Commodities markets are in a rut and that's taken the wind out of the sails of big global miners like Vale SA (ADR) (NYSE: VALE). But the mining business is cyclical and you have to keep spending if you want to be ready for the eventual upturn. The big question, then, is how is Vale balancing growth spending and the current downturn? Believe it or not, you play a big part in the answer.
Iron ore bust
Iron made up roughly 70% of Vale's earnings last year. Needless to say, as iron ore goes so goes Vale. It shouldn't be surprising then, that revenues peaked in 2011 at $60 billion, right when iron ore prices peaked. In 2014 revenues were $37.5 billion, a nearly 40% decline. Earnings have taken an even more dramatic tumble, peaking in 2011 at $4.34 a share only to fall to a lowly $0.13 last year.
Iron Ore Spot Price (Any Origin) data by YCharts
The thing is, running mines is an expensive business. There are high fixed costs to cover before money on the top line can make it down to the bottom line, which is why earnings fell so much more than revenues. As an example, Vale's capital budget in 2014 included roughly $4 billion just to keep its current operations running.
And the future?
But that's maintaining what it has. Mining projects are time consuming and expensive to build. So, while logic says miners like Vale should put growth plans on hold during an industry downturn, that's not really an option if they don't want to be caught unprepared for the next upturn. Thus, Vale spent another $8 billion or so on growth projects last year (for a $12 billion total).
To be fair, Vale's capital spending has fallen drastically since 2011. In that peak year, Vale spent $18 billion with plans to spend $21.4 billion in 2012. In 2011 operating cash flows came in at $24.5 billion, more than enough to cover the projected capital spending for 2012 if everything stayed the same. But things didn't stay the same, and capital spending came in at $17.7 billion.
That sinking feeling
Essentially, the industry trends are going the wrong way, with iron ore prices falling steadily from the 2011 peak. Revenues, operating cash flows, and earnings have all fallen, too. And this is where you come in. Long-term debt increased from $21.5 billion in 2011 to nearly $27 billion in 2012, up $5.5 billion or so. The company's operating cash flow was $16.6 billion that year, so it only needed $1.1 billion to fund its capital expenditures. Where did the rest of the money go?
Is Vale taking on water? Source: Nicholas Mutton, via Wikimedia Commons
Clearly a company has other bills to pay, but one big one that Vale was paying was the dividend. Which in 2012 amounted $6 billion, obviously funded largely by debt. Last year the dividend was $4.2 billion, with plans for the 2015 dividend pegged at $2 billion. In other words, your dividend has been cut to help pay for Vale's capital spending plans so it doesn't have to take on more debt, which has been relatively stable since that $5.5 billion jump. While that's a prudent decision, it sure doesn't feel good for you.
There's no sugar coating what's going on. Vale's not making as much as it was and yet it needs to keep spending on maintaining what it has and growing its business for tomorrow. It's been cutting back on spending and selling noncore assets, but that just hasn't been enough. So, the company has taken on debt, burned through cash, and cut your dividend.
That's a trend that's not likely to reverse until iron ore prices recover. Which, believe it or not, could happen sooner rather than later. Why? Because mining giants like BHP Billiton Ltd (BHP) and Rio Tinto (RIO) are starting to pull back on incremental growth projects now that big projects are coming to completion. That should slow supply growth enough to let demand catch up. And that, in turn, could turn Vale's red ink into black ink, something that might interest more aggressive investors and might induce current shareholders to stick around.
What's particularly interesting now is that most of the big spending is done. So when an iron ore rebound moves revenues higher, cash should flow pretty quickly to the bottom line once operating costs are covered. That, in turn, should lead to debt reduction and a recovery of that slashed dividend at Vale.
