Iron ore prices have been depressed for quite some time now. As a result, iron miners like Vale (VALE, Financial), Cliffs Natural Resources (CLF, Financial) struggled for the majority of 2014 and 2015. What makes matters worse for these companies is that iron ore prices are expected to remain at or under current levels, ending the hopes of any turnaround in the near future. Goldman Sachs recently said:
"The structural drivers of the iron ore price trump cyclical drivers, and they are unchanged since mid-2014: demand is lackluster, supply growth continues, and prices must overshoot on the downside to force high-cost mines to close." The firm further added, "No major producer has revised their long-term production targets downward. The rally is taking place during the early stages of a long bear market that in our view is set to last well into the next decade."
Vale derives a massive portion of its revenue from iron, hence it’s no surprise that the company has been performing terribly.
Iron ore price dropped by $12 per ton in the first quarter of the year. In addition to this price decline, Vale’s price realization was negatively impacted by almost $7 per ton from its price system, representing a negative impact of about $450 million. Despite a good decline in cost and expenses, its EBITDA declined 27% compared to Q4 of 2014. The company’s iron ore segment brought 62.1% of total revenue, down from 67.3% in the fourth quarter of 2014. Vale's first quarter results marked its third consecutive quarterly loss. The company reported a net loss of $3.1B, led by the depreciation of the Brazilian real against the USD.
China accounts for half of the steel production globally and is witnessing an economic slowdown. As iron ore is used in manufacturing steel, so the drop in steel demand has created a negative impact on the raw material as well. A rebound in the Chinese economy looks difficult at present, as the country's producer price index has dropped for 38 months in a row.
Vale's cash position is expected to deteriorate further as the company plans to spend extensively on its massive S11D project. The company is about to spend $3.7 billion on S11D this year, as the company anticipates that it will considerably decrease its costs once it is completed. On the other hand, low iron ore prices put significant pressure on the company's cash flows and will more than offset any gains made from this project.
The market projections for iron ore remain negative as the imbalance of supply and demand continues. The consensus seems to be a further falling iron price which might approach $45 or even $40 in 2016 while the company needs an iron ore price considerably higher than $60 per dry metric ton in order to generate the cash which it desperately needs. The company plans to increase its capacity from 350 million tons to 450 million tons after investing in logistics in Nacala Corridor, which is a risk as there is a weak demand of steel in the market.
Conclusion
Analysts expect iron ore prices to remain depressed, meaning a turnaround for Vale is extremely unlikely. In addition, the company hasn’t taken any smart steps to counterbalance the drop in iron ore price. The company’s investing $3.7 billion in its S11D project, however given the challenging conditions; I don’t think Vale will reach the break-even point in the near future. Investors should expect a turnaround at Vale any time.
