Vale (NYSE:VALE) announced its third quarter results on November 6 and held the earnings conference call on November 7. It reported a net quarterly profit of $3.5 billion compared with a profit of $1.64 billion in Q3 2012. Net operating revenue rose to $12.7 billion from $11.4 billion in the previous year’s comparable quarter, mainly due to higher iron ore prices. Profits rose due to higher prices and lower costs. 
Iron ore production stood at 85.9 million tonnes, which was 2.3% higher than the 83.9 million tonnes produced in Q3 2012. For the first nine months of this year, the production stood at 226.7 million tonnes, about 3% less than the 234.5 million tonnes produced in the comparable period last year.
We have a Trefis price estimate for Vale of $17, which is nearly the same as the current market price. We will update our price estimate shortly since the third quarter earnings results are now out.
Operational Performance In Q3
As expected, Vale benefited from higher iron ore prices in the third quarter. It also managed to reduce sales, general and administrative expenses by 39% to $315 million. Despite higher output and sales, Vale’s cost of goods sold fell by 3.4% to $6.6 billion. This took its cumulative cost savings for the year to around $2 billion over the previous year. 
The average price for Vale’s iron ore shipments stood at $105.6/tonne as compared to$99.2/tonne in Q2 2013. This was due to higher IODEX 62% Fe benchmark prices in the quarter and a larger share of sales made on CFR basis which fetched higher prices. In short, Vale used a mix of different pricing mechanisms in its sales portfolio to optimize profits.
- The production of iron ore this quarter stood at 85.9 million tonnes, a 17.3% rise from the Q3 2012 figure of 83.9 million tonnes. The year-over-year increase was due to higher productivity and efficiency. The production was 17.3% higher on a sequential basis and was largely expected given that the rainy season affected output in Q2 2013.
- Iron pellet production stood at 12.4 million tonnes, 17.2% 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 weaker global demand for blast furnace pellets.
- The production of coal rose to 2.4 million tonnes compared to the Q2 2012 figure of 1.7 million tonnes due to improved operations at its Australian mines and the ramp-up at Moatize in Mozambique.
- Total finished nickel production for the quarter was 62,000 tonnes, 4.9% sequentially and 27.5% higher year-over-year. The ramp-up of VNC was largely responsible for the year-over-year rise in production. 
Iron Ore Prices, S11D And Moatize Will Drive Future Performance
Iron ore prices in the third quarter were higher than expected because the sentiment about China’s economy was buoyant, defying previous expectations. The production of steel surged due to the stimulus aimed at stabilizing the country’s economy. Since inventories of iron ore were low, increased demand from the steel industry triggered a rise in demand for iron ore. Vale admitted in its earnings presentation that there was a surprise rebound in the Chinese economy due to substantial credit expansion in Q1 2013, stronger exports and government support for railway and urban infrastructure. 
What Vale left unstated was its outlook on iron ore prices for the future. Once the stocking cycle is over and more supplies of iron ore hit the market, prices are likely to go down. According to the Bureau for Resources and Energy Economics, the official Australian commodities forecasting agency, iron ore exports from Australia are expected to grow at an annual rate of 8% between 2014-2018. The rise in demand is not expected to be commensurate with the rise in supply. 
Vale expects its ambitious S11D project in Brazil to start iron ore production in 2016 and will likely face the brunt of falling prices even as its production volume surges. The company reported that work on the mine is progressing according to schedule and is 46% complete. The S11D project has an estimated nominal capacity of 90 million tonnes of iron ore per year and proven iron ore reserves of 4.2 billion tonnes so far. To put the production figure in perspective, Vale produced 258 million tonnes of iron ore and about 45 million tonnes of iron ore pellets in 2012. Thus, the S11D project will augment production capacity considerably once it starts in the second half of 2016 and achieves full capacity in 2018.
The Moatize region in Mozambique will start delivering real value once the transport infrastructure bottlenecks are taken care of by building additional railway and port capacity. Vale is investing big in these areas. It reported that at the end of Q3 2013, 30% of the work on the Nacala railway corridor and 33% of the work on the port was complete. Out of a capital expenditure target of $4.4 billion, $956 million has already been spent.
Finally, Vale provided an update on its VLI stake sale transaction. It said that it is in the final stages of negotiations to sell an additional 26% stake in VLI which will bring its stake down in VLI to below 40%. The company hopes to unlock hidden value through this transaction which it claims is not priced into its share price at the moment.Notes: