Vale S.A.'s Dependence on Exports Increases

Vale (NYSE: VALE  ) has been focusing on its core iron ore business for some time. In order to accomplish this task, the company has been selling its non-core assets like its stake in the aluminum producer Norsk Hydro and in the logistics company VLI. The company received as much as $6 billion from those sales in 2013.

As an outcome of this strategy, Vale's ferrous minerals segment constitutes 74.5% of its revenue mix. However, the situation in the iron ore market is not easy, and prices remain depressed. Will this become a strategic weakness?

Dependence on China
Vale reported that Asia represented 54.2% of its total revenues in 2013, and China alone represented 38.6% of revenues. Importantly, Vale's participation in the domestic Brazil market is decreasing, as a bigger part of the steel producers in Brazil are developing their own mines. This means that more of Vale's growing iron ore production will go to exports, especially to China.

However, Vale is not alone in growing its production. Major miners like BHP Billiton (NYSE: BHP  ) and Rio Tinto (NYSE: RIO  ) are making similar moves. Both BHP Billiton and Rio Tinto benefit from the weakness of the Australian dollar, as their iron ore mines are situated in this country. For example, BHP Billiton grew its iron ore production by as much as 19% in the latest half-year. What's more, BHP Billiton and Rio Tinto have additional projects under construction that would bring more ore to the market.

While the supply increases, demand remains fragile. It looks like all major miners count on China to sell their growing iron ore production. Vale stated that it expects a 3% growth in Chinese steel production and a near 7% growth in iron ore imports. Whether the country will be able to absorb increasing imports without further declines in prices remains a big question. As of now, the iron ore market is still in a downtrend.

Vale believes that the price won't be driven below $110, because this price level will force smaller players out of the market. However, it is more likely that major miners will expand their market share when the smaller ones quit rather than the price immediately increasing, at least in the short term.

The dividend looks attractive
Vale's board of directors proposed a minimum dividend of $4.2 billion in 2014. At the current share price, this dividend yields a hefty 5.8%. So far, the company was able to finance its dividend from its operational cash flow, as it significantly exceeded its capital expenditure needs. As Vale completes existing projects and is reluctant to enter major new ones, capital spending will continue to decrease.

This fact is positive for future dividend payments. What's more, the company stated that it would rather increase dividend distribution than lower its debt level with the extra cash.

Bottom line
Vale looks like an interesting income play. However, the increasing dependence on China is worrisome. The latest statistics from the country are mixed at best. To support iron ore prices, the Chinese economy should continue to grow at steady rates. Rio Tinto and BHP Billiton are more diversified, but they come with lower yields of 3.01% and 3.47% respectively.

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