Vale S.A Stock: Headwinds Of Volatility In 2022 (NYSE: VALE)

Thesis

Iron ore prices sharply dropped in September 2021, leading to a steep decline in Vale S.A’s (VALE) stock price to $12 at the beginning of November 2021. However, with prices almost doubling from November to date, the company’s stock has also rebounded with an almost 56% increase in share price. Vale stock is currently trading at about $17.5 per share, up 27% YTD.

The previous article focused on the situation with China and the sharp decline in global iron ore prices, which was weighing in heavily on the stock price. The increasing iron ore prices have backed up the buy rating stipulated in the article, but the price volatility in 2022 is a subject of debate. As evident by recent history, this is likely to weigh in on the company’s stock price, pushing me to lower the buy rating to a “hold.”

The iron ore prices are deeply embedded with Vale’s stock price, and based on the heavy volatility influencing the stock prices, now may not be the best time to invest in the company, except for risk-averse investors.

Vale’s Stock Price and Correlation with Iron Ore Prices

The company’s quarterly production report indicated that its Q4 2021 iron ore output declined 2.4% YoY and 7.8% QoQ to 82.5 million metric tons. This goes hand-in-hand with the company’s guidance set out in October, along with an impact from heavy rainfalls in Brazil, which have adversely affected the company’s operations.

The company has also reiterated guidance for iron ore production to 320-335 Metric Tonnes (MT) for 2022. The current output of 315.6 Mt accounts for about 88% of the company’s annual production, and about 88% of that figure has been converted into revenue during the year. I have placed charts of iron ore prices in the past 52 weeks, and Vale’s stock price for comparison, and the correlation is uncanny.

I stipulate these points to justify the article leaning heavily on iron ore’s significance on Vale’s stock price.

As is apparent from the above chart, the company’s revenue suffered over $550 million because of the falling prices in Q3. This is likely to turn around for the fourth quarter as prices surged at the end of the year, but the consensus analyst estimate of an EPS of $0.79 does not appear to be too optimistic about Vale’s annual performance. If the company misses its EPS targets in the Q4 earnings release, the stock price is likely to tank.

Iron Ore Market Price Outlook for 2022

According to Mathew Hodge, Morningstar’s director of equity research, “The constraints around power in China appear to be easing from their height a few months ago. Monetary policy has also loosened, which could provide an important signal for downstream steel producers that the government and central bank will support the economy and demand will improve.”

In contrast, According to Westpac senior economist Justin Smirk, “The iron ore port inventories built through recent weeks is a bearish signal, and they are expected to continue to lift over the next 2-3 months as pig iron production is not likely to pick up until after the (Beijing) Winter Olympics… Iron ore prices could hit $75 a ton by end-2022.”

Tribeca Investment Partners’ Ben Cleary thinks that the consensus expectations of $90 for 2022 are ‘probably’ too pessimistic again. Further, Commbank’s Vivek Dhar expects China to cut steel output to ensure production remains at 2021 levels in the second half of 2022. “Enforcement will likely intensify if steel output and steel-sector emissions have increased notably in H1 2022.”

These contrasting forecasts are also supported by the Metal Bulletin’s recent report, which iterates that the prices rebound was ‘partially supported by positive sentiment in the Chinese iron ore futures and front-month swaps contracts in Singapore,’ signifying ambiguous factors playing into the current year’s iron ore prices’ outlook.

Winter Olympics seem to be a cutoff point, after which the iron ore price outlook will be much clearer because of the clarity on demand in China; until then, a heavily speculative outlook makes the commodity and Vale’s stock highly volatile.

The heavy disparity between iron ore price outlook for 2022 makes it extremely hard for investors to rely on Vale’s revenue increase based on prices alone. For improved sustainable margins, we will have to rely heavily on the company’s ability to achieve operational efficiencies that result in a higher midline and Bottomline growth.

Profitability: Not Alarming, but Caution is Advised

Let’s take our eyes off the topline for a moment because of the high volatility and assess the company’s situation at midline and bottom line. First off, let’s look at the company’s profitability which has been steadily rising on a TTM basis every quarter since Q4 2019, but the growth has been steadily declining. Similarly, the operating and net income of the company have been following the same patterns with slowing growth. During the same period, the company’s operating margin has grown from 2.5% to about 40% in the MRQ, while the bottom line has grown from a Net Loss Margin of 4.5% in Q4 2019 to a Net Profit Margin of over 31%.

As it was pointed out in the previous article that the net income had increased over 1000%, compared to a revenue increase of about 80% in 2021. So this slowing growth is not alarming because it is completely reasonable for growth to decline as companies grow, especially with such great margins and YoY growth figures.

However, because of the immense volatility around its prime commodity, it is pertinent to keep an eye on the stock as growth investors rely heavily on the growth metrics of a company. Despite healthy current growth levels, if the company continues to follow this pattern, the risks of owning the stock are likely to overtake the rewards, especially with the price and usage ambiguity in the Chinese market.

Shareholder Distributions

As iron ore prices recovered by the end of 2021, the company’s cash flow from operations surged to almost $30 billion, with levered free cash flow amounting to about $25 billion. Because of their capped CapEx at almost $6 billion for 2022, this leaves a lot of room for the company to distribute capital among shareholders. Consequently, Vale announced a share buyback program in April 2021 and has completed it in 4Q by acquiring approximately 270 million shares for a total of about $5.28 billion. Subsequently, the company has announced a new share buyback plan which includes the repurchase of 200 million or approximately 4.1% of its outstanding share.

Up to October 2021, total dividend payments for the year amounted to $ 13.5 billion. The Dividend Yield has fallen from about 20% to about 15% since the last article, mainly due to the increased share price despite a dividend CAGR of 136.73% for 3 years and 88.10% for 5 years.

The payout ratio on these distributions is over 50%, which might be a questionable move concerning the company’s investments in its future, but the company has reportedly said that “Vale’s annual CAPEX of around US$5bn-6bn is likely to remain for many years because there are no significant discoveries of new deposits by the company that would justify a much larger investment.”

Income investors would be better suited elsewhere as historically, Vale doesn’t have a consistent track record with its dividend distributions. With the upcoming volatility, the dividend inconsistency’s persistence wouldn’t be a surprise.

One More Thing: Competitive Valuation

Vale has a P/E ratio of about 5, almost the same as Nucor Corporation (NUE), a company with a share price growth of almost 116% in the previous 52 weeks against Vale’s 1%. Vale also has a higher P/S and P/B ratio at 1.6 and 2.6 against NUE’s 0.95 and 2.3, suggesting a more expensive stock. Vale also has some metrics at comparable or better measures than NUE, but the point stands that with high risks revolving around the stock, the valuation isn’t attractive enough to jump into the stock right now.

Conclusion

Vale stock has enjoyed healthy returns in the previous 6 months, but the volatile iron ore prices in 2022 are likely to stunt that return. The company may be a positive buy in the long run, but the timing of the purchase holds heavy water, and according to the current market situation, the risks of the stock far outweigh the rewards. The company’s massive cash balance and growth metrics paint a bright picture of the future, but the current share price doesn’t offer an attractive enough valuation to justify the risks.

For investors, it’s a good time to keep a close eye on the stock price, especially as the Q4 earnings release hits the market. The company’s performance will play a strong role in forecasting the stock’s performance in relation to the iron ore prices during the year because of the recent events. This will also be critical to help in assessing the volatility and regauge risks and rewards against the new valuation metrics.

Long-plays are still possible, but only for investors who can stomach high volatility; for the rest of us, a wait and watch approach makes more sense until the market settles down by the end of the first half of 2022.