Vale SA (ADR) (VALE), Rio Tinto plc (ADR) (RIO): A Look Into The Iron Ore Marketplace

With global growth slowing further in April, and the market increasingly recognizing that the Chinese slowdown is structural, many commodity prices will probably remain under pressure as we complete the traditionally volatile month of May. Year to date, iron ore prices are down by 8%. What should you do if you hold any of the following popular producers in your portfolio?

Vale SA (ADR) (NYSE:VALE), the Brazilian bet

Management’s efforts are playing a big role in the Brazilian mining champion Vale SA (ADR) (NYSE:VALE). First quarter EPS came at $0.60 from the loss of $0.52 in the last quarter of 2012. EBITDA came up 18% quarter over quarter and 55% up year over year with EBITDA margin increasing from 36% to 48% quarter over quarter thanks to consolidated selling, general and administration expenses decreasing to 3% of net revenues, and second, base metals margin improvement to 41% from 10% in the fourth quarter.

Vale SA (ADR) (NYSE:VALE) is cutting costs efficiently and maintaining its low leverage with net debt to EBITDA at 1.3. Meanwhile, capital expenditures were in line with management’s guidance and the company is on track to deliver by 2014 the expansion of Carajas Norte, Conceicao Itabiritos and Vargem Grande, projects which should drive the company’s growth in net iron ore volume in 2014. Overall, trading at a 2013 5.5 EV/EBITDA (below global peers), Vale SA (ADR) (NYSE:VALE) is the clear buy within the global large cap miners.

Rio Tinto plc (ADR) (NYSE:RIO) is facing problems

Rio Tinto plc (ADR) (NYSE:RIO) is under attack from many angles. At the macro level, weak Chinese growth data and fears of a global slowdown are reducing iron ore prices. At the company level, lower copper production and one-off costs as a result of the Kennecott Copper mine slip (a slide occurred in the northern section of the pit and around 150 meters of waste material slipped from the north wall of the mine into the pit area blocking the mine) are complicating the company’s free cash flow.

Even if a better than expected outcome would result from the various company specific issues, an improved macro outlook is essential for Rio Tinto plc (ADR) (NYSE:RIO) to outperform the market. While Rio Tinto plc (ADR) (NYSE:RIO) offers the best exposure to global iron ore markets, fears of overwhelming market volume growth and a near-term expectation of a slowdown in Chinese steel production are set to put pressure on prices. That said, through its 50% volume increase, I expect Rio Tinto plc (ADR) (NYSE:RIO) to consolidate iron ore market share. This could help offset lower prices.