Vale’s Earnings Will Contend With Weak Iron Ore Prices
Vale (NYSE:VALE), the world’s largest iron ore mining company, will announce its first quarter earnings results on Wednesday, April 24. We expect low iron ore prices to have a significantly negative impact on its year-over-year earnings since iron ore constitutes the majority of its business. The production figures for the quarter were largely along expected lines, and the company has maintained its full year guidance for the most part.
The company announced mothballing of its $6 billion potash project in Argentina after negotiations with the government over tax breaks failed. It issued a statement saying that the economics of the project are not in line with its current commitment to discipline in capital allocation and value creation. ((Vale Shelves Potash Venture in Argentina to Preserve Cash, Bloomberg))
Vale also refused to make any further payments to Beny Steinmetz Group Resources (BSGR), its partner in the Simandou iron-ore project in Guinea. The company is supposed to pay a total of $2.5 billion for its acquisition of a 51% stake in the project from BSGR. Vale has paid $500 million thus far and is refusing to pay the remaining amount for now, arguing that payment should be based on how far the project advances. Vale put Simandou on hold in October and the latest row could create further delays if not resolved amicably. You can read more about the row in an earlier Trefis article here.
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Production In Q1
The production of iron ore this quarter stood at 67.5 million tonnes, a 3.5% drop from the Q1 2012 figure of 69.9 million tonnes. The decline was due to constraints related to permits and other operational issues. The production was 21% lower on a sequential basis as the figure reported in Q4 2012 was 85.4 million tonnes. This is along expected lines, since Vale’s production in the first quarter every year is impacted by the rainy season.
Iron pellet production stood at 11.7 million tonnes, 11.7% below the comparable production figure last year. The decline reflected the shutdown of the Tubarao I and II and Sao Luis pellet plants to accommodate the weaker global demand for blast furnace pellets.
The production of coal rose by 16.6% compared to the Q1 2012 figure of 1.5 million tonnes due to improved operations at its Australian mines, which offset the 16.8% production decline at Moatize in Mozambique due to heavy rainfall.
Total finished nickel production in the quarter was 65,000 tonnes, 1.7% higher sequentially and 3% higher year-over-year. Improved operational reliability in Canada and the ramp-up of VNC more than offset the effect of the production loss from Onça Puma and the maintenance shutdown of a furnace at Sorowako. [1]
Iron Ore Prices
Given the lower iron ore prices this year, we expect the company to post lower year-over-year revenues and profits. [2]
As expected, this year began on a positive note for iron ore miners. The price of iron ore continued to rise in January and February from the previous quarter due to the restocking being carried out by Chinese steel mills. However, once the restocking was done by the end of February, prices began falling. The Chinese government then came out with stringent rules to curb the housing market which appeared to be in a bubble. This reduced the demand for steel, in turn impacting the demand for iron ore.
China is the world’s biggest consumer of commodities and its economic growth data for the first quarter was below expectations. It reported a Gross Domestic Product (GDP) growth rate of 7.7% in Q1 2013, which was much lower than market estimates and the previous quarter’s figure of 7.9%. This belied the belief that the Chinese growth rate had bottomed out last quarter and would only go up in the future. As a result, the prices of nearly all major commodities, including iron ore, took a beating.
Going forward, the growing role of scrap in Chinese steel production and increasing investment in Chinese domestic iron ore production will keep demand growth in check. [3]
Iron ore miners are in for a double whammy as supplies are expected to surge over the next few years. According to the Bureau of Resource and Energy Economics (BREE), the official Australian commodities forecasting agency, iron ore prices will decline going forward and reach its lowest levels around 2018. This is due to a lot of additional production capacity scheduled to come online in this period and a non-commensurate expected rise in demand. Beyond 2018, the balance between demand and supply is likely to be more even. ((Australia predicts fall in iron ore price, Financial Times))
Rio Colorado Potash Project Mothballed
Vale had been seeking tax breaks for the project to help compensate for soaring costs related to inflation and exchange rates. Without tax breaks, the project’s costs could have soared by 86% to $11 billion. The government is now looking for another player to take over the project.
Unofficial estimates measured inflation in Argentina at about 25% a year, well above the official rate of 10.8% in 2012. This might well be true since private economists have long discredited the quality of official Argentine data and even the International Monetary Fund (IMF) has censured the country for the same. [4]
Mothballing will not have a significant impact on Vale’s financials. The company’s revenues from the potash business are a relatively minor percentage of its overall revenues. Even with the Rio Colorado project, potash revenues would not be a significant valuation driver for Vale.
We have a Trefis price estimate for Vale of $20, which will be revised after the earnings results.
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Notes:- Vale Q1 Production Report, Vale Press Release [↩]
- Iron Ore Spot Price Chart, YCharts [↩]
- The best laid plans of miners and men, Financial Times [↩]
- Argentina Says Inflation at 11.1%, Economists Say It’s 26%, NASDAQ [↩]