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Vale SA: Assessing the iron ore giant’s overall position

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Overall position

Vale SA (VALE) is the largest iron ore producer with premium-quality assets in Brazil. The development of the S11D project will further reduce its costs and increase production volumes. Vale’s revenues should also get some support from nickel and copper going forward, as production from these base metals is ramping up.

Yet iron ore contributes the bulk of Vale’s revenues and earnings. Iron ore contributes 62% toward Vale’s revenues and ~80% toward its EBITDA (earnings before interest, tax, depreciation and amortization). As a result, the volume and price outlook for iron ore are critical to determining Vale’s position in the industry.

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Demand and supply

Vale is highly leveraged to iron ore prices, which have been depressed in recent months and have slid ~48% since the start of the year. The main causes of iron ore market woes are oversupply from major iron ore producers such as BHP Billiton Ltd. (BHP), Rio Tinto plc (RIO), and Fortescue Metals Group Ltd. (FSUGY) and weak demand growth from China, which consumes two-thirds of seaborne iron ore.

The SPDR S&P Metals and Mining ETF (XME) invests in the above-mentioned stocks.

In a previously published series, Key indicators for iron ore updated: No respite in sight, Market Realist looked at the bleak prospects for a change in China’s demand situation. The overall policy shift in China from investment to consumption-led growth might not be good for the steel, iron ore, and coking coal sectors.

Challenges

Concerns that Vale’s decisions are influenced by the Brazilian government are not unfounded, as the company’s uneconomic domestic steel investments show. Also, its iron ore mines in the Southern system are getting deeper, and grades are falling. The company needs additional capital to maintain mine infrastructure and keep up its production profile. Finally, its geographic disadvantage relative to its closest competitors will remain a major handicap, even with the development of the Valemax. At least these ships will reduce the company’s overall freight costs.

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