Selling off non-essential assets is a time-tested strategy for troubled businesses, allowing them to focus on what matters most and get back on track. But mining giant Vale (VALE) recently announced it would start selling off core assets, a marked shift from its previous policy of only shedding operations outside its core competency, and a possible troubling indicator for the industry.
Investors should consider these four factors when thinking about Vale's fourth quarter financials results and how they might play out over the coming year and beyond.
1. Not always the master of its universe.
Vale's results were done in by a host of macroeconomic problems over which it had little control. The Brazilian real, for example, lost nearly half its value against the U.S. dollar, and that played havoc on its U.S.-denominated debt, which accounts for 93% of the total $28 billion in gross debt it holds.
Worse, though, was the sustained and dramatic decline in iron ore prices, which went from an average of $96.70 per metric ton in 2014 to $55.50 per metric ton, closing out 2015 below $40 per metric ton. Although it's possible the miner's first quarter of 2016 may look a little better in comparison as iron ore has rallied 18% so far this year, closing above $50 per metric ton the other day, analysts say the bounce is due to Chinese steel mills restocking inventory, but with steel production likely to decline sharply this year even as Australian iron ore output continues to rise, the gains will give way once more.
Shares of Vale, BHP Billiton (BHP -0.60%) and Rio Tinto (RIO -0.62%) have all rallied as a result, rising by double-digit percentages over the past month, but the trio are all part of the problem, continuously adding additional low-cost inventory to an already overburdened supply glut.
2. Everything is for sale.
To reduce its massive debt load, Vale wants to sell some $10 billion worth of assets over the next 18 months. CEO Murilo Ferreira said the miner wasn't married to any of its operations, noting "We don't have a specific attachment to any assets from any commodity," but considering the depressed state of the market, Vale might have a tough time finding a buyer willing to pay a reasonable price.
That's what happened to Rio Tinto when it tried to unload its Canadian iron ore assets a few years ago and found that because there were so many other assets on the market, buyers could be choosy and did not have to pay the premium it was seeking. It eventually pulled them off the market.
3. The sales signal others may begin doing the same.
The first thing that was jettisoned by the miners was their dividends. Vale has been cutting its payout for the past year and both Rio and BHP announced last month they too will give up their resistance and cut their dividends too. Selling core assets may just be the next trend to sweep the industry.
In January copper and gold miner Freeport-McMoRan announced that it would consider selling off core assets as commodities remain depressed, and last month said it had agreed to sell a $1 billion stake in its Morenci open-pit mine in Arizona to Sumitomo Metals Mining as part of its plan to reduce its outsized debt load. That was followed by Anglo American announcing it too would become a seller, ridding itself of its Minas Rio iron ore project in Brazil. If a lot more miners follow their lead, everyone will run into the problem Rio.
4. The impact from the Samarco dam break is still being felt.
Last November, the tailings dam catastrophically failed at Vale's Fundao joint venture project with BHP in Brazil, destroying the town of Bento Rodrigues in the state of Minas Gerais and killing 19 people. Vale's assets were subsequently frozen; it was shut out of the credit markets, causing it to have to draw $3 billion from its revolving credit facilities; and one of the contractors involved was charged with homicide.
Both Vale and BHP Billiton have just reached an agreement with Brazil to pay at least $5 billion in damages for the dam failure, but they will be able to repay this amount over 15 years. It was the reason behind last Wednesday's jump in their stock, but the settlement does not cover lawsuits that may arise from the disaster, which are likely to be many, and the criminal investigations that remain ongoing. This will hurt for a long time to come.
Drastic times may call for drastic measures, but burning the furniture to heat the house may not be the right course for Vale. Rather than selling off essential businesses, a smarter policy might be shutting down production to help ease the supply glut and allow prices to rise. That would be more beneficial in the long run, but its reluctance to do so indicates Vale's stock may tumble yet again.