Vale Earnings Preview: Higher Iron Ore Volumes To Partially Offset Effect Of Lower Prices On Results
Vale (NYSE:VALE), the world’s largest iron ore mining company, will announce its third quarter earnings results and conduct a conference call with analysts on Thursday, October 30. We expect lower iron ore prices in the third quarter, as compared to the corresponding period last year, to negatively impact the company’s quarterly results. The company has released its production report ahead of its earnings announcement. Higher iron ore shipment volumes in the third quarter, supported by the ramp-ups of Plant 2 in Carajás and the new Conceição Itabiritos plant, will partially offset the negative impact of lower prices on results.
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Iron Ore Prices
Iron ore is an important raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining its prices. International iron ore prices are largely determined by Chinese demand since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. [1] Weak demand for steel in China has translated into weak demand for iron ore. Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015 respectively, from 6.1% in 2013. [2] A slowdown in economic growth has tempered the demand for steel. China’s GDP growth is expected to slow to 7.3% and 7.1% in 2014 and 2015 respectively, from 7.7% in 2013. [3] Further, a Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, the tightening of credit by Chinese banks to steel mills that are not performing well, will negatively impact these mills’ prospects. [4] Furthermore, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for steel in the long term. The weak Chinese economic prospects are captured by the Manufacturing Purchasing Managers’ Index (PMI). The Manufacturing PMI measures business conditions in the manufacturing sector of the concerned economy. When the PMI is above 50, it indicates growth in business activity, whereas a value below 50 indicates a contraction. Chinese Manufacturing PMI, reported by China’s National Bureau of Statistics, stood at 51.1 for September, and has ranged between 50.2 and 51.7 for the whole year. [5] With weak Chinese manufacturing growth, demand for steel is expected to remain subdued in China.
On the supply side for iron ore, expansion in production by majors such as Rio Tinto and BHP Billiton despite weak Chinese demand, has created an oversupply situation. A combination of weak demand and oversupply is likely to result in lower iron ore prices in the near term. [6] Iron ore prices stood at $82.38 per dry metric ton (dmt) at the end of September, around 38% lower than at the corresponding point of time last year. [7] As per Goldman Sachs, the worldwide surplus of seaborne iron ore supply will rise to 175 million tons in 2015, from an expected 72 million tons for 2014 and 14 million tons for 2013. [8] Iron ore and iron ore pellets collectively accounted for around 73% of Vale’s net operating revenues in 2013. [9] Weak iron ore prices will certainly have a major impact upon the company’s results.
Production Review
Iron ore production in Q3 2014 rose to 85.7 million tons, which is Vale’s highest ever quarterly production figure. Iron ore production in the third quarter was 3.1% higher than in the corresponding period last year. The increase in iron ore production in the second quarter was due to the ramp-ups of Plant 2 in Carajás and the Conceição Itabiritos plant. [10] The increase in iron ore output is consistent with Vale’s long term plans to boost volumes, capitalizing on its low-cost iron ore deposits. Various projects are expected to result in growth in Vale’s iron ore production from 321 millions tons in 2014 to 453 million tons in 2018. [11]
Nickel production stood at 72,100 tons in Q3 2014, 16.4% higher than in the corresponding period a year ago. This was primarily due to the ramp-ups of production at the Sudbury mining complex in Canada and the Onca Puma mining complex in Brazil, offset by lower production from the company’s operations in Indonesia and New Caledonia. [12] Copper production stood at 104,800 tons, up 10.8% from the corresponding period a year ago, primarily due to ramp-ups of production at the Sudbury and Salobo mining complexes. [12] Coal production stood at 2.3 million tons in Q3 2014, up 5.9% sequentially, due to higher output from the Carborough Downs, Moatize and Isaac Plains operations. ((Vale’s Q3 2014 Production Report, Vale Website))
Other Developments
In view of the weak iron ore pricing environment, Vale has adopted a strategy of cost reduction, disciplined capital allocation and divestment of non-core assets in order to remain competitive. Vale has embarked upon a mission to optimize its portfolio, divesting non-core assets in order to free up capital and invest it in projects that will give better returns. The company sold non-core assets and investments worth $6 billion in 2013. [13]
In addition, the company has also significantly reduced its capital expenditure. Going forward, it is focusing on a smaller project pipeline that would generate greater value for shareholders. Vale’s capital expenditure reduced from $16.2 billion in 2012 to $14.2 billion in 2013. The company’s capital expenditure budget for 2014 is even lower at $13.8 billion. [14] The decision to idle the Isaac Plains coal mine, announced in September, is consistent with its strategy to allocate capital to projects that will generate better returns. [15]
As a part of its efforts to enhance efficiency and cut costs, Vale generated savings of $2.8 billion in 2013. [13] The company continued to achieve results in its cost reduction efforts with savings of $250 million in the first half of 2014, as compared to the corresponding period last year. [16]
Expectations from Conference Call
With iron ore prices likely to remain subdued in the near term, we would like to know what the company’s strategy is in response to the prevailing pricing environment. Specifically, we would like to know if the company management has identified any further opportunities for portfolio optimization or cost reduction. This will throw some light on the road ahead for Vale.
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Notes:
- China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
- Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
- Goldman Sachs cuts China growth forecast sharply, Market Watch [↩]
- The Latest Iron Ore Price Slump: Causes and Effects, Forbes [↩]
- China Manufacturing PMI, Trading Economics [↩]
- BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb [↩]
- Iron Ore Spot Prices, Y Charts [↩]
- Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg [↩]
- Vale’s 2013 20-F, SEC [↩]
- Vale’s Q3 2014 Production Report, Vale Website [↩]
- Vale Day 2013 Presentation, Vale Website [↩]
- Vale’s Q3 2014 Production Report, Vale Website [↩] [↩]
- Vale’s Q4 2013 Earnings Conference Call Transcript, Seeking Alpha [↩] [↩]
- Vale’s 2013 20-F, SEC [↩]
- Vale comments on Isaac Plains mine, Vale News Release [↩]
- Vale’s Q2 2014 Earnings Conference Call Transcript, Seeking Alpha [↩]