What Is The Largest Expense Component For Vale And How Is It Expected To Move Going Forward?

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Vale’s (NYSE: VALE) total expenses have trended steadily higher from around $23.5 billion in 2016 to about $29.7 billion in 2018. However, as a percentage of revenues, expenses have decreased from 85.5% to 81.2% during the same period, due to faster growth in revenues. The company’s expenses are largely driven by cost of sales, which made up almost 75% of Vale’s total expenses in 2018. Cost of sales accounted for 60.4% of revenues as of 2018, reflecting a drop from 64.2% in 2016, primarily due to increase in volume sold and higher iron ore price realization. This decline from 64.2% to 60.4% has added about $1.4 billion to the company’s profits, which translates into additional earnings of $0.27 per share. Cost of sales is further expected to drop to about 59.5% of revenues in 2020, which could lead to additional profit of about $357 million, in turn contributing around $0.07/share in incremental earnings over the next two years. In our dashboard How Does Vale Spend Its Money?, we discuss the trend in Vale’s major expense items and what is driving the change.

Total Expenses

Vale’s total expenses have increased from $23.5 billion in 2016 to about $29.7 billion in 2018. For 2019, we expect total expenses to stand at $30 billion, which comprises of-

  • Cost of Sales: $22.5 billion
  • Operating Expenses: $4.0 billion
  • Non-Operating Expense (Income): $2.3 billion
  • Income Taxes: $1.2 billion

Vale’s Net Income Margins have increased continuously from 14.5% in 2016 to 18.8% in 2018, driven by rising revenues and expense management with the fall in impairment cost and interest expense. Margins are expected to increase to 20% in 2019 and then to 23% by 2020, on the back of rising revenues and the company’s deleveraging program.

Breakdown of Vale’s Total Expenses

Cost of Sales

  • Cost of sales has increased from $17.7 billion in 2016 to $22.1 billion in 2018, driven by rising iron ore shipments, higher costs related to energy, fuel, maintenance, and materials.
  • The cost is expected to rise, albeit at a much lower rate to about $22.4 billion by 2020, driven by a projected drop in shipments of iron ore and nickel.
  • As a % of revenue, cost of sales steadily declined from 64.2% in 2016 to 60.4% in 2018, led by faster growth in revenues.
  • With revenues likely to see further growth in the next two years due to elevated price realization, cost of sales as a % of revenue is likely to go further down to 59.5% by 2020.

SG&A

  • SG&A has remained range bound between $500-$530 million between 2016 and 2018.
  • As a % of revenue it has steadily dropped from 1.8% in 2016 to 1.4% in 2018.
  • This metric is expected to further drop to 1.2% in the next two years, with SG&A decreasing to about $450 million in 2019 and 2020 due to a decrease in personnel and depreciation cost.

Research & Evaluation

  • Research & Evaluation (R&E) cost has increased from $319 million in 2016 to $373 million in 2018, due to higher spending on the copper operations.
  • As a % of revenue it declined from 1.2% in 2016 to 1.0% in 2018 as revenues grew at a much faster rate.
  • The metric is expected to remain at about 1% of revenues in the near term, with R&E cost likely to be almost stable at $375 million in the next two years.

Impairment

  • Impairment cost has remained volatile between 2016 and 2018, with it dropping from $1.2 billion in 2016 to $0.3 billion in 2017, before rising again to $0.9 billion in 2018.
  • Such sharp movements were due to impairment of onerous contracts (proceeds from long term contracts being less than the company’s obligations under such contracts).
  • As a % of revenue, also, impairment has seen volatility, fluctuating between 1% and 4.5%.
  • The metric is expected to remain around 1.5% in the near term, with impairment close to $0.6 billion in the next two years.

Other Operating Expenses

  • Other operating expenses have remained almost stable around $0.7-$0.8 billion between 2016 and 2018.
  • However, it is likely to see a sharp rise in 2019, reflecting the costs related to the major dam accident in Brazil in January 2019 which affected the company’s operations.
  • With most of the cost being incurred in 2019, the metric is again expected to drop close to $1 billion in 2020.

Non-Operating Expense

Effective Tax Rate

  • Vale’s effective tax rate has steadily declined from 34.8% in 2016 to -2.5% in 2018, as the company recognized tax loss carryforwards  from tax losses of a subsidiary abroad.
  • With most of the benefits already realized, we expect the effective tax rate to rise to 20% in 2019 and to 25% by 2020, translating into  tax expense of $1.2 billion and $1.9 billion in the next two years.

 

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