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Assessing Vale’s Position after Its 2Q15 Results

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Aug. 14 2015, Updated 9:07 p.m. ET

Position after 2Q15 results

Vale S.A. (VALE) has delivered a slight beat on expectations on the back of cost improvements in its 2Q15 results. Iron ore makes up the bulk of Vale’s revenues and earnings. Iron ore contributes 62% to Vale’s revenues and ~80% to its EBITDA (earnings before interest, taxes, depreciation, and amortization). As a result, the volume and price outlook for iron ore is critical in order to determine Vale’s position and expected future performance.

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It’s almost market consensus that iron ore prices are expected to remain under pressure for the foreseeable future. This is due to the ramping up of capacity at majors such as BHP Billiton (BHP) and Rio Tinto (RIO). It’s also due to a weak demand growth from China, which consumes two-thirds of seaborne iron ore.

To read more about the iron ore price outlook, read Market Realist’s Long-Term Iron Ore Price Fundamentals: Tough to Love.

Weak fundamentals

Vale isn’t going to get much help from iron ore prices. Vale is expected to remain free-cash-flow-negative going forward, although asset sales could help fill the gap. The upcoming low-cost S11D iron ore volumes after 2018 could be the game-changer for Vale. This makes Vale’s growth profile better than its peers. However, the risk of funding on its new project remains a dark cloud over its stock price.

Vale’s cost-cutting efforts, non-core asset divestment, and FX (freight exchange) and freight costs might bring some relief. However, as we’ve already seen, its increasing financial leverage remains a risk.

Lower iron ore prices are putting pressure on stock prices of other iron ore players with high debt such as Cliffs Natural Resources (CLF).

All listings of BHP, RIO, and VALE make up 17.8%, 11.7%, and 2.6%, respectively, of the iShares MSCI Global Metals & Mining Producers ETF (PICK). The SPDR S&P Metals and Mining ETF (XME) also invests in some of these stocks.

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