Vale (NYSE:VALE) announced its third quarter earnings on October 24, 2012. It reported a 66% fall in profits year-over-year. Net income this quarter was $1.67 billion, compared with $4.94 billion in the comparable period last year. As per our expectations, tumbling iron ore prices were responsible for the steep fall in profits. Profits were also hit by Vale’s decision to set aside $542 million for the possible payment of back royalties in a dispute with Brazil’s government. Net revenues stood at $10.7 billion, a decrease of 34% year-over-year. Iron ore, which accounts for nearly 90% of Vale’s profits, averaged nearly $112 per tonne this quarter, which is 36% less than the price prevailing about a year back. On September 5 this year, the price of iron ore touched a three-year low of $86.70 a tonne. 
The company released its production report for the quarter a few days back. It reported iron ore production of 83.9 million tonnes, which is 4.6% lower on a year-over-year basis. Production at its Carajas iron-ore mine, the world’s largest, dropped almost 11% year-over-year to 27.6 million tonnes in the third quarter. The suspension of projects, asset sales worth $1.2 billion, and a reduction in output of premium pellet products due to decreased demand from Europe and China reduced its share of the global sea-borne iron-ore market. The quality of the ore produced this quarter also emerged as a worrying factor. Vale attributed it to environmental licensing issues. 
In view of the weak earnings, Vale has decided to delay some projects and is considering the sale of some assets. As per our expectations, lower iron ore prices were responsible for the steep fall in profits. This quarter’s results are the worst for the company in nearly three years.
Low Prices And Production Reduction Have Hurt
As a result of economic conditions in the Eurozone and a slowdown in demand from China, iron ore is trading at significantly lower prices than in the corresponding quarter last year. In addition, copper and nickel, by virtue of their heavy industrial usage, have yet to recover to 2011 levels.
Vale’s iron-ore production declined by 2.2% in the first nine months of 2012 to 234.5 million metric tonnes. In the same period, rivals Rio Tinto and BHP Billiton grew their output by 4%-5% and 9.5%, respectively. While Rio Tinto’s quarterly iron-ore production rose to 52.6 million metric tonnes, BHP’s output stood at 39.8 million tonnes. Vale’s output of pellets, a processed form of iron ore used by steelmakers, rose by 2.1% to reach 14.5 million tonnes this quarter. The production of nickel declined by 16% to 49,000 tonnes, copper production dropped 20% to 68,000 tonnes, coal production increased by 91% to 1.73 million tonnes and that of potash fell by 15% to 141,000 tonnes.
Production problems were compounded by a lackluster performance of the nickel segment, which has been one of the largest drags on profit. Vale has been trying to diversify and hopes that nickel would reduce its dependence on iron ore. However, it has had little to show for its $10 billion investment in the business so far. In recent months, Vale’s nickel mines in Canada have suffered shutdowns. Its Goro nickel-and-cobalt mine on the French Pacific island of New Caledonia, and Onca Puma, in Brazil’s Amazon, are producing far below expected levels because of processing problems. The Goro mine, which was supposed to produce 60,000 tonnes of nickel a year, failed to produce any nickel or cobalt in the third quarter. However, Vale claimed that there will be no impact on the production of finished nickel as mine output losses will be offset by higher production in Sorowako. 
Vale has also been hit by higher costs and declining output as delays in obtaining environmental licenses have hobbled the development of the company’s ore reserves. Licensing issues have forced the company to continue producing from its older, less productive pits such as those in Carajas. The company has admitted that it is suffering from depletion in quality across its Brazilian ore deposits. The problems have been compounded by production delays caused due to heavy rains. 
Vale is now looking at selling assets which do not add value in order to improve allocation of capital and free up funds. It says that this is required in order to finance world class investments. These include high-quality reserves such as those at its $19.5 billion Serra Sul project in Brazil which is expected to contain 90 million tonnes of iron. It is also keen to focus on its massive Moatize coal project in Mozambique.
The biggest setback would probably be Vale’s decision to put its investments at Simandou in Guinea on hold. Reserves here contain one of the highest-quality untapped iron ore resources in the world. The company has been unable to tap these so far due to difficulties it is currently facing with Guinea’s operating environment. Output from the $1.3 billion Zogota mine at Simandou was scheduled to begin by year end, but now the project has been put on hold indefinitely. This decision will save Vale $131 million in 2012.
In view of these announcements, you can project your own iron ore shipment figures for Vale by using our interactive graph below:
Amid all the gloom this quarter, there was a silver lining to the dark clouds. The company received permission to dock its giant Valemax ships at a port in China. These ships were built to enable Vale to compete effectively with rivals Rio Tinto and BHP Billiton. Rio and BHP currently enjoy a cost advantage due to the geographical proximity of their Australian operations to China compared to Vale’s Brazilian operations. Valemax ships will reduce the company’s shipment costs. The bad news here is that it will take the Ningbo-Zoushan port two to three years to be ready to receive Valemax ships, so any benefits will accrue only in the long term.
Vale’s iron ore business constitutes 64% of its Trefis price estimate.
We currently have a Trefis price estimate for Vale of $19, which we shall be revising in light of the latest earnings results.Notes:
- UPDATE 3-Brazil’s Vale Q3 net falls 66 pct; Guinea mine on hold, Reuters [↩]
- Vale Losing to Rio Tinto as Iron Output Drops: Corporate Brazil, Bloomberg [↩]
- Facing The Challenges, Vale Press Release [↩]
- Brazil Miner Vale Quarterly Profit May Stumble on Ore Prices, Fox Business [↩]