Vale Is Going to Miss This Projection by 20%

Vale, beset by operational issues, is going to fall well short of its original goals in 2019

Reuben Gregg Brewer
Reuben Gregg Brewer
Apr 12, 2019 at 7:47PM
Energy, Materials, and Utilities

The breach of a waste containment dam in late 2015 at Vale's (NYSE:VALE) Samarco iron ore mine in Brazil was a disaster that destroyed nearby towns and left many people dead. Still, Vale was able to weather the headwind in relative stride. Now that a second Vale waste containment facility has failed, however, the giant miner's outlook appears less certain. Not only did the Brumadinho disaster have a greater impact on the lives of the people around it, but it is also rippling through the entire iron ore sector. 

This was very bad

There's no way to fully explain the disasters here without looking at the pain and suffering caused. The death toll at Samarco was around 20, and the loss of life because of the Brumadinho dam failure was estimated to be around 300. Worse, it appears that Vale, or at least people within the company, knew that the dam was a material risk -- and nothing was done. Add in the previous dam collapse and an ugly trend begins to emerge -- one that is likely to make working through the legal and regulatory issues caused by the current disaster a much more difficult process. 

A scale weighing blocks that spell out RISK and REWARD

Image source: Getty Images

At this point, Brazilian courts have frozen company funds and stopped Vale from operating certain assets. The company has taken precautionary steps and evacuated residents from the regions around a number of other assets that have been deemed a material risk. And the globally important iron ore miner has parted ways with key executives, including the CEO.   

The problems following the Samarco disaster were likely to linger for years. But the impact of Brumadinho could alter Vale's future forever, and at this point there's no clear way to determine what is going to happen from here. It's little wonder the stock plummeted on the news of this second disaster. Most investors would be better off avoiding this risky situation. However, it isn't just impacting Vale.

The bad and the, sadly, good

Vale's decision to evacuate the areas around other mines that may pose a risk wasn't unique. Vertically integrated global steel giant ArcelorMittal (NYSE:MT) also evacuated the residents surrounding one of its mines in Brazil. That's a cost headwind that probably wouldn't have existed without the two disasters at Vale's mining assets. But it isn't the only fallout that steelmaker ArcelorMittal has to deal with.   

Vale recently announced that, because of the Brumadinho disaster and its aftermath, iron ore production would fall 20% below its previous projections in 2019. The miner is one of the largest iron ore producers in the world, so this is a big deal for this market. As a commodity, supply and demand have a huge impact on prices. With a material amount of supply dropping out, the price of iron ore has started to rise. So not only is ArcelorMittal facing costs related to the evacuation, but it is also likely to be hit with rising costs for a key commodity. Owning its own mines will help offset some of the pain, but not all, at this giant steelmaker. 

MT Chart

MT data by YCharts

Part of the issue is that ArcelorMittal makes heavy use of blast furnaces to make primary steel. Iron ore is the main feedstock for this global company, as it is for U.S.-based competitors AK Steel and United States Steel (NYSE:X). The rise in iron ore prices is part of the reason why these stocks swooned in March. Relatively less impacted were peers Nucor and Steel Dynamics, which primarily use scrap metal in their electric arc furnaces.

What's bad for steelmakers, however, is likely to be good for iron ore producers. That includes Vale's largest peers, Rio Tinto (NYSE:RIO) and BHP Group (NYSE:BHP). As iron ore prices rise, these miners will generate more income per ton sold. In fact, their costs could actually go down if shipping costs fall because Vale isn't putting as much iron ore on the water. Either way, profit margins for these iron ore producers are likely to be higher this year, with rising prices the only major change.

VALE Chart

VALE data by YCharts

That said, it's hard to gauge the long-term impact on miners or their customers. Since supply and demand are what drive iron ore prices, the current uptick could turn out to be a short-term benefit. For example, if Vale's production shortfall is long term in nature, it's likely that other producers will quickly step in to fill the void. In other words, the near-term iron ore market uptick isn't one to count on long term even though it's likely to boost Vale's peers in 2019. You'll need to pay close attention to market dynamics and the news out of Vale on the production front.

What's an investor to do?

The second disaster in such a short period of time at Vale shouldn't be overlooked by investors. All but the most aggressive would be much better off avoiding this troubled company. If you are looking for a globally important miner, peers like Rio Tinto and BHP are much better options. However, don't go in thinking that the recent uptick in iron ore prices is permanent. The supply disruption is likely to be fleeting as the industry adapts, and could even lead to excesses when (maybe if) Vale's production picks up again. The better play today, in fact, might be to look at steelmakers, like ArcelorMittal, that have been impacted by Vale's troubles -- which could turn out to be a temporary headwind that's put Mr. Market into an overly downbeat mood.