Vale (NYSE:VALE) announced its fourth quarter and annual earnings results on February 27. It reported a net quarterly loss of $2.65 billion after writing down the value of some nickel, coal and steel assets, compared with profit of $4.67 billion in the comparable period in 2011. Net profit for the full year stood at $5.5 billion compared to $22.9 billion in 2011. 
The main reasons for the poor performance in the fourth quarter and the whole of 2012 were low prices of iron ore and substantial non-cash non-recurring charges of $5.7 billion incurred by the company. These include a $5.2 billion write-down of nickel, coal and aluminum assets, a $232 million charge to settle a tax dispute with Switzerland and a $254 million charge for back tax payments to Brazil’s Minas Gerais state. Operating revenues in Q4 2012 slid 19% to $12 billion as prices for iron ore and other products fell short of Q4 2011 levels.
While iron ore production in the fourth quarter grew year-over-year, it wasn’t sufficient to offset the overall decline in production. Production in 2012 stood at 320 metric tonnes, a 0.8% year-over-year decline. The slight production decline was mainly due to abnormally heavy rainfall in the Brazilian states of Minas Gerais, Rio de Janeiro and Espirito Santo, which seriously constrained mining and logistics activity. With average iron ore prices in 2012 being much lower than the previous year, there was an overall decline in revenues. 
Low Prices And Production Reduction Hurt Revenues
As a result of economic conditions in the Eurozone and a slowdown in demand from China, iron ore traded at significantly lower prices for much of 2012. Average realized price in 2012 at $97 per tonne was much lower than the price of $136 per tonne the previous year.
While Vale’s iron ore production showed a 0.8% year-over-year decline to reach 320 million tonnes, rival Rio Tinto increased its output by 3.7% to 199 million tonnes. Vale’s lead over Rio Tinto thus narrowed to 121 million tons, the smallest in three years. Not just that, Vale forecasts a further drop in iron ore production for 2013. Excluding its stake in a joint venture with BHP Billiton, it expects iron ore production to stand at 306 million tonnes. On the other hand, Rio expects to produce 290 million tonnes next year, a 21% expansion in production from current levels. The expected production decline this year is largely due to aging of some of the companies’ mines in southeastern Brazil. 
Production of nickel declined from 242 million tonnes to 237 million tonnes and that of copper from 302 million tonnes to 292 million tonnes. Production of these two metals was affected mainly by a longer-than-expected temporary suspension of mining operations in Sudbury during the first quarter.
Total coal shipments were 7.9 million tonnes in 2012, an increase of 4.2% from 7.7 million tonnes in 2011, mostly due to the large increase of 2.5 million tonnes in metallurgical coal volumes, driven by the ramp-up of Moatize, in Mozambique. The drop in thermal coal volumes by 2.2 million tonnes was caused by the sale of thermal coal assets in Colombia. Despite a huge ramp-up in the volume of higher priced metallurgical coal, revenues from coal increased only marginally to $1.09 billion from $1.05 billion in 2011. This can be attributed to a steep fall in prices of metallurgical coal from $235 per tonne in 2011 to $171 per tonne in 2012.
Impairments And Additional Tax Charges
Vale took a $2.85 billion pretax writedown on its Brazilian nickel project Onca Puma, which had been producing far below expected levels due to processing problems. The operations here finally had to be shut down temporarily after problems were detected in the furnaces.
In addition to nickel, Vale also recognized a $1.3 billion pretax impairment on its 20% 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.
What came as a surprise was the $1.03 billion impairment on the Australian coal business due to the lower-than-expected price of coal last year.
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.
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.
The company has slashed its investment spending target for 2013 to $16.3 billion, the lowest level in three years. We expect the company to be in consolidation mode for sometime and even get rid of some its non-core assets to finance its expenditure programs. 
We have a Trefis price estimate for Vale of $20, which we will revise soon to incorporate the fourth quarter earnings results.Notes: