Higher Iron Ore Shipments And Cost Reductions Partially Offset Impact Of Lower Iron Ore Prices On Vale’s Q4 Results

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Vale (NYSE:VALE), the world’s largest iron ore mining company, announced its fourth quarter results and conducted a conference call with analysts on February 26. As expected, the sharp decline in iron ore prices over the course of the last year negatively impacted the company’s results. However, a boost in quarterly iron ore shipments driven by record Q4 production levels, in addition to the company’s cost reduction efforts, partially offset the impact of a fall in prices on the company’s results. Despite a sharp 48% year-over-year decline in realized prices for Vale’s shipments of iron ore fines, the decline in the company’s adjusted EBITDA margin was far more gradual. [1] Vale’s adjusted EBITDA margin stood at 33.1% in Q4 2014, as compared to 24.1% in the corresponding period of 2013. [1] The company’s net operating revenues for Q4 2014 stood at  $9.07 billion, flat as compared to its revenues in the corresponding period of 2013. [1]

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The average realized price for Vale’s iron ore fines stood at $61.57 per ton in Q4 2014, nearly 48% lower than its average realized price for Q4 2013, which stood at $118.77 per ton. [1] The sale of iron ore fines and pellets collectively accounted for around 65% of Vale’s net operating revenues in Q4 2014. [1] Thus, the decline in iron ore prices was primarily responsible for Vale’s poor quarterly results.

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. [2] Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3%, in 2013 and 2014, respectively. [3] 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. [4]  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. [5] [6] Due to the persisting weak demand and oversupply situation, iron ore prices will remain under pressure in the near term.

Production and Shipment Volumes

Despite iron ore prices expected to remain subdued in the near term, the company has adopted a high production volumes strategy. Vale expects to benefit from economies of scale, capitalizing on its low-cost iron ore deposits. In keeping with this strategy, the company’s iron ore shipments in Q4 2014 rose to 71.4 million tons, around 9% higher than in the corresponding period of 2013. [1] Higher shipments were driven by an increase in production volumes due to the ramp-ups of Plant 2 in Carajás and the Conceição Itabiritos plant. [7] In keeping with its high volumes strategy, various projects are expected to result in a growth in Vale’s iron ore production from 331 millions tons in 2014 to 459 million tons in 2019. [8]

Nickel production stood at 73,600 tons in Q4 2014, 8.4% higher than in the corresponding period a year ago. [7] 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. [7] 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. [7]

Costs

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 2014, the company realized $1.2 billion in savings in operating costs as compared to the previous year. [1] The main components of this decline in operating costs were selling, general, and administrative expenses, which decreased by around 21%, and pre-operating and stoppage expenses, which decreased by around 46%. [1]

Vale’s capital expenditure in 2014 stood at $12 billion, as compared to $14.2 billion in 2013. [1] The company idled the Isaac Plains and Integra coal mines earlier on in the year. This is consistent with its strategy to allocate capital to projects that will generate better returns. [9] Disciplined capital allocation will continue to be the strategy for Vale in 2015, with capital spending expected to be further reduced to $10.2 billion. [8] With iron ore prices expected to remain subdued, the company’s efforts to reduce costs and capital spending will stand it in good stead in 2015.

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