Iron ore is crucial to the global economy. That's because it's a key component in steel, which is in everything from bridges and buildings to cars and wind turbines. Steel is so essential in supporting the economy that iron ore is the most-used metal on the planet.
As the world's largest iron ore producer, Vale (VALE 1.47%) stands to benefit from the global economy's continued use of steel. However, the company's outsized exposure to that market does have its drawbacks. That's why the iron ore giant's stock has tumbled about 15% in 2019 and is down more than 27% over the past year.
Here's a look at the case for and against buying shares of the mining giant.
Image source: Getty Images.
The bull case for Vale
Vale operates several iron ore mines in its home country of Brazil, which boasts the highest ore concentration on the planet. Because of that high concentration -- the rocks found in the country's northern Carajas region contain 67% iron ore on average -- Vale can produce lots of low-cost iron ore. That enables it to make lots of money in strong market conditions. During the second quarter, for example, Vale's iron-ore-related business hauled in $4.2 billion of earnings before interest, taxes, depreciation, and amortization (EBITDA), 17% higher than its first-quarter total despite weather-related issues and higher costs following a dam rupture, thanks to a 21% uptick in iron ore prices. That ability to cash in on higher iron ore prices is one of the main reasons an investor would buy shares of Vale.
While iron ore is Vale's biggest moneymaker, the company also mines two other key metals: nickel and copper. That's worth noting since both are vital for renewable energy. Copper is an excellent conductor of electricity, which is why the demand for that metal is on track to surge in the coming years as investment in wind, solar, and electric vehicles accelerates. Meanwhile, nickel is an important metal for energy storage.
Another noteworthy feature of Vale is its healthy financial profile. While the company had nearly $10 billion of debt on its balance sheet as of the end of the second quarter, its leverage ratio was 0.9 times of net debt-to-EBITDA. That's a comfortable level for a mining company. It's also down from 1.0 times at the end of the first quarter after the company used some of its $2.2 billion of free cash flow to pay off $1.2 billion in debt.
The bear case for Vale
Vale produces several commodities in addition to iron ore -- it's the world's largest nickel producer and a top 10 copper company. However, iron ore is by far its biggest revenue generator at 74% of its sales last year, followed by nickel at 13% and copper at 6%. That high exposure to iron ore makes the company highly susceptible to volatility in that economically sensitive market. That's a concern given the current fears that the global economy could be heading into a recession. If that happens, iron ore prices will likely plummet, which would put pressure on Vale's profits and stock price.
Another concern with the company is its environmental track record. In 2015, one of the company's mining dams in Brazil collapsed, killing 19 people and polluting a river. Meanwhile, earlier this year, an even bigger catastrophe occurred when the Brumadinho dam collapsed. It spilled 3 million gallons of contaminated water, destroying a town and killing nearly 250 people. These tragic incidences have cost the company a lot of money as it has already set aside or spent $6 billion on remediating the environmental damages of the Brumadinho dam collapse.
Vale owns several other large-scale mining dams in the country, which is a concern given that it has had two disasters in recent years. While the company verified the safety of its dams following the 2015 accident, Brumadinho's collapse suggests that they might not be as sound as the company thinks. Because of that, it might need to spend money to reinforce its remaining ones. If not, the risk of another disaster will loom over the company.
Verdict: Vale is too risky to buy
Vale has unparalleled upside to the iron ore market. Add that to its healthy balance sheet and exposure to the clean-energy-powered nickel and copper markets, and there are lots of things to like about the company's prospects.
However, after two devastating dam disasters in Brazil, there's too much risk that an even greater tragedy could strike. Add that to the growing concerns that the global economy could tip into a recession, and the risks seem to overshadow the company's reward potential, even with the decline in its share price.
