Is Vale SA (ADR) (VALE) Stock a Value or Value Trap?

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It’s amazing what a few dollars in price difference can do. As we’ve said before — when your profits are directly tied to the production of some natural resource, you live and die by the underlying price of that commodity. For Brazilian iron ore giant Vale SA (ADR) (NYSE:VALE), higher prices have meant a return to the good times.

Is Vale SA (ADR) (VALE) Stock a Value or a Value Trap?

VALE was one of 2016’s top stocks, rising more than 161% on the back of higher iron ore and ferrous metal prices. Moves to help strengthen its balance sheet and simplify its capital structure didn’t hurt either.

However, this year has been a tad bit different.

After hitting a new 52-week high mid-February, VALE stock has stumbled in recent weeks and has basically erased its gains since hitting that high. The question now is whether the recent hiccups are just a temporary setback or something more sinister.

VALE Stock Surges on High Metal Prices

VALE — along with its two main rivals Rio Tinto Plc (ADR) (NYSE:RIO) and BHP Billiton Limited (ADR) (NYSE:BHP, NYSE:BBL) — had spent the latter part of the year moving higher as prices for iron ore also increased.

The reason for the climb comes from a familiar source — China. Stimulus measures enacted by Beijing over the last year designed to help reignited its stagnating economy have also served to help boost overall Chinese steel demand. With China’s steel mills now running at full tilt, import demand for iron ore has once again returned to the boom days of yore.

As a result, prices for iron ore have nearly doubled since the beginning of last summer and hit $94.86 a dry ton in February. That’s the highest price since August of 2014. Not quite as high as before the recession, but very much a marked improvement over the last few years.

Those higher prices have been a boon for Vale, and its rivals as the price of iron ore are the single largest driver of their revenues and profits. The surge in pricing manifested itself in Vale’s last quarterly results. The firm’s earnings before interest, tax, depreciation and amortization (EBITDA) clocked in at $4.1 billion. That was over $1.6 billion higher than a year ago, thanks to higher prices and volumes.

All of these have helped support VALE over the last year.

The Support for VALE Stock Starts to Crack

The problem is, we may have already hit iron ore’s — and VALE stock’s — peak. Since the mid-February peak, prices for iron ore have already sunk 5%, and analysts are now predicting that it could tumble even further.

Beijing has already signaled that they are putting the brakes on the economy as credit expansion is once again getting a little “too hot” in China. With that, supplies of steel have already begun to pick up, and stockpiles of iron ore held at Chinese ports have now climbed to a whopping 130 million tons.

But those supplies could still grow according to analysts at Deutsche Bank. The investment bank estimates that at current prices, only about 1% of all iron ore production isn’t profitable. That will cause global producers to mine more to try and capture whatever demand is out there. At $60 per ton, only 14% of suppliers are losing money. In the bank’s eyes, that’s the level when we’ll start to see meaningful productions. But those cuts will be too little, too late.

The growing stockpiles and slack demand will push iron ore prices all the way down to the $45 per ton mark over the next year. That’s about 48% lower than spot prices today. And Deutsche Bank isn’t alone in their prediction. Even BHP itself is warning of much much much lower prices throughout 2017.

Lower prices, of course, are a big problem for Vale. Iron ore mining accounts for roughly 85% of its earnings. Sequential rises in profits as iron ore has increased been the primary driver for shares over the last year.

While iron ore is a big part of BHP and RIO’s underlying businesses, they do have a much wider commodity net to play with. But for Vale, the name of the game really is ferrous metals. That’s evident by the decline in its stock since the pricing bubble popped. VALE stock is down by nearly 5%.

But lower iron ore prices also put several of Vale’s other projects on ice as well — namely, its debt reduction plans.

The miner ended 2016 with around $25.1 billion in debt. Management’s plans were to significantly reduce its overall debt this year to around $15 to $17 billion. Driving that has been cash flows from higher ore prices and asset sales on non-core assets- stuff like the sale of its fertilizer business, vessels and ships, and gold streaming assets.

That’s a very aggressive debt reduction plan that hinders on having iron ore higher. Vale is driving even further into being a strictly ferrous metals producer and reaping the cash flows from that business to dig itself out of its hole. With prices for its primary commodity crashing, there might not be enough to go around.

Skip VALE Stock For Now

Given its previous year’s performance, some investors may be tempted to buy the recent dip in VALE stock. That might be a bad idea. The two of the main reasons pushing VALE stock up — higher iron ore prices and its debt reduction plan — are basically now in the air. Lower prices will only mean more depressed profits and cash flows. And without those cash flows, Vale can’t execute on its debt plans.

Unless iron ore sharply reverses course, which is unlikely given the stockpiles and lowered demand, the miner’s shares won’t be returning to their recent glory. Vale could be a value trap rather than a value at this point.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.


Article printed from InvestorPlace Media, https://investorplace.com/2017/03/vale-sa-adr-vale-stock-value/.

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