How Big Is Vale's Dam Problem?

If your portfolio includes mining stocks in general, or Vale SA (VALE -1.11%) specifically, you may be rethinking it in the wake of the Jan. 25 Brumadinho dam disaster, which spilled 3 million gallons of contaminated mining waste, destroyed a town, and killed at least 65 people in Brazil. (The death toll is uncertain, but hundreds are still missing.) As the largest iron ore extractor in the world, Vale has many, many similar tailings dams at its mines across Brazil, and this one -- like the others -- had been inspected and certified as safe.

In this segment of the MarketFoolery podcast, host Chris Hill and Motley Fool director of small-cap research Bill Mann address a listener's question: Is this going to lead to serious long-term troubles for Vale?

A full transcript follows the video.

Check out the latest earnings call transcripts for companies we cover.

This video was recorded on Jan. 29, 2019.

Chris Hill: Before I get to the email, this requires some setup. Some listeners may have seen the news out of Brazil from last weekend. A terrible story of a mining dam bursting, which triggered a deadly mudslide. Somewhere in the neighborhood of at least 60 people confirmed dead.

Bill Mann: Three hundred missing.

Hill: Hundreds more missing, probably presumed dead at this point. It's a tragic story.

One of our listeners, looking at it through the lens of investing -- and we've seen this play out before -- an email from David, who asked, "I was wondering how the dam burst in Brazil affects Vale in the long term." Vale, the company attached to this. "BP's stock still hasn't recovered from its pre-2010 disaster levels. Does this dam spell doom for the world's largest iron ore company?"

Vale, probably not well known to a lot of listeners just because we don't really focus on commodity stocks all that much.

Mann: No, but touch something metal to your left or your right, and most likely Vale produced some of the metal that's in it. It's a foundationally important company to the global economy. It's very, very important to the Brazilian economy. And therein lies a little bit of the rub.

Vale has been sued by the Brazilian government for a 2015 disaster that happened about 80 miles up the road from this dam, in which 10 people were killed. The government sued for $5.3 billion U.S. dollars. That was a much smaller accident. After that accident, Vale and all of the Brazilian miners went through a process of verifying the safety of all of their dams. According to the Brazilian National Water Agency, there are 600 -- this is called a tailings dam, it's part of the mining process. There are 600 of them in Brazil, and 144 of them are big enough to cause catastrophic environmental damage.

The fact is, they've gone through the process to verify these dams. In fact, this dam was 28 stories high. To me, that's an interesting balance between -- there's no such thing as a story as a precise amount of measurement, but there was 28 of them. It's a huge dam. The dam itself basically is made out of mud. What happened, they believe, is that the mud literally liquefied in place. So it looks like it's in good shape until suddenly, it fails. There are 144 dams just like this. Vale owns a large number of them.

I'm not saying that this is a no-touch company, but I am saying that they don't really have the ability to either replace the dams or to say for sure that these dams are safe. I'm relatively sure they had $5.3 billion worth of interest last time in making sure this didn't happen again, and it happened again.

Hill: It seems like, if you're an owner of this stock, you might want to start looking at what's on your watchlist.

Mann: Yeah. It's interesting, because in the same way that the state of New York is so careful with its Wall Street firms -- Wall Street is worth 25% of the tax base of New York State, there's only so much they're going to do to punish them. We look back at the financial crisis, the answer was basically nothing. Brazil is in the same boat. Brazil gets a huge amount of its tax base from its largest mining companies, in particular Vale. So, I don't think that Brazil will do anything that is existentially threatening to Vale. They just can't.

Hill: You think back to the recent scandal involving Volkswagen and getting around the emissions test, all that sort of thing. Somewhat analogous in that, at that moment in time, you can look at that and say, "Boy, they're really going to get punished." And then, you start to look at how crucial Volkswagen and the automotive industry is to the German economy, and then you go, "Oh, OK. They can't. That's a really bad idea, to punish Volkswagen to the point where it goes out of business."

Mann: Right. They can't leave a crater where Volkswagen was. The other thing for Vale that's interesting is, there's a brand-new government in Brazil, and he's a populist. I think you could see a scenario where he comes down really, really hard on them in ways that are visible, like, "I'm here to protect the people of Brazil," but in invisible ways, Vale will ultimately be allowed to continue to exist.

Now, the question that's being asked is, "What do I do with the equity?" And I think you've got to see what the lawsuits look like before you touch. Just because they lost 25% doesn't mean that it's not going to get much, much worse for them.