How Will Vale Meet the Challenges of Weak Demand and Samarco?
The Samarco effect in the near term
In the near term, the uncertainty from the Samarco accident will continue to weigh heavily on Vale SA (VALE). Vale has estimated costs of $443 million for Samarco, which doesn’t include legal costs. Costs could escalate far beyond Vale’s expectations. Fitch has already put Vale on a negative watch.
Another challenging year
Vale is expected to have another challenging year in 2016. Cost-cutting and volume growth, especially in iron ore, is expected to continue going forward. This would place Vale at a very advantageous position on the overall industry cost curve. But the further downside to iron ore prices doesn’t bode well for a company whose majority of revenues comes from earnings from this segment.
Vale’s stretched balance sheet with substantial growth capex (capital expenditure) needs going forward doesn’t help matters either. And it’s working against a backdrop of lackluster commodity prices. Worsening free cash flow and leverage ratios going into 2016 remains a key concern for investors. Vale’s high capex plans will continue to put a strain on free cash flow.
Other miners, including BHP Billiton (BHP) (BBL), Rio Tinto (RIO), and Cliffs Natural Resources (CLF), are also going through a rough phase in the face of the bearish commodity (DBC) price environment.
Are analysts turning bearish?
After the Vale Day presentation on December 1, 2015, analysts seem to be turning bearish on the company. BMO Capital Markets has lowered its target price to $3 from $3.75 while maintaining its “underperform” rating. BMO believes Vale’s cost reduction efforts are praiseworthy, but it’s concerned about the massive challenges Vale faces amid depressed commodity prices.
Barclays also lowered its target price from $4 to $3.30 while maintaining a “neutral” rating. Nomura also reduced its target price from $7 to $6, mainly due to the added risk related to potential Samarco liabilities.
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