Vale Q3 Earnings Review: Cost Reduction Partially Offsets The Impact Of Weak Iron Ore Prices

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Vale (NYSE:VALE) announced its third quarter earnings results on Thursday, October 22. [1] As expected, the sharp decline in iron ore prices over the last twelve months adversely impacted the company’s results, with the increase in shipment volumes and the company’s cost reduction initiatives mitigating the impact of the fall in prices on results. Vale’s adjusted EBITDA margin fell to 28.8% in Q3 2015, as compared to 33.1% in the corresponding period of 2014, despite the much sharper decline in iron ore prices. [1] Net operating revenues stood at $6.5 billion in Q3 2015, around 28% lower year-over-year, largely due to the decline in iron ore prices. [1] In this article, we will take a closer look at Vale’s Q3 results.

Iron Ore Prices

Vale’s Q3 results were negatively impacted by the sharp decline in iron ore prices over the past twelve months. The realized price for Vale’s iron ore fines stood at $46.48 per ton in Q3 2015, around 32% lower year-over-year. [1]

Iron Ore Prices, Source: Y Charts

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Since iron ore is the chief raw material for steelmaking, the 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 around two-thirds of the world’s seaborne iron ore supply. [2] Chinese steel demand 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. [3] Weak demand for steel has translated into weak demand for iron ore.

On the supply side, a sustained increase in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. [4] Rising production in backdrop of weak demand is expected to widen the worldwide oversupply of seaborne iron ore to 437 million tons in 2018, from a surplus of 184 million tons in 2015. [5] The prevailing oversupply situation has resulted in a sharp decline in iron ore prices, which has negatively impacted Vale’s quarterly results.

Cost Reduction

In response to the subdued iron ore pricing environment, Vale has adopted a strategy of cost reduction in order to prop up its margins. In Q3 2015, the company’s costs and expenses (net of depreciation) declined by nearly 26% year-over-year to $4.65 billion. [1] The decline in costs and expenses (in Dollar terms) was driven by the depreciation of the Brazilian Real against the Dollar and the ramp-up of low-cost mining operations at N4Ws and Ns5 extension mines, the Vargem Grande mine, and the Conceicao Itabirites project.

Vale has successfully reined in it production costs, with unit cost of iron ore fines landed in China, the company’s largest market, standing at $34.20 per ton in Q3 2015. [1] This implies that Vale can continue to produce profitably even if iron ore prices decline further. However, the global supply glut, created by sustained increases in production by iron ore majors including Vale, has ensured that the upside to iron ore prices remains limited in the near term. Thus, even for Vale, amongst the lowest cost iron ore miners in the world, business prospects remain subdued. Cost reduction will continue to be the major area of focus for the company in the near term.

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Notes:
  1. Vale’s Q3 2015 Earnings Release, Vale News Release [] [] [] [] [] []
  2. China Plans Iron Ore Subsidy for Miners Amid Rout, News Says, Bloomberg []
  3. Short Range Outlook 2015-2016, World Steel Association []
  4. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  5. Iron Ore Majors Boosting Supply as Glut, China Sink Prices, Bloomberg []