EUR 850.00 For Business Accounts Only

Morningstar | Vale’s 2018 Profit an Afterthought Given Recent Events; USD 9.80 Fair Value Estimate Intact

Vale’s 2018 net profit after tax of USD 6.9 billion was 25% ahead of the 2017 result. Adjusted net profit after tax was USD 9.2 billion after excluding unrealised foreign exchange movements, impairments, and losses on asset sales. At the divisional level, EBITDA increased 8.1% to USD 16.6 billion. The uplift was driven by higher profit from iron ore and pellets and nickel, reflecting an uplift in realised prices and iron ore volumes. The result was slightly ahead of our forecast with Vale outperforming on costs for iron ore and nickel.

Lower unit costs in 2018 benefit our future unit cost forecasts. This is offset by a further reduction in near-term iron ore volume forecasts. Our USD 9.80 per share fair value estimate stands. We lower forecast iron ore sales volumes to 330 million metric tons in 2019 and 355 million metric tons in 2020 versus 350 million metric tons and 370 million metric tons previously. Our 2021 forecast remains 390 million metric tons. Guidance for 2019 is for sales of 307-332 million metric tons. We’re near the top end of guidance given Vale has potential to boost sales through inventory sales, the additional supply of low-grade ore stockpiles, restarting suspended mines, and potentially restarting some excess capacity.

There's considerable uncertainty around the speed of Vale’s recovery, and its impact  could see iron ore prices remain elevated for longer than expected. The Brazilian government has understandably lifted the standard around tailings dams. Vale is still figuring out how to meet the new standard for all of its dams. Currently around 90 million metric tons of capacity is suspended. Prior to the incident, Vale expected to produce 400 million metric tons and to ship around 382 million metric tons in 2019--he difference being a planned inventory build-up. Some of the suspended capacity should restart relatively quickly, notably the 30 million metric ton Brucutu mine. The full 90 million metric tons is unlikely to be lost in 2019.

We’ve maintained our USD 5.0 billion estimate of the pretax costs as a result of the failure of the Feijao dam and the associated costs. However, there’s significant uncertainty around this number as it’s based on the costs to rehabilitate the Samarco dam failure in 2015. There’s the potential for the cost to fix the remaining upstream dams to mean this number grows. Vale provisionally estimated a total USD 1.3 billion to remove and reprocess all tailings contained in upstream dams. However, it’s likely this figure will grow as Vale is working on detailed engineering plans for each dam. The assets of the Feijao mine itself, totaling USD 124 million, will be written off in 2019.

The Samarco failure was much larger, 60 million cubic metres of tailings versus less than 12 million cubic metres at Feijao. The scale and cost of the environmental clean-up from Feijao should be much less. However, the loss of life is much greater at Feijao--more than 300 versus 19 at Samarco, and that will require compensation. In addition, almost 1,000 people have been evacuated downstream of the Feijao dam and other dams that no longer meet the government’s new standards. Further testing, rectification works, and decommissioning of dams will be required to ensure their safety and compliance.

Approximately USD 4.3 billion of Vale’s funds have been frozen through legal action. This is to ensure funds are available for the victims, the government, the environmental clean-up, and compensation for others evacuated downstream from dams no longer compliant. Vale’s balance sheet was fairly strong at the end of 2018. The company had USD 5.8 billion in cash, net debt of USD 9.7 billion and net debt/adjusted EBITDA of 0.6. Net debt nearly halved from USD 18.1 billion at end 2017. Free cash flow of USD 13.0 billion, up from USD 9.1 billion in 2017, benefited from USD 4.0 billion of asset sales. We don’t expect this to repeat in 2019. With dividends to shareholders frozen and the iron ore price elevated from the shortages, Vale’s financial position should remain robust despite the impending liabilities.