Vale Lives or Dies on Iron Prices

Like Rio Tinto and to a lesser extent BHP Billiton, Vale's stock price is closely tied to underlying iron ore prices. But, over the longer term Vale is a buy because it has the staying power to withstand a weak spot price and thrive when the iron ore price recovers.

Jun 26, 2014 at 1:44PM

There's been a great deal written about falling iron ore prices and for good reason. The price, currently near $92 per metric tonne, is at a troublesome level for mid-tier and junior iron ore producers. However, the outlook for the Big 3 iron ore producers BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), and Vale (NYSE:VALE) is different because they control the market. Of the three iron ore majors, Vale is most at risk to the weak iron ore price because it has a hefty 6% dividend yield and has operating costs that are higher than BHP's and Rio's Australian operations. 

In the short term, Vale might have to revise earnings estimates for 2014 lower. However, that announcement could already be factored into the stock price, barely above its 52-week low. Still, analysts continue to estimate positive free cash flow in the billions of dollars per year as the company prudently cuts spending and sells non-core assets. 

Vale's stock not immune from further weakness in spot prices
I believe that Vale makes sense as a long-term investment, but if the iron ore spot price falls to $80 per tonne or lower, the company's dividend would be at risk and the stock price would fall. To be clear, I don't believe that the iron ore price will remain at or below $80 per tonne for an extended period. Further, I don't think that Vale's stock price would fall more than 10%-15% from currently depressed levels. On the flip side, if iron ore prices remain steady or rebound to the $100-$120 per tonne range over the next few years, Vale stock could return 50% or more (including dividends). 

It's important to remember that all the doom and gloom about the iron ore price is due to rapidly increasing global supply. But, the companies that are pumping out the onslaught of supply will make more money, just with lower margins. Vale hopes to increase iron ore volumes from 320 million tonnes in 2014 to 342 million in 2015. In the long run, Vale, BHP, and Rio are pursuing a prudent pricing strategy. For example, BHP and Rio have the lowest costs in the world in the $20s/$30's per tonne, so they can comfortably navigate the lower spot price. 

Why Not Buy BHP or Rio Tinto Instead?
BHP is a giant, diversified conglomerate with a 3.5% yield. It's a stronger, lower-risk company, but it has less upside than the more volatile Vale. While Vale languishes near its 52-week low, BHP is closer to its 52-week high. In part, that's do to BHP's impressive oil and gas segment. Rio Tinto historically has been an iron ore play, but it's diversifying into aluminum, copper and diamonds. For example, it has a massive copper/gold project in Mongolia. Like BHP, Rio probably has less upside than Vale. 

One last name to consider is Cliffs Natural Resources (NYSE:CLF). A lot has been written about Cliffs lately, including my article here. Cliffs is a high beta play on iron ore. It's a stock that could double in 1-2 years, but only if the iron ore price jumps to say $130-$140 per tonne. A move like that is possible, but not likely anytime soon. 

Bottom line
Vale has more upside than BHP or Rio Tinto, but is riskier. It has a 6% dividend yield, but that yield is not entirely safe if iron ore prices fall further. Vale's stock is trading near its 52-week low due to that fear of a dividend cut, so a lot of bad news is priced in. Over the long term, measured in years, not months, I believe that Vale is a solid investment. 

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Peter Epstein owns shares of Vale. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers