Vale’s Earnings Preview: Lower Iron Ore Prices To Impact Results

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Vale (NYSE:VALE), the world’s largest producer of iron ore and iron ore pellets, will announce its quarterly earnings on Wednesday, April 30. Though this time the company has not announced production data in advance of the earnings announcement, we are expecting higher quarterly iron ore shipment volumes year-over-year. However, the effect of higher shipment volumes will be offset by an adverse pricing environment for iron ore this quarter relative to the corresponding period a year ago. [1]

You can check out our full analysis for Vale here:

Iron Ore Prices

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Vale’s iron ore and iron ore pellets are sold to the global steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining iron ore prices. International iron ore prices are largely determined by Chinese demand as China is the largest consumer of iron ore in the world. China also accounted for nearly half of Vale’s iron ore and iron ore pellet shipments in 2013. Flagging demand for iron ore from China in the wake of an economic slowdown has put downward pressure on iron ore prices. According to data from China’s National Bureau of Statistics, growth in investment, factory output and retail sales has slowed to multi-year lows in the first two months of the year. A Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, tightening of credit by Chinese banks to steel plants that are not performing well will affect their ability to purchase iron ore and thus the overall demand for it. This has resulted in an inventory build-up at Chinese ports which will further curtail imports. Further, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from an investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for copper in the long run. [2]

On the supply side, iron ore majors such as Rio Tinto, BHP Billiton have expanded production of the ore. These companies are banking on higher volumes to compensate for lower prices and drive profits given their low costs of production of iron ore. These companies are betting on continued strength in iron ore demand over the long term. The main drivers of such long-term demand are increasing levels of urbanization and industrialization in developing and emerging economies, particularly China and India. However, given the weak demand scenario at least in the near term,  expanded production by iron ore majors has resulted in an oversupply situation which is expected to keep prices subdued in the near term. [3]

Volumes

Vale is maintaining its thrust on volumes growth in the backdrop of a subdued iron ore pricing environment. The company is expecting rising production volumes in the years to come from the ramping up of production from various mines including the ambitious S11D project in Brazil. Production from this mine is expected to begin in 2016 and reach 90 million tonnes by 2018. This will represent a significant chunk of Vale’s iron ore production which stood at 306 million tonnes in 2013. Thus, Vale hopes to compensate for lower prices with higher shipment volumes by capitalizing on its low costs of production for iron ore relative to the industry. [4]

Other Developments

Moving forward, Vale is expected to continue to focus on its core businesses in terms of capital allocations and also maintain its thrust on cost cutting. These efforts also involve selectiveness in capital expenditure and divestment of non-core assets. The company sold non-core assets and investments worth $6 billion in 2013 which underlines the commitment to its approach. It has also been able to cut costs, including a $2 billion year-over-year capital expenditure reduction in 2013. These are a part of efforts by the company to manage its debt and operate effectively in an adverse pricing environment. [5]

What To Look Out For

We will be keen to hear the management’s outlook on iron ore prices in the near and medium term. Further clarity in terms of company strategy in the context of the expected pricing environment will shed some light on the road ahead for Vale. In particular we will be looking out for more information on volume growth and cost cutting measures over the next few years.

 

Notes:
  1. Iron Ore Spot Price Chart, YCharts []
  2. The Latest Iron Ore Price Slump: Causes and Effects, Forbes []
  3. BHP, Rio Gamble With A Stacked Iron Ore Deck, Mineweb []
  4. Vale’s 2013 20-F,SEC []
  5. Vale’s Q4 2013 Earnings Call Transcript, Seeking Alpha []