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What Would It Take for Vale to Close Valuation Gap versus Peers?

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EV-to-EBITDA multiples

The EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) is a good multiple to value companies in capital-intensive industries such as metals and mining.

Currently, Vale (VALE) has a forward EV-to-EBITDA multiple of 4.3x, ~40% lower than its last-five-year average multiple. Other diversified miners such as Rio Tinto (RIO) and BHP Billiton (BHP) are trading at higher multiples of 5.9x and 6.0x, respectively.

Cliffs Natural Resources (CLF), which is not directly comparable to these miners because of the difference in its target market, the nature of contracts, and products, is trading at a forward multiple of 5.7x.

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Valuation gap

As you can see in the above graph, there is a clear valuation gap between Vale and its close peers. This discount is in-line with the historical gap Vale’s stock has traded at with respect to its peers. There are several reasons for this gap.

The first reason is the distance between its mines and its major seaborne iron ore consumer, China, which is almost three times the distance for BHP and RIO. This distance leads to higher costs for the same ore from Vale as compared to its Australian peers. Secondly, its debt level is higher than its peers, making it much more leveraged to the volatilities of commodity prices. Another reason for its valuation gap was its corporate governance policies. Starting in February 2017, Vale has worked to improve its governance and be more transparent with shareholders. This could be the first step towards greater transparency and could lead to the re-rating of its shares.

Valuation catalysts

Vale’s S11D project started commercial operations in late 2016. It is the company’s largest iron ore project. The project is currently ramping up and will continue to do so for the next two years. This project won’t only increase Vale’s iron ore production, it will also reduce its unit costs. A faster-than-expected ramp-up of S11D could be a positive catalyst. Also, any further news regarding the reduction of the company’s debt could also lead to a stock re-rating. That said, the major catalyst for these miners lies in rising commodity prices (COMT) (GNR), especially iron ore prices.

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