After a 28% drawdown in just three months, shares of Vale SA (VALE) simply look too cheap to ignore.
At current levels, I am bullish on Vale. It had been a banner year for Vale and many other players in the commodities world, as the reflation trade and soaring demand for raw materials grew.
Founded in 1942, Brazil-based Vale SA produces and exports iron ore, pellets, manganese, and iron alloys, which are used as raw materials in steelmaking. It operates through the following segments: Ferrous Minerals, Coal and Base Metals.
When much of the world came out of lockdown, it breathed new life into the energy and mining sectors. However, China’s pledge to cut down on steel production (which negatively affects Vale, as iron ore is its major input) and the Evergrande crisis have quickly decimated the share price of Vale and its peers.
However, it appears that these risks are already priced into the stock, and patient investors will be rewarded for holding Vale during the turbulence, thanks to its generous dividend and share buyback programs.
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Valuation
Vale looks strikingly cheap, no matter which way you look at it. Shares trade at a P/E of 4.5, which is a very inexpensive multiple in today’s market.
A price-to-free cash flow of 3.2 is equally notable, as well as a price-to-sales ratio of just 1.5. This inexpensive valuation is also highlighted when looking at the company’s dividend yield.
Returns to Shareholders
Vale’s dividend yield of over 18.4% also jumps off the page. To be clear, this payout ratio must be taken with a grain of salt, as it is a product of record high iron ore prices last quarter, coupled with Vale’s current depressed valuation.
This yield, resulting from the past quarter’s $1.54 dividend payout, will not be sustainable indefinitely. The company paid out $0.43 in June, and $0.74 in March.
While these payouts are much lower than the September payout, even a return to these levels would still be a great yield for shareholders. For example, even a return to June’s $0.43 payout would still result in a substantial 12% yield.
Beyond dividend payouts, Vale is also committed to returning capital to shareholders via an aggressive share buyback program. On April 1 of this year, Vale announced its new share repurchase program, which authorizes the company to buy back up to 5.3% of its shares outstanding.
Vale has already repurchased about $2 billion worth of shares on the open market over the past quarter. This indicates management’s confidence in the company, and shows that it feels it is undervalued at current prices.
Between the dividend payout and $2 billion in share repurchases over the last quarter, Vale returned an impressive $4 billion to shareholders in just the past quarter alone.
More to Vale than Iron Ore
While Vale derives the vast majority of its earnings from iron ore, the company also has substantial operations in copper, nickel, and other metals. The company has reportedly considered spinning off its base metals (copper and nickel) business to unlock its value, which is currently being obscured by its iron ore business.
Copper and nickel are both key metals in the world’s pursuit of transitioning towards renewable energy and EVs. While these plans do not appear imminent at this point in time, they highlight the attractiveness of this base metals business. Vale values it at $25 billion, which would be almost a third of the company’s current market cap.
Analyst Sentiment
Vale is viewed as a Moderate Buy by analysts. Four analysts have a Buy rating on Vale, four classify it as a Hold, and one analyst has a Sell rating on the stock.
The average Vale price target is $19.26, representing 34.5% upside from the current price. Note that even the lowest analyst price target of $15 is still above Vale’s current price.
Takeaway
Shares of Vale have been battered because of worries that China’s steel crackdown, and decreased demand, could put a damper on iron ore prices.
However, we may have already turned a corner regarding iron ore prices, which have been on the rise.
Investors who wait for Vale’s share price to stabilize and reflect this might be rewarded for their patience, thanks to Vale’s substantial dividend payouts, and its continued share repurchases.
The stock is trading at valuation multiples rarely seen in today’s market, and we have also seen how quickly shares of Vale can move to the upside, if talk of inflation grips the market again.
Disclosure: At the time of publication, Michael Byrne owned shares of Vale.
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