Vale Facing Legal Issues and Weaker Iron Ore Pricing Outlook

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After witnessing two years of spectacular growth on the back of skyrocketing iron ore prices, mining behemoth Vale (NYSE:VALE) is bracing itself for tougher times ahead due to the relatively bleak iron ore outlook. Last month, the company disappointed the market when its earnings missed expectations. Furthermore, the company will have to pay $4 billion in a bid to settle royalty dispute with the Brazilian government. Additionally, the company could face charges related to the deaths of two workers in its mines last year. While the latter two are obviously company-specific issues, we expect that other miners such as Rio Tinto (NYSE:RIO) and BHP Billiton will also feel some pressure from the iron ore pricing dynamics going forward. Our price estimate for Vale stands at $31, implying a premium of about 25% to the current market price.See Full Analysis for Vale Here

What goes up, must come down

Over the last two years, iron ore prices have soared to new highs before correcting 30% in the last quarter. According to a research note published by Moody’s, iron ore prices are likely to come under further pressure due to additional capacity that is expected to come online  over the next two years. Moody’s expects capacity to increase by more than 450 million tons per annum, which will significantly lower the demand-supply deficit. However, lower-cost mining giants such as Vale and Rio Tinto may not feel as much heat when compared to higher-cost producers. [1]

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Further, steel demand in China, the world’s largest steel consumer, is not picking up as much as expected which is putting pressure on iron ore prices. Ferrous minerals (iron ore) constitute 53% of our price estimate for Vale; accordingly any prolonged weakness in iron ore prices could impact our estimate of the company’s value.

Likely to settle with Brazilian government over royalties, taxes could go up

Vale and the Brazilian government, which have been tussling over royalty payments, are close to reaching an agreement. According to news agencies, Vale may have to shell out $4 billion including penalties and interest. The company and Brazil’s National Mineral Production Department have been disputing the amount since last year and failed to reach an agreement previously. Additionally, the country is looking to impose additional taxes on profits from Vale’s foreign operations. [2]

Could face charges related to deaths in Canada

The workers’ union is asking the Canadian government to consider pressing criminal charges against the company for negligence of safety and putting the life of workers in jeopardy. Last June, two workers died in an accident after wet mud and ore flooded a tunnel. If the Canadian government agrees with the union’s stance it could cause big problems for the company. [3]

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over royalty disputeAcc
Notes:
  1. Moody’s: Capacity expansion to drive iron ore prices lower, Feb 29 2012 []
  2. Vale Royalty Dispute With Brazil Close to End, Minister Says, Mar 2 2012 []
  3. Vale fatal accident report stuns mining community, Mar 1 2012 []