Like all miners, Vale SA (ADR) (NYSE:VALE) is facing significant headwinds. That led to a tough third-quarter. But that was expected. What you really want to understand is what's going on behind the numbers, and on that score, Vale's management has a few things it wants you to know about.
Yes, it was bad
Vale CEO Murilo Ferreira actually started with some good news before getting into the actual results, but we'll start with the bad news first. According to Ferreira, "Adjusted EBITDA was US$1.9 billion, 15% lower than second quarter 2015, mainly as a result of lower sales prices in all our commodity except gold and phosphate. Gross revenue amounted US$6.6 billion, 7% lower in the second quarter 2015, also due to lower commodity prices."
Note that these numbers are sequential quarters, year over year it was even worse. Adjusted EBITDA was down nearly 50% compared to the third quarter of 2014 and gross revenues were down almost 30%. Ouch! But this was pretty much expected because commodities have been in a funk and there's not much a commodity player like Vale can do about that piece of the equation. Still, these results show just how bad the downturn has been, which is an important thing to keep in mind.
Now for something completely different
But that's the bad news. Remember it, but you'll want to see beyond it, too. For example, the first bit of information Ferreira shared was, "I'm pleased to report that Vale had a sound operational result achieving a production record for iron ore ... " Iron ore related products make up about two-thirds of Vale's revenues, so this is the big business to watch.
Although the steep drop in iron ore prices is a big concern, the projects on which Vale is working are coming online largely as planned. It's nice to see solid execution. This includes cost cutting efforts, but also efforts to prepare for a future in which Vale sees more demand.
So the CEO's highlight of increased production really has two implications. The first is that Vale, as a business, is still doing just fine. Which is what Ferreira was trying to get across. The second take away is more nuanced.
Our costs are falling
It may at first seem odd to produce more iron ore when iron ore prices are low. But there are reasons why this is happening. For example, the iron ore projects now coming to fruition are ones that were started years ago. It's not always practical to stop moving on a project once it reaches a certain stage. Also, and this is the one to really take note of, the projects Vale is working on are lowering its production costs.
According to the CEO, "... above all I'm proud to inform you that our iron ore cash cost decreased by $3.10 per ton and reach[ed] $12.07 per ton this quarter." There's a lot of moving parts behind that number. But a core reason for the falling costs is that new mines are producing high quality iron ore at lower costs than Vale's older mines. So the projects that are still working their way through the pipeline, like SD11 which is about 75% complete, are making Vale a stronger competitor. That helps now, to be sure, but it really sets the company up for a better future when commodity prices recover.
Speaking of volatility
So that's the bad news and some of the good news underneath. Now for a mixed blessing: exchange rates. Around half of Vale's production costs and roughly 75% of its capital expenditures are denominated in Brazilian real. That currency has fallen dramatically versus the dollar, which is the currency used for the commodities the miner sells.
In other words, the weak real is helping Vale keep its costs down. That's a benefit right now because it helps make Vale even more competitive. However, a lot of Vale's debt is denominated in dollars, which means Vale's interest costs are higher. So a weak real isn't all good, it's more of a mixed blessing.
The real problem, though, is that volatile exchange rates make understanding Vale's results a lot more complicated. Which is why CFO Luciano Siani Pires explained, "... this wasn't only because of exchange rate and volume there was a real gain in productivity ..." when asked about the cash cost improvement. If you are watching Vale, it's worth taking a moment to look through its earnings release which includes a section dedicated to the impact of exchange rates. Some things aren't as clean cut as you might like.
It's a rough time
The last big takeaway from the quarter is that Vale is doing more than just improving its business. It realizes that the market is weak and it needs to make it to the other side if it wants to see the fruits of its labors. Which is why CEO Ferreira updated investors on some finance issues:
"In line with our divestment plan, we concluded the sale of a minority stake in MBR for over $1 billion and for Valemax to China merchant for roughly $450 million ... Net debt decreased $2.3 billion to $24.2 billion with a cash balance of $4 billion ..."
You don't need to know the fine details, the basics are enough. Vale is trying to monetize non-core assets to help shore up its balance sheet. That will help the miner make it through this rough patch. This is the right thing to do and essentially what all other miners are doing, too.
Take Rio Tinto (NYSE:RIO), for example, which recently agreed to a roughly $600 million sale of some coal assets. The logic supporting the move is that Rio would rather direct its capital to opportunities with higher returns. That's basically what Vale is doing, too, putting its money behind its most promising opportunities -- like low cost, high quality iron ore mines. Essentially, miners across the board are raising money where they can to keep their best businesses rolling.
There's no way to sugarcoat Vale's third quarter; financially speaking, it wasn't good and volatile exchange rates only complicate the issue. But Vale is doing the right things to improve the company and to make it through the commodity downturn. That's the story behind the headlines and the one that you, as an investor, need to focus on. Yes, Vale is struggling in many ways, but it's also getting better, too.