Vale’s Q4 2014 Earnings Preview: Higher Shipment Volumes To Partially Offset Impact Of Lower Iron Ore Prices

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Vale (NYSE:VALE), the world’s largest iron ore mining company, will announce its fourth quarter earnings results and conduct a conference call with analysts on Thursday, February 26. We expect lower iron ore prices in the fourth quarter, as compared to the corresponding period of 2013, to negatively impact the company’s quarterly results. Vale’s underlying earnings, which exclude the impact of one-time items on the company’s profits, fell nearly 82% to $666 million in Q3 2014. [1] In addition to the fall in iron ore prices, iron ore shipment volumes fell 9.3% due to interruptions along the Carajas railroad in September. [1] As Vale will make up for these delayed shipment volumes in Q4, we expect shipments to rise more than the 2% year-over-year rise in production volumes reported by the company in its Q4 production report. [2] Higher shipment volumes will partially offset the impact of lower iron ore prices on results. In this article we will take a look at what to expect from Vale’s fourth quarter results.

See our complete analysis for Vale

Iron Ore Prices

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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. Benchmark 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. [3] Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3% in 2013 and 2014, respectively. [4] Weak demand for steel has indirectly resulted in weak demand for iron ore.

On the supply side, an expansion in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. A combination of weak demand and oversupply is likely to result in weak iron ore prices in the near term. [5] Iron ore prices stood at $68 per dry metric ton (dmt) at the end of December 2014, around 50% lower as compared to prices at the end of December 2013. [6]  The worldwide surplus of seaborne iron ore supply is expected to rise to 300 million tons in 2017, from an expected surplus of 175 million tons in 2015, and a surplus of 72 million tons and 14 million tons in 2014 and 2013, respectively. [7] [8] In view of the persisting oversupply situation, iron ore prices will remain subdued in the near term. The sale of iron ore fines and 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 Q4 2014 rose to 86.3 million tons, which was 2% higher than in the corresponding period of 2013. [2] The increase in iron ore production in the fourth quarter was due to the ramp-ups of Plant 2 in Carajás and the new Conceição Itabiritos plant, partially offset by scheduled maintenance activity at the Minais Centrais mining hub. [2] 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. [10]

Nickel production stood at 73,600 tons in Q4 2014, 8.4% higher than in the corresponding period a year ago. [2] 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. Copper production stood at 105,400 tons in Q4 2014, up 11.4% from the corresponding period in 2013, primarily due to ramp-ups of production at the Sudbury and Salobo mining complexes. [2] Coal production stood at 2.3 million tons in Q4 2014, up 2.3% year-over-year, due to higher output from Moatize, offset by a fall in volumes from the Integra and Isaac Plains coal mining operations, which were idled earlier on in the year. [2]

Other Developments

In view of the weak iron ore pricing environment, Vale has adopted a strategy of cost reduction and disciplined capital allocation, in order to remain competitive. In the first nine months of the year, the company realized $520 million in savings in costs and expenses as compared to the corresponding period last year. [1] The main components of this decline in costs and expenses were selling, general and administrative expenses, which decreased by around 23%, and pre-operating and stoppage expenses, which decreased by around 46%. [1] In addition, the company sold non-core assets and investments worth $6 billion in 2013. [11]

Vale’s capital expenditure for the first nine months of the year stood at $8.23 billion, $2.16 billion lower than the capital expenditure incurred in the corresponding period last year. [1] This reflects the lower capital expenditure budgeted for 2014 as part of its disciplined approach to capital allocation. The decision to idle the Integra and Isaac Plains coal mining operations, announced earlier on in the year, is consistent with its strategy to allocate capital to projects that will generate better returns. [12]

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:
  1. Vale’s Q3 2014 Earnings Release, SEC [] [] [] [] []
  2. Vale’s Q4 Production Report, Vale Website [] [] [] [] [] []
  3. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  4. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  5. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  6. Iron Ore Spot Prices, Y Charts []
  7. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  8. Iron Ore Caps 2014 Loss as Morgan Stanley Says Worst Over, Bloomberg []
  9. Vale’s 2013 20-F, SEC []
  10. Vale Day 2013 Presentation, Vale Website []
  11. Vale’s Q4 2013 Earnings Conference Call Transcript, Seeking Alpha []
  12. Vale comments on Isaac Plains mine, Vale News Release []