Can Deleveraging Help Vale Offset Lower Iron Ore Production In Q1 2019?
Vale (NYSE: VALE) is set to announce its Q1 2019 results on May 9, 2019, followed by a conference call with analysts the next day. Vale’s total revenue has continuously increased over all four quarters of 2018, primarily driven by a strong growth in pellet shipments and premium pricing, partially offset by lower copper sales and a decline in nickel shipments. We expect revenues to increase by 9%-10% (y-o-y) in Q1 2019, driven by increased premium pricing for iron ore and pellet, higher copper price realization, and revenue contribution from the S11D mine (after its recent ramp-up), partially offset by a decrease in iron ore volume due to production cuts following the dam accident at its plant in Brazil’s Minas Gerais state in the last week of January 2019. The company’s earnings are also expected to increase on a y-o-y basis, mainly driven by higher revenue and lower interest cost following the company’s successful deleveraging, partially offset by costs related to the dam accident.
We have summarized the key expectations from the announcement in our interactive dashboard – How is Vale expected to fare in Q1 2019 and what is the full year outlook? In addition, here is more Materials data.
A Quick Look at Vale’s Revenue Sources:
Vale reported total revenue of $36.6 billion in FY 2018. This included 2 revenue streams:
- Bulk Materials and Others: $29.9 billion in FY 2018 (82% of total revenue). This includes four systems in Brazil for producing and distributing iron ore and ten iron ore pellet producing plants in Brazil and two in Oman.
- Base Metals: $6.7 billion in FY 2018 (18% of total revenue). This includes the company’s nickel and copper mining operations, along with sale of by-products of the company’s base metal mining operations including precious metals such as gold, silver, platinum, and palladium, as well as cobalt.
A] Key Revenue Trends
Iron Ore and Pellet Revenue
- Iron ore and pellet revenue has largely remained higher in the second half of 2018, driven by higher price realization following China’s recent iron ore restrictions (only ores with minimum iron content of 62% to be used in China) to mitigate environmental degradation, and higher demand from emerging markets.
- Shipments increased driven by the company’s decision to restart three idle pellet plants.
- However, shipments are expected to witness a decline in Q1 2019 due to production cuts after the recent dam incident, partially offset by ramp up of the S11D mine.
- In this case, segment revenue growth is expected to be driven by premium pricing, which is likely to more than offset lower production.
Nickel Revenue
- Nickel revenue has largely trended lower through 2018, as Vale has reduced its nickel production in the last one year due to volatile market prices on the back of US-China trade tension.
- We expect nickel revenue to decrease further in 2019 as Vale is reducing supply and will ramp it up as soon as it can take advantage of higher prices, which would most likely be in FY 2020.
B] Expense Trend
Total expenses increased sharply in Q2 2018, driven by large foreign exchange losses due to the stronger dollar, followed by decrease in total expenses in the second half of the year due to lower interest cost following debt repayment.
1) Interest Expense
- Due to the deleverage program launched by Vale, the company has been able to reduce its net debt (which had clocked a recent record in 2016) by approximately $8.5 billion in one year, from $18.1 billion at the end of Q4 2017 to $9.7 billion at the end of Q4 2018. This has helped the company to significantly reduce its interest outgo in a year. We expect interest expense to further decrease in Q1 2019.
2) Monetary and Exchange Gain/(Loss)
- As more than 71% of Vale’s loans and borrowings are denominated in USD, with the strengthening of the dollar vis-à-vis emerging market currencies, the company had to bear huge forex losses for a major part of 2018 on its loans and borrowings, which almost wiped out the gains from deleveraging and tax credits.
- With the dollar stabilizing, we expect currency headwinds to have minimal impact on margins in 2019.
Net income margin dropped significantly in Q2 2018, due to a sharp rise in total expenses, followed by improving margins in the latter half of 2018. We expect margins to improve further in 2019 as the company benefits from lower interest burden and a relatively stable dollar.
Full Year Outlook
- For the full year, we expect revenue to increase by about 2% to $37.3 billion in 2019.
- Higher revenue would primarily be driven by higher iron ore and pellet shipments due to an increase in production from S11D mine and restarting of idle pellet plants, premium pricing of iron ore, higher price realization for copper, partially offset by lower nickel revenue due to production cuts.
- Net income margin is expected to increase from 18.8% in 2018 to about 22% in 2019, supported by a decrease in interest outgo, lower currency headwinds and premium pricing, partially offset by additional expenses related to the recent dam accident.
Trefis has a price estimate of $14 per share for Vale’s stock. Though, in the short term, Vale’s stock is expected to decouple from its fundamentals and is likely to be driven by news related to inspection fallout and remediation expenses to be borne for the dam incident, we believe that the company is fundamentally on a strong growth trajectory, with a positive outlook driven by higher prices for its premium products and improving bottom line.
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