Vale Is Staring At A Q4 Loss On Impairments And Additional Tax Charges
Vale (NYSE:VALE) seems all but certain to report a loss in the fourth quarter of the ongoing financial year. The company has suffered two major setbacks in the last few days. Firstly, it announced that it will book a $4.2 billion fourth-quarter pretax charge after lowering the valuation of a nickel mine and its stake in aluminum producer Norsk Hydro ASA. Also, last week the company announced tax losses of nearly $483 million relating to cases in Brazil and Switzerland. Of this, $451 million will be booked in the balance sheet for Q4 and the rest of the amount will be adjusted in the next financial year. [1]
These two setbacks are only recent additions to a long list. Tumbling iron ore prices on a weak demand outlook, failure to begin docking Valemax ships in China due to permission issues, and the shelving of the Simandou project in Guinea due to an uncertain and adverse operating environment are some issues which have been highlighted frequently in the past. The company has been forced to contract its capital expenditure plans for next year and announce sale of non-core assets in order to reduce costs and improve efficiency. However, any gains due to these are certain to be negated due to the latest charges as far as earnings are concerned. [2]
See Full Analysis of Vale Here
What Is The Reason For A Writedown In The Nickel Business?
Vale will take a $2.85 billion pretax writedown on its Brazilian nickel project Onca Puma. The problems in its nickel business have been festering for some time.
As reported in its third quarter earnings results, lackluster performance of the nickel segment has been one of the largest drags on profit. Vale has been trying to diversify away from iron ore 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 the last few 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. [3]
Finally, operations stopped at Onco Puma and prices for nickel declined. The writedown on account of the nickel business was therefore inevitable.
Why An Impairment In The Aluminum Business?
In addition to nickel, Vale also said that it will recognize a $1.3 billion pretax impairment on its 22% stake in Oslo-based Norsk Hydro, an aluminum producer. The company blamed the impairment on downward volatility in aluminum prices and macroeconomic uncertainties in the European economy. The rating agency Moody’s cited more or less the same reasons when last week it placed Alcoa‘s (NYSE:AA) rating on review for a potential downgrade. ((Alcoa May Be Cut to Junk by Moody’s on Lower Aluminum, Bloomberg))
We think that aluminum prices are probably being driven not by fundamentals but investor sentiment and macroeconomic factors such as the Euro zone crisis, worries over mounting U.S. debt and the hotly debated fiscal cliff situation, and the slowdown in China. Fundamentals alone cannot explain the volatility that has been observed in aluminum prices this year. In any case, there isn’t much Vale can do about its aluminum business. In an environment of slow economic growth, it would be a stretch to expect aluminum prices to trend upwards in the near future because it is primarily an industrial metal. ((LME Aluminum Price Graph, LME))
In addition to these impairment charges, Vale announced the settlement of two major tax disputes, at a considerably higher cost than originally envisaged. It settled a dispute with Swiss tax authorities over differences in interpretation of the federal tax breaks granted to Vale’s international business in 2006 and the consequent tax liability figure. While the company had already set aside $37 million for the Swiss claim, it said it would now have to pay $232 million, which is almost six times that amount. [4]
Vale settled another tax dispute over unpaid sales taxes in the state of Minas Gerais, Brazil’s traditional mining hub. Here also, while Vale had provisioned $64 million for the case, its eventual liability would actually be five times higher at $317 million.
What Now?
This is not even the end of story. Vale said on December 6 that it will make impairment announcements in two stages. A second writedown worth around $50-$100 million on several different assets is expected to be announced with the release of the company’s 2012 results. Vale is also contesting claims that it must pay as much as $14 billion (roughly 30 billion Brazilian reals) in back taxes on overseas earnings that were already taxed locally in those countries. The case is currently being reviewed by Brazil’s Supreme Court and represents a mind-boggling potential financial liability.
Net income last quarter was $1.67 billion and the macroeconomic factors that caused the steep 66% year-over-year decline in profits remain largely unchanged this quarter. Thus, it’s more or less a foregone conclusion that the company will report a steep loss this quarter. What will certainly be distressing for Vale management is the fact that the assets that the company is looking to sell will probably have to be used to compensate for these one-time losses. This will leave less resources for investment in capital projects next year which may have bearing on future growth. One of the assets being considered for sale is the company’s stake in Norsk Hydro itself. The recent writedown may fetch a much lower valuation now. [5]
We have a Trefis price estimate for Vale of $20 after the third quarter earnings results.
Understand How a Company’s Products Impact its Stock at Trefis
Notes:- Vale to Book $4.2 Billion Charge for Nickel, Aluminum Assets, Bloomberg [↩]
- Is There No End To Vale’s Woes?, Trefis [↩]
- Facing The Challenges, Vale Press Release [↩]
- For Vale, the taxman cometh, Financial Times [↩]
- Vale’s Profits Fall Due To Low Iron Prices, Trefis [↩]