How to Play the Rebound in Iron Ore

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

Iron ore is a commodity, which is directly linked to infrastructural activity around the globe. Iron ore used to trade near the $200 mark in 2011, which recently fell to the sub $90 levels, all thanks to the uncertainty in Europe. We still cannot expect any turnaround in infrastructural activities in Europe, but in my opinion, the housing recovery in the US and the stimulus package of China, could drive the prices of iron ore higher than the current levels. The company I am bullish on is Vale S.A (NYSE: VALE) and here are a few reasons that support my stance.

The interest rates in the US have been kept very low, and will hover around the same levels at least until mid-2015. The unemployment rates recently hit a 4 year low of 7.8%, indicating that more people will have added disposable income. In addition to this, the Fed will be injecting liquidity in the market by buying mortgage backed securities worth $40 billion, for 12 months straight. Additionally mortgage prepayment rates recently hit a 7 year high, and all these facts are contributing to the housing recovery in the US.

In China, a $156 billion spending plan for infrastructural projects was approved. To ramp up the growth, the plan involves building up of subways, flyovers and highways. These projects are not underway yet, and their existence merely on paper isn’t going to help iron ore prices. Pessimists may argue that global iron ore demand is falling and that the world is ending. I, being optimistic in nature, believe that once these projects are initiated, iron ore demand will see an upswing and its price will follow.

Additionally, the iron ore mining mess in India has forced the government authorities in the country to ban operations of 90 mines in Goa. The state has the capacity to produce nearly 50 million tonnes per annum, and the imposed bans would create a strain on the supply.

This summer, electrical power grids in the country developed faults, and nearly 650 million people were left in the dark. The electrical infrastructure needs to be upgraded before the summer of 2013, and the falling domestic iron ore supply, would force India to import iron ore. These developments indicate that the global iron ore prices are headed north and iron ore mining companies would be the biggest beneficiaries.

Vale is a metals and mining company, based in Brazil, which is mainly involved in the extraction of iron ore, manganese ore and ferro alloys. On a global scale, Vale is the second largest mining company, and the largest producer of iron ore. The production of iron ore in Q2 stood at 80.54 million tonnes. Management expects a rebound in iron ore prices, and is looking to increase the iron ore production capacity at its Sohar plant to 12mtpa, up by 30%.

Vale S.A faces competition from Rio Tinto (NYSE: RIO) and BHP Billiton (NYSE: BHP).

Company

P/E

PEG

Debt/Equity

Net Profit Margin

Vale

5.93x

0.47x

34%

27.9%

Rio Tinto

11.81x

1.60x

43%

21.5%

BHP Billiton

21.50x

1.28x

38%

8.45%

 

Amongst the peers, Vale enjoys the highest net profit margin, and the least debt/equity levels. The P/E and PEG ratios indicate that the stock is undervalued. To add to it, the company yields a decent 3.2%, making Vale our fundamental pick.

The company generates more than 50% of its revenues from the Asian markets, a region with mostly developing nations. In my opinion, iron ore prices are set to rebound, and Vale would be one of the biggest beneficiaries.


PiyushArora 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.

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