The Brazil dam-burst catastrophe at the beginning of 2019 ensured miner Vale (NYSE:VALE) stock remains sideways to lower almost through the year. Moving into 2020, Vale stock seems to have gathered momentum.
A strong balance sheet fundamental is the first bullish factor. Vale has healthy credit metrics even after the losses and write-down related to the dam disaster. Vale reported gross debt of $14.8 billion and net debt of $5.3 billion for the third quarter of 2019. As a matter of fact, net debt for the company is the lowest since Q4 2008.
Additionally, Vale reported net debt to EBITDA of 0.5 and EBITDA interest coverage ratio of 10.8 for Q3 2019. This implies low leverage and smooth debt servicing. It is also worth noting that 70% of the company’s debt is due for refinancing after 2023. With an extended maturity profile, robust liquidity and high interest coverage, Vale has minimal credit stress.
Strong free cash flow is another factor that supports the bullish fundamental story. For Q3 2019, Vale reported operating cash flow of $5.1 billion and free cash flow of $2.9 billion. This implies an annualized FCF of $11.6 billion. Vale is therefore positioned to deleverage and absorb any further expense related to Brumadinho dam rupture.
EBITDA will Increase in 2020, 2021
Vale has already resumed iron ore production at the Brucutu mine. In addition, part of the dry processing operations at the Vargem Grande complex is also operational. The remaining halted production of approximately 50 metric tons will resume in 2020 and 2021.
As iron ore production increases in the next 24 months, the company’s EBITDA and cash flows will also accelerate. It is worth noting that as compared to Q2 2019, the company’s iron ore production has already increased by 35.4% in Q3 2019. I am focused on iron ore, since it remains the key revenue and EBITDA driver.
From an EBITDA perspective, price realization for iron ore fines was $100.2 per metric ton in 3Q19 as compared to $76.6 in 3Q18. Higher price realization has already boosted EBITDA and cash flows. However, this positive was offset by the write-down burden in 2019. In 2020 and 2021, it is likely that the focus will shift to volumes growth and cash flow acceleration. This should help Vale stock trend higher.
I also believe that price realization will remain strong in 2020. As Vale announced a lower production outlook for Q1 2020, iron ore futures trended higher. China’s iron ore demand has also remained strong and should support healthy price realization. Analysts are expecting China to grow at 6% in 2020 despite trade-wear headwinds. With China’s iron ore inventory declining to the lowest in 10 weeks in December, prices should trend higher.
EBITDA margin will also remain healthy with rising share of premium products. As of Q3 2019, Vale sold 86% of premium quality iron ore and pellets. The share of premium products was 79% in Q3 2018. Vale is focused on premium products that are tailored for current market demand and this should help in higher price realization.
My Final View on Vale Stock
After a challenging 2019, Vale is well positioned to expand EBITDA and cash flows in 2020. In addition, I expect deleveraging to continue. Therefore, stronger growth and improved credit metrics should take Vale stock higher in 2020.
The key risk factor relates to economic growth. World steel demand is likely to grow by a sluggish 1.7% in 2020. However, production cut can keep the demand-supply scenario relatively tight for iron ore and price realization will remain healthy. In addition, possible resolution of trade war can boost Chinese economic growth and demand for iron ore.
Overall, Vale stock is interesting for 2020 and I believe that the stock can trend higher with deleveraging and EBITDA expansion as key triggers. The worst is over for Vale in terms of losses related to the Brumadinho dam rupture. The focus of markets will shift to growth and Vale has the potential to deliver healthy results.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
