Vale’s Q3 Earnings Preview: Weak Iron Ore Prices To Negatively Impact Results
Vale (NYSE:VALE) will announce its third quarter earnings results on Thursday, October 22 and conduct a conference call with analysts the next day. [1] We expect the sharp decline 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 31.8% in Q2 2015, as compared to 41.5% in the corresponding period of 2014, largely due to the decline in iron ore prices. [2] Vale has already released its production report for Q3 in advance of the earnings release. The company reported record iron ore production levels, despite the shut down of some of the company’s high cost iron ore processing plants. Higher shipment volumes will partially offset the impact of lower iron ore prices on the company’s margins in Q3. In this article, we will take a look at what to expect from Vale’s third quarter results.
Iron Ore Prices
Vale is a diversified mining company and the world’s largest producer of iron ore by production volumes. The sale of iron ore fines and pellets collectively account for nearly two-thirds of the company’s revenues. Thus, fluctuations in iron ore prices have a major impact upon Vale’s prospects. Iron ore is the chief raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining prices of the commodity. Benchmark international iron ore prices are largely determined by Chinese demand, since the Chinese steel industry accounts for the purchase of nearly two-thirds of the world’s seaborne iron ore supply. [3] As per World Steel Association estimates, Chinese steel demand growth is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014, as a result of slowing economic growth in China. [4] Weak demand for steel has translated into weak demand for iron ore.
On the supply side, a steady increase in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. [5] Rising production in the face of weak demand is expected to widen the worldwide surplus of seaborne iron ore supply to 437 million tons in 2018, from an expected surplus of 184 million tons in 2015. [6] As a result of the prevailing oversupply situation, the weakness in iron ore prices is likely to persist in the near term. The following chart illustrates the decline in iron ore prices over the past twelve months. ((Iron Ore Spot Prices, Y Charts)) Thus, weak iron ore prices will certainly have a major impact upon the company’s results.
Iron Ore Prices, Source: Y Charts
Production Review
Vale’s iron ore production (excluding third party purchases) rose to 88.2 million tons in Q3 2015, which represents a quarterly production record. [7] However, this figure represents only a 2.9% increase as compared to Q3 2014, since Vale shut down roughly 13 million tons worth of high-cost iron ore processing capacity in Q3 2015. [7] The increase in iron ore production was primarily due to the ramp-up of production at the Carajas and Minas Centrais mines, where production rose 5.4% and 24.6%, respectively, year-over-year. [7] The increasing 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 332 millions tons in 2014, to 459 million tons in 2019. [8]
Vale’s copper production declined 5.3% year-over-year to 99,300 tons in Q3 2015, as a result of maintenance shutdowns affecting production. [7] On the other hand, nickel production rose 6.7% year-over-year to 71,600 tons in Q3 2015, with maintenance shutdowns lowering production in Q3 2014. [7] Coal production declined 12.3% year-over-year to 2.1 million tons in Q3 2015, with higher production from the Moatize and Carborough Downs mines partially offsetting the fall in volumes from the Integra and Isaac Plains coal mining operations, which were idled in 2014. [7]
Other Developments
In order to combat the weak iron ore pricing environment, Vale has adopted a strategy of cost reduction and disciplined capital allocation. In Q2 2015, the company’s costs and expenses (net of depreciation) declined by roughly 18% year-over-year to $4.9 billion. [2] The main components of this decline in operating costs were selling, general, and administrative expenses, R&D expenses, and pre-operating and stoppage expenses. [9] It would be interesting to note to what extent the company is able to offset the impact of weak commodity prices by increasing the productivity of its operations and lowering costs. Whereas Vale’s cost reduction initiatives are consistent with the weak commodity pricing environment, the company’s plans to increase production are at odds with it. However, the company did shut down 13 million tons of high cost processing capacity in Q3. We would like to hear from the company management if it intends to undertake any similar actions going forward. More information on this front will shed more light on the road ahead for Vale.
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Notes:
- Vale’s Quarterly Results, Vale News Release [↩]
- Vale’s Q2 2015 Earnings Release, SEC [↩] [↩]
- China Plans Iron Ore Subsidy for Miners Amid Rout, News Says, Bloomberg [↩]
- Short Range Outlook 2015-2016, World Steel Association [↩]
- BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb [↩]
- Iron Ore Majors Boosting Supply as Glut, China Sink Prices, Bloomberg [↩]
- Vale’s Q3 2015 Production Report, Vale Website [↩] [↩] [↩] [↩] [↩] [↩]
- BofAML 2015 Global Metals Mining & Steel Conference Presentation, Vale Website [↩]
- Vale’s Q2 2015 Earnings Conference Call Transcript, Seeking Alpha [↩]