Vale: A Cash Cow, but Business Is Cyclical

Vale S.A. (VALE) is one of the largest metals and mining companies in the world, based on market capitalization. The company is one of the world’s largest producers of iron ore and nickel, but it also produces iron ore pellets, manganese ore, ferroalloys, metallurgical and thermal coal, copper, platinum group metals (PGMs), gold, silver, and cobalt.

Based in Brazil, Vale operates logistics systems, including railroads, maritime terminals, and ports, which are integrated with its mining operations. For this reason, the company enjoys unparallel operational efficiencies. I am neutral on the stock. (See Analysts’ Top Stocks on TipRanks)

While basic material companies had stayed away from the spotlight for quite some time, the ongoing global logistics crisis has resulted in commodity prices skyrocketing, increasing investor interest in the space. Today, we are discussing an industry leader that is worth taking a look at.

Recent Developments

In its Q3 results, Vale revealed it produced nearly 90 million tons of iron ore during the period, which is about an 18% increase quarter-over-quarter. The company is also expanding its iron ore capacity by building new plants, which should result in a total production capacity of around 400 and 450 Mtpy (million metric tons per year). This suggests an increase of 30% from Vale’s current capacity of around 341 Mtpy.

In any case, since commodity demand can be cyclical, Vale will only tap into its increased capacity capabilities if the underlying demand is strong enough to justify producing more of anything.

The volatility in iron ore prices, along with the rest of commodity prices over the past year, greatly showcases the sector’s cyclicality. Iron ore prices more than doubled last year. However, with prices normalizing lately, Vale’s revenues were materially impacted.

Specifically, revenues declined to $12.7 billion, down from $16.7 billion in Q2 2021. With lower pricing power, Vale’s profitability margins also contracted this quarter. Particularly, EBITDA margins slipped to 55% versus 66% in Q2. Consequently, EPS also halved from $1.49 to $0.76 sequentially.

Moving Forward

With iron ore prices expected to gradually decline in the medium term, analysts have been cautious when it comes to Vale’s profitability in the coming years.

EPS is expected to decline through 2025, which is the reason the stock is trading at such low forward P/E levels – around 4 times 2022 earnings estimates and 8 times 2025 estimates. Remember, profitability can be extremely volatile, which also contributes to a multiple in the single digits.

What is likely to benefit shareholders significantly at Vale’s current valuation levels is the board’s approval of a new stock buyback program, which authorizes the repurchase of up to 4.1% of Vale’s current outstanding shares.

The recent valuation compression has likely formed an opening for management to deliver increased value in the short term to investors through this authorization.

In my view, considering Vale’s strong capital returns over the years, industry-leading position, and still attractive valuation multiple despite the fact that earnings may decline in the medium term, Vale could likely present a compelling investment case. The stock makes for a great vehicle into betting on higher iron price levels. Nonetheless, I remain neutral.

Wall Street’s Take

Turning to Wall Street, Vale SA has a Hold consensus rating, based on two Buys, five Holds, and two Sells assigned in the past three months.

The average Vale SA price target of $17.20 implies 35% upside potential.

Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

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