Why Vale SA (ADR) (VALE) Has Yet to Bottom

Just how cheap is Vale at this time?

At this time Vale SA (ADR) (NYSE:VALE) appears to be particularly cheap with a price to book ratio of 2 and an enterprise value to EBITDA ratio of 6. But as the table below illustrates, both Cliff’s and Rio appear to be far better value on the basis of those metrics.

Source data: Yahoo Finance, Y Charts and Fidelity.

Furthermore, while I am confident that BHP and Rio can continue to grow profitability in an environment where iron ore prices are continuing to fall by virtue of their diversified operations, I do not believe that Vale or Cliff’s can. This is because of the significant dependence on iron ore sales as a driver of revenue.

The impact of the falling iron ore prices on Vale’s financial performance can already be seen in the company’s first quarter 2013 performance, with revenue falling by almost 33% quarter on quarter to $10 billion. While net income more than doubled for the same period to almost $3 billion. The almost doubling in net income, despite appearing to be a solid achievement, did not occur because of decreasing costs or increasing profitability but can be primarily attributed to asset write downs that saw the company report a loss in the fourth quarter 2012.

Risks remain high for Vale

Vale SA (ADR) (NYSE:VALE) also continues to remain a far higher risk play for investors than either Rio or BHP, with the company still experiencing problems associated with the shipping costs and times to reach China. Vale is also exposed to increasing political and economic risk in Brazil, with the Rousseff government having defined iron ore as a strategic asset and continuing to pursue Vale for $15.5 billion in additional income taxes that it claims are due on the profits of Vale’s foreign subsidiaries.

Neither Rio, BHP or Cliff’s are exposed to such a high degree of political and economic risk in the countries in which they are domiciled or where they have the majority of their iron ore operations. I also expect to see Rio and BHP continue to cut costs through extensive restructuring operations and the economies of scale available in their operations in north-west Australia.

Bottom line

It is clear that demand for and the price of iron ore price will continue to fall on the back of slowing economic growth in China. This will have a significant impact on Vale’s sales growth and profitability given its significant reliance upon iron ore as a driver of revenue, which may further pressure its ability to pay its dividend. As a result I don’t believe that Vale’s share price has bottomed and that the other diversified miners are better investment opportunities for investors seeking exposure to the sector.

Matt Smith has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Matt is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article Why Vale Has Yet to Bottom originally appeared on Fool.com and is written by Matt Smith.

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