Vale’s Q1 Earnings Review: Lower Iron Ore Prices Negatively Impact Results

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Vale (NYSE:VALE), the world’s largest iron ore mining company, announced its first quarter results and conducted a conference call with analysts on April 30. 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 Q1 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 51% 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 25.7% in Q1 2015, as compared to 42.7% in the corresponding period of 2014. [1] The company’s net operating revenues for Q1 2015 stood at  $6.24 billion, as compared to $9.5 billion in the corresponding period of 2014. [1]

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Iron Ore Prices

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The average realized price for Vale’s iron ore fines stood at $46.01 per ton in Q1 2015, nearly 51% lower than its average realized price for Q1 2014, which stood at $94.79 per ton. [1] The sale of iron ore fines and pellets collectively accounted for around 60% of Vale’s net operating revenues in Q1 2015. [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 decline by 0.5% in 2015, following on from a similar decline in 2014. [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. [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] A combination of weak demand and oversupply is likely to result in weak iron ore prices in the near term.

Production and Shipment Volumes

Despite expectations of subdued iron ore prices 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 fines shipments in Q1 2015 rose to 49.4 million tons, around 9% higher than in the corresponding period of 2014. [1] The increase in iron ore production was due to the ramp-ups of Plant 2 and the Serra Leste processing plant at the Carajás mine, where production rose 18% year-over-year. [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]

Copper production stood at 107,200 tons in Q1 2015, up 21.1% from the corresponding period in 2014, primarily due to the ramp-up of production at the Salobo mining complex. [7] Nickel production stood at 69,200 tons in Q1 2015, 2.5% higher than in the corresponding period a year ago. [7] This was primarily due to higher production at the company’s operations in Indonesia and New Caledonia, offsetting the decline in production from the company’s Canadian operations, which were negatively impacted by bad weather conditions. Coal production stood at 1.7 million tons in Q1 2015, down 5.1% year-over-year. [7] Higher production from the Moatize and Carborough Downs mines partially offset the fall in volumes from the Integra and Isaac Plains coal mining operations, which were idled in 2014.

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 Q1 2015, the company’s costs and expenses declined by 12% to $5.7 billion, as compared to figures for the corresponding period of last year. [7] The main components of this decline in operating costs were selling, general, and administrative expenses, which decreased by around 30%, and pre-operating and stoppage expenses, which decreased by around 18%. [9]

In addition to lowering its costs, Vale generated $1 billion in Q1 through a combination of the sale of a precious metal stream from the Salobo copper mine to Silver Wheaton for $900 million, and the sale of its stake in a hydroelectric power plant for $100 million. [9] Further, the company has also lowered its capital expenditure, with capital spending expected to fall to $10.2 billion in 2015, as compared to $12 billion in 2014. [8] With iron ore prices expected to remain subdued in the near term, 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 Q1 2015 Earnings Release, SEC [] [] [] [] [] []
  2. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  3. Short Range Outlook 2015-2016, 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 Q1 2015 Production Report, Vale Website [] [] [] [] []
  8. Vale Day 2014 Presentation, Vale Website [] []
  9. Vale’s Q1 2015 Earnings Conference Call Transcript, Seeking Alpha [] []