Vale Sells Stake In Logistics Firm As Part Of Divestment Program

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Vale (NYSE:VALE) has struck deals to sell a 36% stake in its logistics unit VLI, a 100% subsidiary, to Japan’s Mitsui & Company Ltd. and Brazil’s worker compensation and retirement fund FGTS. While Mitsui will pay $667 million for a 20% stake, FGTS will pay nearly $573 million for a 15.9% stake. [1]

Vale is also in discussion with Brookfield Asset Management to sell a further 26% stake in VLI. While the concluded deals with Mitsui and FGTS will bring Vale’s stake in VLI to 64.1%, a potential deal with Brookfield will bring it down to nearly 38%. Even with less than a 40% stake, Vale will retain management control of VLI.

VLI has significant concessions for operating railroads and also owns port infrastructure and warehouses. Its integrated logistics system enable it to transport cargo for more than 100 clients across the length and breadth of the country. Vale’s decision to reduce its stake in VLI is part of its strategy to get rid of non-core assets in order to reduce future capital expenditure on them and instead concentrate on its core operations. Weak iron prices have dented the company’s results in the last few quarters. [2]

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VLI’s Operations

VLI provides integrated logistics solutions to clients through 10,540 kilometers of railroads, four inland terminals with a total storage capacity of 220,000 tonnes and three maritime terminals and ports operations. While VLI itself owns the concessions and sub-concessions for railroads, it also has access to Vale’s rail concessions. It also has a rolling stock of 13,000 rail cars and 600 locomotives. The cargo carried generally includes grains, fertilizers and steel materials and products. Vale’s own output of iron ore and other minerals is not handled by VLI. [3]

The Opportunity For VLI

It is expected that cargo volume for grains, fertilizers and steel products will increase in Brazil going forward. The country has a lot of land and can easily meet the growth in global demand for food as world population increases and countries with a paucity of arable land are forced to import. Also, a number of infrastructure investment projects are being carried out by the Brazilian government which require huge quantities of steel. The country’s transport infrastructure is creaking and will require the development of new railroads to ease pressure on the road network.

VLI plans to double its cargo handling capacity by investing approximately $3.8 billion over the next 5 years in locomotives, wagons, rail network and port terminal capacity. While part of the capital expense is to be met by using operating cash flow and debt, about $820 million will be financed by capital increase. Thus, while there is immense future opportunity in cargo transportation, it will also require further capital investment to develop the capacity to handle more cargo. [4]

Why Vale Is Selling Stake

In Q2 2013, Vale reported a net quarterly profit of $424 million compared with a profit of $2.64 billion in Q2 2012. The previous year’s results included $1.24 billion in the reversal of deferred income tax while this year net income plunged due to a surprise $2.78 billion hit from foreign exchange losses on currency derivatives and debt. The Brazilian currency real depreciated significantly against the U.S. dollar. Excluding these items, net profit stood at $3.24 billion. Net operating revenue fell to $11.03 billion from $12.47 billion in the previous year’s comparable quarter, mainly due to lower iron ore prices. [5]

Vale is looking to cut down on capital expenditure on non-core businesses in face of challenging market conditions for iron ore. Hence, selling a stake in VLI is a prudent move by the company to bring in equity partners to share its burden. In its 2012 annual report, Vale had expressed its desire to bring in equity partners in VLI to fund its capital requirements. Therefore, the deals aren’t surprising for the market. [6]

The Future Course

Vale will retain management control of VLI even if its stake falls to less than 40%. In recent years, the Brazilian government has pushed Vale to set up and maintain freight operations, even as its own efforts in the area have faltered due to high costs, bureaucratic obstacles and political conditions. Therefore, the stake sale in VLI will reduce Vale’s burden to some extent. Vale is even considering a public listing for VLI going forward, which will help it raise more money and reduce its own commitment. We think it would allow Vale to better compete with global mining rivals like Rio Tinto and BHP Billiton, which are also reducing non-core assets to focus on their bread-and-butter iron ore business.

Mitsui is already engaged in locomotive leasing and logistics management and maintenance services in Brazil. It also has an existing strategic alliance agreement with Vale and wants to further develop its business in Brazil. The FTGS is already used by the Brazilian government to make loans at below market rates for public-interest projects. Hence, funding for future expansion should not be an issue at all. ((Mitsui & Co Ltd : Mitsui to participate in Integrated Logistics Business in Brazil, 4-traders.com))

We have a Trefis price estimate for Vale of $17.

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Notes:
  1. UPDATE 2-Vale to sell control of VLI unit to Mitsui, Brookfield, Reuters []
  2. Vale to sell logistics unit stake to Mitsui, Financial Times []
  3. Vale To Sell Stakes In VLI Logistics Unit For $1.24 Billion, RTT News []
  4. Vale Sale of $1.5 Billion Cargo Unit to Help Shares, Itau Says, Bloomberg []
  5. Vale Q2 2013 Earnings Release, Vale Media Release []
  6. Vale 2012 20-F, SEC []