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Morningstar | Improving Financial Position Sees Vale Up Dividends, But Shares Remain Overvalued

We maintain our USD 8.90 per share fair value estimate for no-moat-rated Vale. Second-quarter realised prices for Vale's key commodities were largely as expected. The 3.6% higher spot nickel price assumption of USD 6.29 per pound is a minor benefit. We’ve also increased our coal price forecasts between 2018 and 2020 by about 10%, however, coal is a small part of Vale's business. We estimate it will contribute just 1% to group EBIT in 2018. Our 4% lower 2018 capital expenditure forecast of USD 3.6 billion, in line with Vale's new guidance, is also a benefit. Offsetting these minor positives are the reduction in nickel production guidance in 2018, an increase in expenditure for the rehabilitation of Samarco and the proposed USD 1 billion share buyback. Assuming the shares are bought back at the prevailing USD 14.60 share price, the buyback is dilutive to our fair value estimate by USD 0.08 per share.

Vale's financial position continues to strengthen, benefiting from continued favourable commodity prices and restrained capital expenditure. Net debt has almost halved in the year to June 2018 to USD 11.5 billion and is approaching management’s USD 10 billion. Annualised net debt/EBITDA of 0.8 is comfortable. The company has rightly turned its attention to increasing cash returns to shareholders. The new dividend policy is for semiannual payments based on 30% of EBITDA after sustaining capital expenditure. This equates to USD 2.05 billion or USD 0.40 per share for the first half of 2018. In addition to the dividend, Vale will buy back USD 1 billion of shares. Here we're more critical given conditions and earnings for mining firms are presently favourable. Our criticism is lessened by the scale of the buyback, which is just 1.3% of Vale's market capitalisation.

Second-quarter operating earnings for Vale were in line with our expectations. Excluding these nonrecurring charges, adjusted EBITDA of USD 3.9 billion was just 2% below the prior quarter. Our full-year EBITDA forecast remains USD 15.9 billion. However, attributable net profit after tax of USD 86 million was well down on the previous quarter's USD 1.67 billion. The result was impacted by unfavourable and unrealised pretax finance expenses of USD 2.6 billion, primarily due to movements in the market values of interest rate and currency hedges. An additional pretax USD 391 million provision for rehabilitation of Samarco also detracted.