What Does the Future Hold for This Mining Giant?

Dr. Osman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Brazilian mining company Vale (NYSE: VALE), the world’s largest iron ore and pellet producer, operates in a cyclical-natured mining industry, which is why the company’s performance and growth opportunities are both vulnerable to global market volatility. In such business conditions, productivity growth and cost reduction have become strategic priorities in order to outperform in a highly competitive steel industry. What are the growth opportunities for Vale over the next few years?

Recent Moves

Nowadays, the company is largely focused on investments in world-class assets with long life and low costs. Adhering to a diversification concept in capital management, Vale also invests in non-iron-ore assets, but only when an investment expects to improve capital allocation and, therefore, create significant value for the company. This year, Vale’s capital expenditure reached $12.3 billion, almost 8.5% above the amount invested in the same quarter last year. The most advantageous deals the company has struck are its new, highly profitable projects starting in the coming future. They are as follows:

-      Carajás, Additional 40 Mtpy, Pará state, northern Brazil – starting in 2H 2013

-      Carajás Serra Sul S11D – starting in 2H 2013

-      Simandou I – Zogota starting in 2H 2012

-      Moatize II – starting in 2H 2014

In addition, Vale has received environmental approval for the building of a new railway and the permission from four Argentinean provinces. This project is expected to start in 2H 2014. 

Future Challenges and Prospects

In recent years, the steel industry upswing has been in line with Chinese economic development. Since China has become the world’s largest steel consumer and has reached about two-thirds of international seaborne iron ore imports, almost 65% of the world's seaborne iron ore was delivered to Chinese ports in 2011. Hence, continued growth in steel production in China provoked international pressure on seaborne iron ore supplies, and thereby caused prices to rise. Since Vale has been striving to increase its production capacity over the next few years, the company might expect massive profits.

In Q2 2011, growth in production provoked a downward trend in minerals and metals prices. However, there are also some encouraging facts: China’s economy has bottomed in H1 2012, and therefore recent growth of 7.5% in Q3 2012 showed an improvement in Chinese economic activity.

Additionally, investment in transport infrastructure was forced in Q3 2012, and the transportation sector is one of the largest consumers of minerals and metals. A cement production increase since June suggests a stronger demand from the pickup in railway and highway funding, and Chinese iron ore imports reached an all-time high for the first nine months of 2012, increasing by 8.7%.

Vale vs. the Rest       

Miners such as BHP Billiton (NYSE: BHP) and Rio Tinto (NYSE: RIO) seem to be Vale’s main competitors. In the table below, we compare Vale's metrics within a group of these mining companies.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Vale </strong></p> </td> <td> <p><strong>BHP Billiton</strong></p> </td> <td> <p><strong>Rio Tinto </strong></p> </td> </tr> <tr> <td> <p>Market Cap</p> </td> <td> <p>$130.4 bil</p> </td> <td> <p>$190.2 bil</p> </td> <td> <p>$91.5 bil</p> </td> </tr> <tr> <td> <p>Trailing P/E</p> </td> <td> <p>4.6</p> </td> <td> <p>12.4</p> </td> <td> <p>22.7</p> </td> </tr> <tr> <td> <p>P/B Ratio</p> </td> <td> <p>2.0</p> </td> <td> <p>2.9</p> </td> <td> <p>1.7</p> </td> </tr> <tr> <td> <p>Earnings Growth</p> </td> <td> <p>18.8</p> </td> <td> <p>39.9</p> </td> <td> <p>1.8</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>7.2</p> </td> <td> <p>3.12</p> </td> <td> <p>3.3</p> </td> </tr> <tr> <td> <p>Debt/Equity</p> </td> <td> <p>0.4</p> </td> <td> <p>0.3</p> </td> <td> <p>0.4</p> </td> </tr> <tr> <td> <p>Return on Equity</p> </td> <td> <p>20.4</p> </td> <td> <p>25.1</p> </td> <td> <p>7.0</p> </td> </tr> </tbody> </table>

Vale has a TTM ROE of 20.4%, while Rio's rate of 7.0% is only a third of this figure; but BHP's performance looks more attractive in terms of profitability. The debt philosophy of these three companies seems very similar. However, yield-hungry investors would certainly prefer Vale instead of BHP or Rio, due to its comparably high dividend yield. Vale’s earnings growth rate for the last three years is twice as low as BHP’s. Moreover, the significantly higher ttm P/E ratio of Vale’s rivals suggests a more promising future might be expected for them when compared to Vale. The comparison above allows me to suggest that Vale is currently performing much better than Rio Tinto, but notably worse that BHP Billiton.

Foolish Summary

Increasing construction activity in three eastern countries – China, South Korea and India – promises encouraging growth opportunities for the international steel market. Vale can be optimistic about the future because of Chinese economic growth opportunities, as well as a slow recovery in the US housing market. Vale is one of the mining companies that might benefit most from this over the next few years. 

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