Shares of global mining giant Vale (VALE 2.87%) look enticing today relative to its closest peers Rio Tinto (RIO 0.43%) and BHP Group (BHP 0.22%). But before you pull the trigger on a relatively cheap stock, step back and look at the bigger picture. And when it comes to Vale, that picture is increasingly ugly. Here's why Vale is best avoided by most investors.
These numbers look too good to be true
Since the start of Oct of 2018, Vale's stock is down around 15%. Over that same time span, Rio Tinto's shares are up 14% and BHP's stock is up around 5%. That disparate performance has set up a material valuation gap between Vale and its largest competitors in the mining space.
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For example, Vale's price-to-book value ratio is around 1.5 times compared to 2.2 and 2.6 times, respectively, for BHP and Rio. Vale's price-to-sales ratio of 1.8 times is a little below Rio's 1.9 times and notably beneath BHP's 3.3 times. Although these are two of the more dramatic valuation examples, the point is that Vale's stock is currently trading at what, compared to its closest peers, seems to be a pretty attractive price.
The problem here is that valuation alone doesn't tell you the entire story. While it is great to buy stocks when Wall Street puts them in the sale bin, often there is a good reason for the discounting going on. You need to be selective when looking at off-price merchandise. And in the case of Vale, there's an extremely good reason for the low relative valuation.
The fly in this ointment
Vale's current woes have been years in the making. The big problems started in late 2015, when a mine waste containment dam at the Samarco mine collapsed in Brazil. This mine was owned 50/50 by Rio and BHP. Property was destroyed, lives were lost. The two companies will split the material legal costs related to this disaster. They were working toward an over $40 billion settlement agreement with Brazil, which was supposedly close to being completed in late 2018.
And then there was a second mine collapse in late January 2019, this time at Vale's 100%-owned Brumadinho mine. Property was destroyed and materially more lives were lost. On a company level, the CEO departed, the dividend was eliminated, and the miner was forced to cut production by as much as 20% because of the need to close mines across its portfolio for inspection.
One disaster is an unfortunate event. Two suggests that there is a potentially bigger problem that may, in fact, be symptomatic of a troubled safety culture. News that the company had been warned of the risk with regard to the Brumadinho mine didn't help the situation any. The second disaster also put the settlement talks surrounding the first one on hold. This is an ugly situation with no clear solution or final cost at this point.
Vale Price to Book Value data by YCharts.
The problem of lax self-regulation has been taken up by the entire mining community, with the industry setting up a task force to examine the issue and set binding regulations. Although too late to stop the two disasters that have taken place, this is an admirable move that shows the industry is taking the issue seriously. But it won't solve the problem that currently exists, since the risk of mining waste dam collapses built up over years of miners neglecting the issue.
Which is why it is so unsettling that Vale had to warn Brazilian regulators that another waste dam was at a high risk for collapse. Shifting at the waste dam at the Gongo Soco mine spurred Vale to make that announcement. Although nothing material has happened there, the fact that a third mine was troubled enough to be pointed out to regulators speaks volumes about the risk Vale and its shareholders face.
You simply can't own Vale without wondering when the next shoe will drop. And while Vale is taking steps to be more transparent, releasing a report on the risk profiles of all of its Brazilian dams, that doesn't actually change the fact that it still has dams that pose a risk to the surrounding communities. It really just highlights that this issue is larger than many may wish to believe.
That, meanwhile, doesn't take into consideration the legal issues Vale continues to face. It hasn't even put the Samarco disaster behind it and it's already dealing with another, larger, collapse. Moreover, Vale will be 100% responsible for any costs stemming from the Brumadinho event. So even if another mine collapse is avoided, the financial future for Vale is still very hard to predict. And any final resolution will likely take years to complete; it has been more than three years since the Samarco collapse, and the outcome there remains up in the air.
Cheap but not worth the risk
Vale stock is, indeed, cheap relative to the valuation of its peers Rio Tinto and BHP. That, however, doesn't make it a good deal. Two mine disasters, concern about other waste dams in the miner's portfolio, and the ongoing legal issues related to the events so far create too much uncertainty. With little to no way to get a handle on the risks facing Vale today, the cheap price isn't enough to justify buying.
