by Stephanie Link | January 3, 2013 1:30 pm
Editor’s note: This column is part of our “Best Stocks for 2013″ series; stay tuned for more entrants today and tomorrow.
A yearlong stock-picking contest poses challenges, but this one was easy. Vale (NYSE:VALE) is one of my favorite stories for 2013 based on its strong exposure to the emerging markets, improving internal fundamentals and an attractive valuation.
The company is the world’s largest producer of iron ore; China is far and away its biggest customer at 44% of its total iron ore/pellet exports, making up 32.4% of total revenue. After aggressive stimulus efforts last year (two interest rate cuts, three cuts to reserve requirement ratios, and sizable liquidity injections), China is poised to see not only a soft landing to its economy in 2013, but a reacceleration by the end of 2013 and into 2014. Several data points support a stabilization, including better-than-expected industrial production, retail sales and exports, and increases in electricity and steel production.
Brazil is also an important region for Vale, with 18.1% of total revenues, and this country has also implemented stimulus programs and fiscal monetary policy changes that should result in an economic recovery. And the 2014 World Cup and 2016 Olympics in Brazil are additional drivers for investment spending in this region.
In response to the global macro pressures, Vale management has scaled back its production portfolio, selling noncore assets and focusing on profitability. Importantly, the company is very focused on maintaining its strong balance sheet and dividend.
At its recent investor day, management outlined this shift away from marginal volume and toward more capital-efficient volumes. The resulting plans dropped its forecasted capex budget 6.9% to $16.3 billion in 2013; management intends to spend on fewer, yet more profitable projects with longer reserve lives — thereby creating better visibility.
The largest project in the company’s history, the Carajas iron mine, will start up in 2016; this project and a few other key ongoing projects will help the company achieve 39% production growth from 2011-2017. Vale has always operated at a low-cost competitive advantage, but its new restructuring program will allow the company to operate in any economic environment and continue its advantage over its high-cost rivals.
Valuation is the final factor that makes this a great prospect for 2013. Shares are down from a high above $35 in early 2011 and were virtually flat for 2012. Vale trades at 6.3x 2013 enterprise value to EBITDA, below the group average of 6.6x. It also trades below its two largest competitors, BHP (NYSE:BHP) at 6.6x and Rio Tinto (NYSE:RIO) at 8.1x.
I believe the downside is limited as production continues to grow and the resource-hungry economies of the emerging markets get back to their strong growth trajectory. This global recovery should bring iron ore prices higher, but management’s plan to lower costs will make the company profitable even at current levels.
In summary, the strong profitability drive by management; leverage to the emerging markets, particularly China; and attractive valuation position Vale nicely for 2013.
At the time of publication, Action Alerts PLUS, which Link co-manages with Jim Cramer, was long VALE.
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