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This Undervalued Miner Has the Right Focus

By Vladimir Zernov - Nov 12, 2013 at 11:47AM

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Vale trades at a discount to peers despite growing revenue and operational improvements.

Vale (VALE -2.73%) is an underperformer among big diversified miners. The stock lost almost 20% this year, while BHP Billiton (BHP -2.45%), for example, lost just 5%. However, I think that Vale's focus on iron ore in combination with cheap valuation makes the stock interesting.

Iron ore brings results
Iron ore brought in 73.4% of Vale's revenues in the third quarter of this year. Importantly, cash cost to produce iron ore fell 8.5%. Iron ore was a major contributor to the fact that operating revenues rose 14.5% in comparison with the second quarter. Both iron ore sales volumes and prices rose, boosting revenue.

Vale's main customers are in China, Japan, and Brazil, so the company is dependent on their steel manufacturing demand. Lately, Chinese demand was strong, leading to the increase in iron ore prices. This is surely positive for Cliffs Natural Resources (CLF -6.05%), whose revenue mostly depends on iron ore.

Cliffs is yet to solve numerous problems under the leadership of new president and chief operating officer Gary Halverson, who came from Barrick Gold. Cliffs has to decide whether to proceed with the Bloom Lake mine expansion project, as well as how to reduce its $3.3 billion debt at the same time.

While Cliffs is thinking, others are increasing production. BHP's iron ore production rose 23% in just one year. BHP has almost completed the expansion of its Jimblebar mine in Australia, which increases the mining capacity to 35 million tons per year.

Solid financial position
Vale had $7 billion of cash at the end of the third quarter. This number should rise significantly after the company completes the sale of its Norsk Hydro shares. Vale is going to sell 224 million shares, roughly 50% of its current stake.

This move is a logical continuation of current Vale's strategy to divest non-core assets. This move could be favorable to shareholders, as some of that money would probably end up in a dividend. At the beginning of this year, Vale approved a $4 billion minimum total dividend. In fact, the company has already distributed $4.5 billion to its shareholders. I think that shareholders can count on next year's dividend not being lower.

Cheap valuation
Despite the run-up from July's lows, Vale remains very conservatively valued. The company is trading slightly above its book value, and at less than 8 times its future earnings. In comparison, BHP Billiton is generously valued, trading at more than 13 times its future earnings. Vale is also undervalued if compared to Rio Tinto, which trades at 10 times its future earnings.

I think that this is a little bit irrational. Vale focuses on iron ore, but remains a diversified producer. Iron ore and met coal prices seem to have bottomed, as steel production gains some steam. The company's revenue is growing. Gross margin rose from 43.6% in the second quarter to 48.3% in the third quarter. At the same time, selling, general, and administrative expenses dropped from 324 million to 315 million. This improvement looks more significant if we remember that Vale's revenues rose 14.5%.

All in all, I believe that Vale is currently undervalued in relation to its peers. The company is executing well, and is returning money to shareholders. At current prices, Vale could be a good fit for your portfolio.

 

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Cliffs Natural Resources Inc. Stock Quote
Cliffs Natural Resources Inc.
CLF
$18.47 (-6.05%) $-1.19
BHP Group Stock Quote
BHP Group
BHP
$56.55 (-2.45%) $-1.42
Vale S.A. Stock Quote
Vale S.A.
VALE
$13.21 (-2.73%) $0.37

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