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Morningstar | Cost of Vale’s Feijao Tailings Dam Failure as Expected, USD 10.60 per Share FVE Retained

While the market was interested in no-moat-rated Vale’s production, particularly iron ore, the key first-quarter result concern was how much would the Feijao tailings dam failure cost? Collectively, Vale has so far taken USD 4.8 billion of pretax charges relating to the failure and remediation. This is in line with our rough expectation for a USD 5.0 billion pretax charge, which we based on the cost of the 2015 Samarco dam failure. The major components of the USD 4.8 billion charge are a USD 2.4 billion provision for remediation of the Feijao tailings dam failure and USD 1.9 billion to remediate all of Vale’s other tailings dams constructed using the upstream method. The upstream method was common to the failures at both Samarco and Feijao.

However, the estimate of the damages is still likely to rise over time. Vale has provisioned for the social and economic damage and compensation, which we think will make up the vast majority of the cost. However, it has yet to provision for the environmental costs given the uncertainty around the estimates. There is also potential for legal damages in future and a further cost to decommission the Germano tailings dam at Samarco, which will be split 50/50 with BHP. We’ve increased our estimate of the cost of the failure by USD 1.0 billion pretax, however, the impact is not material enough to change our USD 10.60 per share fair value estimate.

Vale’s first-quarter net loss aftertax of USD 1.6 billion was driven by the USD 4.8 billion of pretax charges relating to the tailings dam failure. Excluding this, adjusted EBITDA of USD 3.85 billion was down 2% versus a year ago with higher iron ore earnings due to price offset by lower nickel earnings and losses in coal. Despite the headline loss and USD 3.5 billion of cash frozen for remediation, the balance sheet is strong. Net debt increased 24% to USD 12.0 billion due to the freezing of funds, but net debt/adjusted EBITDA remains comfortable at less than 1.0.

First-quarter production was softer than expected in a couple of areas. Iron ore production was down 11% versus a year ago to 72.9 million tonnes. Sales were even softer down 24% to 55.4 million tonnes. Iron ore pellet production declined just 6% to 12.3 million tonnes. Vale reaffirmed its guidance to sell 307 to 332 million tonnes of iron ore and pellets in 2019, but now expects to be in the mid- to low-end of the range. We’ve lowered our forecast by 4.5% to 315 million tonnes. In addition, Vale expects to take two to three years to return production to 400 million tonnes. We previously expected production of 390 million tonnes in 2021 and 400 million tonnes in 2022 but now forecast 370 million tonnes and 390 million tonnes in those years, respectively. The impact to valuation is immaterial given our midcycle volumes forecast is unchanged at 315 million tonnes from 2023.

Nickel production also declined 6.5% compared with a year ago to 54,800 tonnes. With the company focused on turning around the business, improving operations and lowering costs, nickel production guidance was lowered modestly to 232,000 to 236,000 tonnes. Copper output of 93,800 tonnes was in line with a year ago. The company’s coal operations continue to lag. Vale aims to increase production by about 21% in 2019 but first-quarter output fell 9% compared with a year ago, due to a severe wet season. Improving coal volumes is key to turning around the business, which posted an EBITDA loss of USD 69 million for the quarter. The wet season impact saw unit costs blow out, but regardless, the operations are high cost.