Sahil Alvi

Tag: The Great Recession

Vale: The performance and promise of Brazil and Basic Materials packed into one

by sahilalvi on Dec.04, 2010, under Economics, Finance

Vale

According to the company itself: “Vale is the world leader in iron ore and pellet production and the second biggest nickel producer.”

Coming out of The Great Recession, Vale (NYSE: VALE) is poised to gain from expansion of the manufacturing base — particularly in markets like China, India, Asia-Pacific, Middle East, and Latin America. The second-biggest miner in the world already, Vale has a growing global footprint of 38 countries with an exposure to most of the world’s high growth markets — not in the least its home country of Brazil.

Furthermore, there are very real geological and geo-political constraints on the supply of minerals Vale (or any of its competitors) can extract, process and sell on the world markets. This demand-supply dynamic has both secular as well as a cyclical themes interwoven. Hence, the global demand-supply dynamic for Vale’s products bodes well for the company’s growth prospects and profit margins for a long-time to come.

Vale is also showing an enormous appetite for bottom-line results with Net Profit Margin almost doubling from a 2009 margin of 21.6% to the Q3, 2010 figure of 40.9% . Even as of 2009, the company was only 310 basis points (in net profit margins) behind the industry’s most profitable of the large mining and metals companies: BHP Billiton.

Vale’s Net Profits are just as noteworthy because the Brazilian company generates revenues that are approximately half compared with another industry leader Rio Tinto — whose top-line figure for 2009 was US$ 41.8 billion compared to Vale’s US$ 23.3 billion. Yet, Vale’s 2009 Net Profits were US$ 5 billion compared with Rio Tinto’s US$ 5.8 billion — which makes Vale’s profits merely 15%  less that that of Rio Tinto’s.

In light of the positive fundamentals, the company is on massive expansion drive with a planned capital outlay of US$ 24 in 2011 alone. To contextualize Vale’s ambitious growth plans, Xtrata — the Anglo-Swiss rival has planned capital outlays of US$ 23 billion over 6 years from 2011 through 2016.

In
2009, Chinese demand represented 68% of global demand for seaborne iron ore, 44% of global demand for
nickel, 39% of global demand for aluminum and 40% of global demand for copper. The percentage of our
operating revenues attributable to sales to consumers in China was 38% in 2009.

There are — however — large, concentrated, inter-connected and material risks to Vale’s growth story. Two that are particularly noteworthy:

1. China, and

2. Steel.

According to Vale’s 2009 annual report:

“In 2009, Chinese demand represented 68% of global demand for seaborne iron ore, 44% of global demand for nickel, 39% of global demand for aluminum and 40% of global demand for copper. The percentage of our operating revenues attributable to sales to consumers in China was 38% in 2009.”

If China slows down, Vale’s (and most metals and mining companies’) revenues and profits decline. Furthermore, the company’s heavy exposure to the global steel market makes it vulnerable to fluctuations in the fortunes of this industry — particularly from a downstream steel consumption perspective in industries like infrastructure, transportation, construction and real estate.

The annual report goes on to say:

“Iron ore and iron ore pellets, which together accounted for 59% of our 2009 operating revenues, are used to produce carbon steel. Nickel, which accounted for 14% of our 2009 operating revenues, is used mainly to produce stainless and alloy steels…The prices of different steels and the performance of the global steel industry are highly cyclical and volatile, and these business cycles in the steel industry affect demand and prices for our products.”

There are other lesser risks such as:

  • Price volatility of nickel, copper and aluminum that are actively traded on global commodity markets;
  • Capacity expansion gestation periods and consequent constraints to meet demand in the short-to-medium term;
  • Geo-political considerations given that many of the mineral-rich countries have unstable political and regulatory regimes.

All that said, the company has a growing and diversified geographic market with 50% of its sales coming from the growing continent of Asia. Vale also has a swath of valuable mines being developed in resource-rich Latin America, Africa and Central Asia, among other mineral-rich locations around the world. Over several decades, the company has developed an extensive, defensible, and hard-to-replicate production and distribution capability — again with a global span. With the insatiable demand for basic materials in developing and frontier markets, Vale is a growth story based on strong fundamentals.

Not to mention, given the company’s healthy cash flow generation capability, Vale can be expected to pay out steady dividends in the forthcoming years.

As of December 3, 2010, Vale’s ADR (NYSE: VALE) traded at approximately 14.2 times earnings compared with its other global metals and mining peers’ ADRs:

  • Rio Tinto (NYSE:RIO): 14.9
  • BHP Billiton plc (NYSE:BBL): 16.8
  • BHP Billiton Ltd (NYSE:BHP): 19.5
  • Xstrata (LON:XTA): 29.1
  • Anglo American plc (PINK:AAUKY): 40.2

Since I added Vale’s ADR to my simulation portfolio on Sept 17, 2010, the position has gone up by 23% in merely two and half months (as of Dec 3, 2010).

Moreover, it is a highly liquid ADR — consistently ranking as one of the highest traded ADR’s on NYSE.

The target P/E one could set for the ADR is a value of 20 times its earnings per share compared with its current P/E of 14.2. Even at a P/E of 20, it is worth “taking stock” (no pun intended) rather than sell-off the entire position.

Given Vale’s exposure to the twin forces of Brazil’s breathtaking economic expansion coupled with the insatiable global demand for minerals and metals that Vale produces, the company’s stock and ADR are poised for a significant upside.

In essence, Vale is really a “buy and hold” play over the medium-to-long run.

Disclosure: The author owns no stock of Vale and has written this research note purely based on publicly available information.

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Could US face Stagflation in 2011?

by sahilalvi on Aug.20, 2010, under Economics

Stagflation in the US economy is now within the legitimate bounds of possibility.

US jobless claims have reached a nine-month, seasonally adjusted high. Official unemployment figures are at 9.5%. Add to these figures, all of those workers who have taken themselves out of the reckoning and the ones who are under-employed, and we have unofficial unemployment estimates in the low-to-mid teens.

United-States-Interest-Rate-Chart

The overnight lending benchmark Fed Fund’s Rate is at 0.25%. After the massive amounts of liquidity injections in the wake of the credit crunch, the Fed has few substantive monetary measures left to stimulate money supply into productive capacity generation, capital formation or even consumption.

United-States-GDP-Growth-Rate-Chart

In the face of persistently high unemployment levels and a high degree of economic uncertainty, consumption will remain lower than what is required to pull the US economy out of a potential stagnation, i.e. 3 to 4 % GDP growth. Meanwhile, real GDP growth has dropped roughly by a third from over 3.7% in Q1, 2010 to 2.4% by the end of Q2, 2010. Business lending remains anemic due to the structural constraints forged by lack of competitiveness of US producers of consumer and capital goods. GDP growth is also being affected by the US businesses not being able to borrow as readily for them to produce more goods and services in an environment where their output is already uncompetitive from a price (and sometimes, quality) standpoint compared with Chinese, Japanese, Korean, Indian, and even European counterparts. The European sovereign debt crisis has not helped matters in the US either.

United-States-Inflation-Rate-Chart

Despite all the quantitative easing of the last couple of years, inflation remains worryingly low at 1.2%. What this means is the massive amounts of liquidity injected into the banks during 2008 and 2009 — will start bursting at the seams of the US banks’ balance sheets at some point in the near future. Infact, Fed’s recent announcement about its intended intervention, to purchase billions of dollars worth of treasuries to ensure healthy levels of liquidity in the capital markets, is likely to exacerbate this excess liquidity problem in the not-too-distant future. All of these fruits of “quantitative easing” will chase down whatever grade of commercial and consumer credit creation such liquidity can find to generate the credit business at the banks.

Potential result of all of the above factors coming together would not be a pleasant scenario: Stagnation or worse — on the one hand. Inflation in the price of assets, commodities, goods and services — on the other hand.

Could we see a nasty bout of Stagflation gripping United States in 2011?

Charts: Courtesy – Trading Economics

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