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Morningstar | Further Supply Disruptions to Boost Near-Term Iron Ore but Declining Steel Demand in China Looms

Vale is the world's largest iron ore miner and a key supplier to the global steel industry. It is highly leveraged to Chinese raw materials demand, which we expect to decelerate as the country's infrastructure-led investment boom wanes. Vale is dominated by its exposure to bulk materials, which make up approximately 70% of group forecast EBITDA. The segment primarily produces iron ore fines and pellets, with minor contributions from similar products such as metallurgical coal and manganese, also used to produce steel. Vale’s position on the seaborne iron ore cost curve is middling, higher than Rio Tinto and BHP but better than Fortescue, Anglo American and the smaller producers, particularly once product premiums are taken into account.Vale’s cost disadvantage relative to the Australian majors stems primarily from the additional cost of shipping iron ore to China from Brazil versus Western Australia for Rio Tinto and BHP. Freight rates to China for bulk capesize vessels are about USD 15 per tonne from Brazil versus about USD 6 per tonne from Western Australia. Vale somewhat mitigates the disadvantage with a fleet of very large ore carriers (Valemax ships) which can reduce freight costs through economies of scale. We expect the build-out of more Valemax to further decrease freight costs and improve Vale's relative cost position by narrowing the gap to BHP and Rio Tinto.We expect the break-even cost curve to materially flatten by midcycle, a function of a slight decline in demand, loss of market share by high-cost producers, greater efficiency from the miners, a normalisation of currently elevated product discounts, lower freight rates, and, for Vale, ramp-up of the low-cost 90 million tonne S11D mine. Failure of the tailings dam at Vale’s Corrego de Feijao iron ore mine in Brazil in January 2019 will bring environmental and humanitarian liabilities for Vale, and potentially impact its social licence in the near to medium term.The base metals division accounts for approximately 30% of forecast EBITDA, approximately four fifths from nickel and one fifth from copper. Copper cash costs are close to the industry median, but nickel assets have generally been made EBIT losses since the nickel price collapsed in 2008. Approximately half of Vale's adjusted asset base sits outside the most profitable bulk materials division. Diversification away from iron ore was done procyclically and has generally been significantly value-destructive.