The EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) is used for the relative valuation of capital-intensive industries such as metals and mining. The metric takes into account a company’s capital structure.
Vale (VALE) is trading at a forward EV-to-EBITDA multiple of 4.1x, which is 42% lower than its last-five-year average multiple. Its peers Rio Tinto (RIO) and BHP Billiton (BHP) are trading at higher multiples of 5.2x and 5.3x, respectively.
Cliffs Natural Resources (CLF), which is not directly comparable to these miners because of difference in its target market, nature of contracts, and products, is trading at a forward multiple of 5.1x.
The valuation gap between Vale and its peers is due to several reasons. First, the distance from its mines to the major seaborne iron ore consumer, China, is almost three times as compared to BHP and RIO. This distance leads to an escalation of costs while delivering the product to the source of consumption. Secondly, its financial leverage is higher than its peers. One other reason is its corporate governance policies compared to peers until 2017. Starting in February 2017, Vale has worked to improve its governance and be more transparent towards shareholders. This step is seen as a major governance overhaul that could lead to re-rating of its shares.
Vale’s iron ore production is steadily rising, as its largest project, S11D, came online in December 2016. This project is currently going according to plan and should ramp up further in 2017 and 2018. The project will likely help the company improve unit costs, making it the lowest-cost iron ore producer in the world. An earlier-than-expected ramp-up could be a positive catalyst. In addition, any further news regarding the reduction of the company’s debt could go a long way towards improving its valuation multiple. That said, the major catalyst for these miners lies in rising commodity prices (COMT), especially iron ore prices.