Vale SA (ADR) (NYSE:VALE) posted another loss in the third quarter. That means the iron ore miner has bled red ink in four of the last five quarters, not a particularly inspiring trend. However, underneath the losses is a company that's preparing for the next upturn. Here's the good and the bad from the quarter.
What do you want to hear first?
When someone tells me there's good news and bad news, I always ask for the bad first. So here's the tough stuff from Vale's third quarter. On a GAAP basis, Vale lost $0.41 a share. Underlying earnings, which pulls out certain one-time items like the impact of currency shifts, was a loss of $0.19 a share. Analysts had been calling for a loss of $0.02 a share and in the year ago quarter the company's underlying earnings were $0.13 a share. It was, clearly, a bad quarter.
On the revenue side of the equation, analysts were looking for sales of around $7 billion. Vale pulled in closer to $6.5 billion, missing the mark by a wide margin. A year ago the company's top line was a bit over $9 billion.
Why the pair of big misses? Two reasons. First, the price of iron ore continues to be weak. Iron ore makes up roughly two-thirds of Vale's top line and, thus, drives bottom line results. In fact, it accounts for nearly 90% of the company's earnings before interest, taxes, depreciation, and amortization. The company's realized prices for its iron ore products fell roughly 15% year over year.
The second big negative was the Brazilian real, which fell nearly 30% in the third quarter alone. Although Vale reports earnings in U.S. dollars, it's functional currency is the real. So as it converts its results it takes a big haircut along the way. In the quarter the miner estimates currency impacts at around negative $5 billion.
How about some good news...
Just to sum it up, weak commodity prices and a depreciating real were the big negatives from the quarter. Those are largely out of Vale's control. This brings us to the good news, which is largely being overshadowed by the red ink.
For starters, Vale was able to increase it's iron ore production in the quarter, hitting an all-time record. That helped to soften the blow of falling iron ore prices, but seems a questionable choice in an oversupplied market. The reason for the increase, however, is more important than the increase itself. Vale is continuing to pursue projects that are lowering its costs or improving its iron ore quality, which allows for higher realized prices than might otherwise be attained.
For example, new iron ore projects led to an increase in iron ore content from 63.2% to 63.5%. That may seem small, but it's a notable change. And the cash cost of sending iron ore to China, a major end market for Vale accounting for roughly 40% of sales, fell 12% sequentially from the second quarter. None of this would have been possible without a combination of cost cutting and Vale's continued investment in new iron ore projects.
It's worth noting that Vale isn't alone in this effort. For Example, Rio Tinto plc (ADR) (NYSE:RIO) increased its iron ore production, too, in the third quarter. This Vale competitor produced roughly 12% more iron ore year over year and 8% more sequentially compared to the second quarter.
Currency issues, meanwhile, are a mix of good and bad. While it makes the earnings presentation something of a nightmare to read, roughly half of its production costs and three quarters of its capital spending is denominated in Brazilian real. This helps keep the company's costs low relative to the competition. That said, the company has a significant amount of dollar denominated debt which is then more costly to service. In the end, currencies tend to ebb and flow over time. Although the impact on the quarter was substantial, the damage has been done and as long as the real remains depressed Vale will have a cost advantage over other iron ore miners. That's the glass half full view.
Two sides to every coin
There's no denying that Vale had another difficult quarter. Based on the iron ore price and currency headwinds that was pretty much baked in the cake. And until there's a notable commodity upturn, more tough times should be expected in the near term. But if you look past the headline numbers, there are still positive things going on at this miner that should position it to come out of the commodity downturn a stronger competitor.