When Vale SA (ADR) (NYSE:VALE) reported earnings, the headline number was a vast improvement over the previous quarter. But that was largely due to currency fluctuations, which makes understanding the underlying trends even more difficult at this giant iron ore miner. Here are five key takeaways (plus a bonus one) that Vale's management wants you to know so you can get a handle on how the company is doing.
The "real" thing
The first quarter of the year was deep in the red because of a 20% decline in the value of the Brazilian Real, Vale's home currency. That didn't repeat, thank goodness, because currency issues weren't a headwind this quarter. In fact, currency changes actually helped out a bit, with CEO Murilo Ferreira noting that the, "... appreciation of the Brazilian Real on the translation of Brazilian reais denominated debt in U.S. dollars," was a net benefit.
Although currency wasn't a huge deal this quarter, it's important to keep in mind the impact of such currency swings when looking at a foreign company like Vale that does business around the globe. Just how important is clear from the different impact between the first and second quarters.
The business is solid
With that complication out of the way, CEO Ferreira was excited to highlight his company's operational successes. For example, he noted Vale had, "... production records for the second quarter in iron ore, copper and gold."
While it's hard to look at that statement and feel good about it when the world's commodity markets are oversupplied, pushing prices down, you shouldn't underestimate the hard work and time it takes to increase production. In fact, because mines take so long to build and expand, you can't wait for demand to tick up to start construction. So the timing of the increases isn't great, but it will position the company for the next commodity upturn.
For the margin of it
That said, production increases aren't exactly hurting Vale today even though the biggest benefits probably won't be seen until commodity markets turn higher. For example, Gerd Peter Poppinga, head of the company's iron ore business, noted that, "... in 2015 we are going to substitute low margin high silica products ..." with, "... higher grade material from Carajás and Southeastern system ..."
That's a little cryptic if you don't know Vale, but what he's saying is that newer mines with higher quality iron ore are displacing production from older mines with lesser quality ores. So Vale's product is getting better because of the new production it's bringing online. This has notable implications.
While talking about the company's results, the CEO noted that higher sales volumes and lower costs were both positives. However, another key driver were was, "... higher realized prices ..." One example of this he gave was in the iron ore fines business, where the price Vale realized was $2 per tonne higher than the year ago period.
That's an example of what Vale's continued iron ore expansion is allowing the company to do. So on the one hand, the miner's production growth is helping put pressure on global iron ore prices. But on the other it's improving the quality of Vale's product today, allowing it to realize better prices, and positioning the company to gain market share and widen margins down the road.
Lower costs, too?
But the really interesting thing is that all of this is happening at a time when Vale is cutting costs. For example, CEO Ferreira explained that, "Cost and expenses decreased by more than $1.6 billion in the first half of 2015 when compared with the same period in 2014, despite the higher sales volume." Cost cutting came across the board, with a notable drop in capital spending, "... of over $700 million when compared to the first half of 2014."
So Vale is doing more with less and getting better at the same time. That's exactly what you want to see during a downturn. And why you should be pleased with Vale's operating results even if its top- and bottom-lines aren't what they used to be.
The bonus round ...
The sixth key takeaway from the earnings call is that Vale continues to creatively use its assets to bolster its finances. For example, it's been selling its ships and streaming rights to gold, and taking on partners to help fund growth. This quarter it, "... concluded the sale of four Valemax [ships] for US$445 million ..." And inked a deal to sell some more. It also sold a minority stake in an iron ore smelter business.
These actions allow Vale to keep moving forward without as great a need to tap the capital markets for cash. Since Vale's business is under pressure that's a big benefit right now and shows that management is working hard to preserve value for shareholders over the long term.
In the end, it wasn't a great quarter financially for Vale, but with the commodity downturn that's to be expected. However, if you look past the big picture numbers, there's a lot of good things going on behind the scenes. Basically Vale is becoming a better company despite the downturn.