Vale, Multiple Ways to Win
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Brazilian mega-miner Vale, (NYSE: VALE) is the world's largest producer of iron ore. Foolish investors that have read my posts over the past week know that iron ore prices have sunk to about $135 per metric tonne from $180-$185 last year. So it's no surprise that Vale's earnings will take a big hit in 2012. However, there are many ways to win with an investment in Vale.
First there's a 6% dividend yield. When a company pays such a high dividend, it signals confidence in longer-term earnings. The attractive yield also mitigates downside on the stock. Another way to win with Vale is that the company produces hard assets, meaning that an investment in Vale is a hedge against inflation.
Despite a material decline in earnings this year, the company is still generating huge free cash flow before capital-expenditures. Typically, the global miners re-invest most of that cash flow into growth. For example, BHP, (NYSE: BHP) has a 5-yr cap-ex budget of $80 billion. However, BHP recently announced the postponement of funding decisions with regard to the pace and sequence of major expansion and green field projects. Vale had $21.4 billion budgeted for 2012, but analysts believe that number will come in lower by $3-$4 billion.
Reduced cap-ex frees up significant cash flow to make acquisitions, increase the dividend, pay a special dividend or buy back shares. All of these things are good for Vale shareholders. Investors need not shed a tear for Vale. Barclay's has EBITDA margins declining from 55% to 44% this year, but increasing to 49% in 2013 and 50% in 2014. With all the talk about the marginal cost of iron ore in the low $100's per tonne, Vale's cash costs are in the $40's.
After agressive debt refinancing and repayments post the global financial meltdown, interest expense has been reduced, another source of excess cash flow. In fact, a pristine balance sheet will allow Vale to borrow new funds to make acquisitions. Given that valuations of target companies have fallen by half or more, Vale might not need to borrow all that much. And there's this story from Reuters:
"Aug. 7 (Reuters) - Small mining and exploration companies are facing a less-than-receptive contingent of lenders and financiers at an annual gathering in the Australian outback designed to bring the two sides together. A barrage of nearly 50 companies present their cases in a beauty pageant-styled setting over three days."
"The miners blame banks' growing reluctance to part with funds on a souring outlook for mineral commodities as Chinese industrial growth slows and economies in Europe worsen."
Banks and presumably hedge fund and private equity groups are pulling back, just when it's probably a good time to buy! Vale and majors like Rio Tinto, (NYSE: RIO) will be piling up cash faster than they know what to do with. Rio Tinto acquired a highly prospective company named Riversdale Mining last year, giving it a strong foothold in coking coal in Mozambique. And, Rio is near the end of large upfront cap-ex for a massive copper/gold project in Mongolia. Rio too will have cash coming out of their ears.
Finally, there's good old fashioned multiple expansion. Vale is trading at an EV/EBITDA multiple of about 4.5x. As cash comes in that's not spent on growth, the EV (market cap + debt - cash) goes down. With Vale's EBITDA margins, cash flow and balance sheet, it should be trading at a higher multiple. Either that, or the excess cash driving the EV lower will be returned to shareholders. If Vale's forward EV/EBITDA multiple were to increase to 5.5x, still a very reasonable ratio, that alone would generate a total return in the stock of 28%. As, I said, there are multiple ways to win with Vale.
MockingJay2011 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.