company has a BBB-rated balance sheet and a net leverage ratio of less than 0.4x EBITDA.
With that said, I believe that VALE has room to fall to $12 per share if the global economy continues to cool. At that point, I consider the risk/reward for long-term investments to be highly favorable.
My long-term target is $30 per share, based on a considerable recovery in high-quality iron ore demand, the company's progress in the non-iron ore segment, and the increasingly important role of Brazil in the China-led alliance of emerging markets that seems to be causing significant geopolitical issues.
Upcoming Earnings
On April 26, Vale is expected to report its earnings. The consensus EPS forecast is $0.55, which comes with a wide expectations range. This result would be a multi-year low, as cyclical headwinds pressure the short-term performance of the company.
Moreover, according to Nasdaq data, the company has not received any downside revisions over the past four weeks.
I believe that VALE could beat estimates, as I expect some underestimated tailwinds related to the Chinese economic reopening despite the fact that iron ore is weakening.
However, even if Vale were to rise after earnings, I wouldn't be a buyer until shares come close to $12.
Takeaway
In this article, we discussed Brazilian iron ore giant Vale. The company is currently facing tremendous headwinds related to cyclical economic weakness, which could push shares lower to $12.
At those levels, I'm interested in buying Vale as I believe that the company benefits from a number of tailwinds, including long-term growth in iron ore, outperforming growth in high-quality iron ore, Brazil's improving ties with China and its emerging market peers, Vale's progress in expanding its energy transition business, its attractive valuation, and healthy balance sheet.
In conclusion, despite the current economic challenges faced by Vale, the company's long-term growth prospects and positive developments in key areas make it an attractive long-term investment opportunity that I would prefer to add as soon as the market prices in more short-term growth headwinds.
For further details see:
Vale: The Correction Before The Surge