After Sharp Production Cuts In Q1, Can Vale Manage A Turnaround In FY 2019?

by Trefis Team
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Vale (NYSE: VALE) released its Q1 2019 results on May 9, 2019. The company reported total revenue of $8.2 billion in Q1 2019, marking a y-o-y decline of 4.6% from Q1 2018, and a sequential decline of 16.4% compared to Q4 2018. The decline in revenue was primarily driven by a 11.1% (y-o-y) drop in iron ore production due to the Brumadinho dam failure in Brazil in January 2019, partially offset by improved price realization. Additionally, lower coal, manganese, and nickel volumes also contributed to a lower top line. Vale reported a loss of $0.32 per share in Q1 2019, as against earnings of $0.30/share in the previous year period. Gains from lower interest expense and stable dollar were completely wiped away by a whopping $4.5 billion expense related to the dam accident, which led to losses during the quarter.

We have summarized the key announcements in our interactive dashboard – How did Vale 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 two 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 revenue was 4.8% lower compared to Q1 2018 and 18.4% lower compared to Q4 2018.
  • Lower revenue was mainly driven by a significant drop in shipments following production cuts due to the Brazil dam accident.
  • However, pellet revenue increased by 5.6% (y-o-y) in Q1 2019, driven by improved price realization, along with ramp up of the S11D mine and restarting of three idle pellet plants.
  • China’s recent iron ore restrictions (only ores with minimum iron content of 62% are to be used in China) to mitigate environmental degradation, and higher demand from emerging markets, has led to premium pricing for Vale’s high-grade ores and pellets.
  • With the dam incident expected to affect full year iron ore production by about 40 million tons, segment revenue would be driven by premium pricing through 2019.

Nickel Revenue

  • Nickel revenue decreased by 20% (y-o-y) in Q1 2019, driven by lower volume 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 though FY 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] Expenses and Profitability

Total expenses increased by over 40% (y-o-y) to $9.8 billion in Q1 2019, as benefits from lower interest expense and absence of currency headwinds were more than offset by significant increase in operating expenses related to the dam accident.

  • Interest Expense: Interest expense has steadily declined from $336 million in Q1 2018 to $252 million in Q1 2019, as the company has been able to reduce its net debt (which had clocked a recent record in 2016) following the launch of its deleveraging program.
  • Monetary & 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. With the dollar stabilizing, forex losses declined sharply from the previous year period to $10 million in Q1 2019.
  • Operating Expenses: Operating expenses witnessed an increase from $396 million in Q1 2018 to $4,983 million in Q1 2019. Such a sharp rise was mainly driven by $4,504 million of provisions and expenses related to Brumadinho incident, all of which were recorded in Q1 2019.

Net income margin witnessed a significant decline to -20% in Q1 2019 from 18.5% in the year-ago period. A sharp rise in one-time expenses and provisions led to losses during the quarter.

Full Year Outlook

  • For the full year we expect revenue to decrease by about 0.8% to $36.3 billion in FY 2019.
  • Lower revenue would most likely be driven by lower iron ore shipments, due to approximately 40 million tons of production cuts due to the Brazil dam accident.
  • Additionally, the top line is also expected to be affected by lower nickel and manganese shipments, partially offset by premium pricing for pellet and higher copper price realization.
  • Net income margin is expected to increase from 18.8% in 2018 to about 20% in 2019, supported by a decrease in interest outgo, lower currency headwinds, and premium pricing, partially offset by one-time additional expenses related to the recent dam accident which have been recorded in Q1 2019.

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 deleveraging benefits.


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