Vale’s Q2 Earnings Preview: Lower Iron Ore Prices To Weigh On Results
Vale (NYSE:VALE) will announce its second quarter earnings results and conduct a conference call with analysts on Thursday, July 30. [1] We expect the sharp fall in iron ore prices over the course of the last twelve months to negatively impact the company’s quarterly results. Vale’s adjusted EBITDA margin fell to 25.7% in Q1 2015, as compared to 42.7% in the corresponding period of 2014, primarily due to a fall in iron ore prices. [2] Vale has already released is production figures for Q2, which point to a significant year-over-year increase in iron ore and copper production volumes. Higher shipment volumes will partially offset the impact of lower iron ore prices on the company’s Q2 results. In this article, we will take a look at what to expect from Vale’s second quarter results.
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. 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 is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014. [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. 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] A combination of weak demand and oversupply is likely to result in weak iron ore prices in the near term. [6] Iron ore spot prices stood at $63 per dry metric ton (dmt) at the end of June, around 33% lower year-over-year. [7]
Iron Ore Prices, Source: Y Charts
The sale of iron ore fines and pellets collectively accounted for around 65% of Vale’s net operating revenues in 2014. [8] Thus, weak iron ore prices will certainly have a major impact upon the company’s results.
Production Review
Iron ore production in Q2 2015 rose to 85.3 million tons, which was 7.4% higher than in the corresponding period of 2014. [9] The increase in iron ore production was primarily due to the ramp-up of production at the Itabira and Minas Centrais mines, where production rose 11.4% and 18.5%, respectively, year-over-year. [9] 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 a growth in Vale’s iron ore production from 331 millions tons in 2014 to 459 million tons in 2019. [9]
Copper production stood at 104,900 tons in Q2 2015, up 29.5% from the corresponding period in 2014, primarily due to the ramp-up of production at the Salobo mining complex. [9] Nickel production stood at 67,100 tons in Q2 2015, 8.7% higher than in the corresponding period a year ago. [9] This was primarily due to higher production at the company’s operations in Canada, with higher production at the Sudbury and Voisey’s Bay mines, along with higher purchases of ores from third parties boosting the production of finished nickel at Vale’s facilities. Coal production stood at 2 million tons in Q2 2015, up 8.9% year-over-year. [9] 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.
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 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. [2] 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%. [10]
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. [10] Further, the company has cut its capital spending, with the company’s capital expenditure in 2015 expected to be much lower than in 2014. 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:
- Vale announces dates for reporting of 2Q15 performance, Vale News Release [↩]
- Vale’s Q1 2015 Earnings Release, SEC [↩] [↩]
- China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
- Short Range Outlook for Apparent Steel Use 2014-2016, World Steel Association [↩]
- Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg [↩]
- BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb [↩]
- Iron Ore Spot Prices, Y Charts [↩]
- Vale’s 2014 20-F, SEC [↩]
- Vale’s Q2 2015 Production Report, Vale Website [↩] [↩] [↩] [↩] [↩] [↩]
- Vale’s Q1 2015 Earnings Conference Call Transcript, Seeking Alpha [↩] [↩]