Vale (NYSE:VALE)’s common share price has declined 40% to $5.32 after peaking at $8.80 on May 5. Vale’s preferred shares now trade at only $4.48. We anticipate the steep fall in Vale’s share price is derivable to a 30% drop in the iron ore price to $44.60/tonne in just two weeks. We believe iron ore prices will potentially remain volatile in second half, as steel demand softens and supply gains. Further, we believe it could take time before Chinese steel prices reverse their downtrend (domestic rebar and HRC are down 24% and 31% year-to-date at $339/t and $300/t) and normalize.
We disagree with some market participants about sustained falls of global operating costs, who suggest iron ore prices may remain subdued at recent levels for a while. In our perspective, the extent of opex reductions is likely to prove too optimistic and the influence on pricing too pessimistic.
Reducing its costs further, Vale estimates iron ore EBITDA in 2015 to break even with prices at $37-$41/t. Our base case 2015-18 fully loaded cost estimates (FLAISC) stand at $48-$53 per tonne, and would decline to $46-$49 per tonne if the iron ore price stays at spot ($45 per tonne) on lower taxes. We question if other miners can parallel Vale’s low costs.
Long-term oriented investors that anticipate iron ore prices to normalize at $70/t or above should consider Vale’s eye-catching risk-reward proposition. We forecast a 5-year CAGR of 31% from today’s stock price. Further, derived from our cost and capex estimates, we now see eye-catching upside if longterm iron ore prices surge to $70/t (we forecast share upside of 18% CAGR, well above Vale’s forecasted cost of equity of 11.9%). On our calculations, Vale’s cash from operations would be insufficient to pay dividends in the future if the iron ore price remains at $50/t, which seems stable with our FLAISC forecast of $48/t-$53/t. Unless Vale becomes a marginal cost producer of iron ore, which is a highly unlikely scenario in our perspective, we see attractive long-term value in the stock.
We believe today’s iron ore price at $45/t is unsustainably low from the producers’ side. To us, Vale’s balance sheet deterioration looks temporary and manageable. Our long-term dividend model shows there is attractive upside if iron ore prices return to $70/t or ahead of.
We reiterate “Sector Outperform” rating. Commodity price; operating and technical risks; political, environmental, and legal risks are potential risks to be considered while investing.