Vale: Cost-Cutting Won't Help Due to Weak Fundamentals

Vale's (VALE) woes have continued in 2015 as the mining company has lost almost half of its market value. Looking ahead, the possibility that Vale's business will continue remaining under pressure is high, as iron ore prices will remain battered due to low demand from China. As a result, the oversupply in the iron ore market will continue to weigh on the price of the commodity, which will ultimately keep Vale's performance under pressure.

Vale's moves to counter a difficult environment

However, in order to counter the downturn in its end market, Vale is taking steps to reduce costs.

For instance, Vale has successfully reduced its cash cost per metric ton for iron ore, ex-royalties, to $15.8 per ton during the second quarter of 2015 as compared to $18.3 per ton in the first quarter of 2015. This is a result of the continued cost control efforts and the ongoing optimization at the N4WS mine and certain areas of the Itabirites projects.

Also, Vale has strategically sold four of its key ore carriers to China Ocean Shipping Company for $445 million. These proceeds will be used by Vale to pay off its high debt and bring down the interest burden. In fact, Vale has a really high debt of $29 billion, which is way more than its cash position of $3 billion. As a result, the company is being forced to sell its non-core assets in order to improve its balance sheet.

But, Vale is primarily relying on cost reductions in order to negotiate the difficult end market environment. To achieve lower costs, the company is focused on enhancing the quality of its iron content in the ore from 63% during the first quarter of 2015 to 63.2% during the second quarter. This is primarily a result of cost-optimizations at the Itabirites projects and the N4WS mine.

Moreover, Vale recorded unit cash costs and expenditures (regulated for moisture and quality) in China at $39.1 per ton during the second quarter of 2015. This was down from $43.4 per ton in the first quarter of 2015 for iron ore measured by dry metric ton.

In addition, Vale's production costs at the Carajás FOB port fell below $12 per ton in June 2015. In addition, unit freight cost for iron ore, excluding the impact of planned hedging, was approximately $16.8 per ton during the second quarter of 2015 as compared to $17.2 per ton during the first quarter.

Hence, Vale is taking strong steps to improve its cost profile, which is the right thing to do in a weak iron ore pricing environment. Additionally, the company is increasing its reliance on other commodities as well to mitigate the impact of weak iron ore pricing.

Diversification is a good move

Last quarter, Vale produced 67,100 tons of nickel despite production issues at Sudbury and intended maintenance closures in New Caledonia and Indonesia. In addition, the company's second quarter gold and copper production stood at 100,000 ounces and 104,900 tons, respectively.

The year-over-year improvement in nickel, copper, and gold production in the previous quarter was driven by the robust mining technology implemented by the company. An improved mining technology will allow Vale to both reduce cost and improve production, which will ultimately have a positive impact on its margin performance.

Conclusion

Despite the improvements that Vale is making to its business, investors should not forget that the company is in a weak position fundamentally. As already mentioned earlier in the article, it has a huge debt burden that easily eclipses its cash flow and cash position. Additionally, a current ratio of just 1.74 indicates weak short-term liquidity. Moreover, the weakness in the iron ore market will continue weighing on its profit margin, which is already weak at a negative 15%.

Thus, until and unless there is a turnaround in the iron ore market, investors should avoid Vale despite a steep drop this year.

Published on Aug 26, 2015
By Yaggyaseni Mittra

Copyrighted 2016. Content published with author's permission.

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