Vale Needs to Dry Off

04/27/2012 4:31 pm EST


Jim Jubak

Founder and Editor,

The Brazilian iron-ore king, which took a beating on declining demand from Europe and terrible weather at home, could reverse its misfortunes in the second half…but concerns linger, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.

I’d like to blame the weather. And there is no doubt that weather in Brazil’s rainy season hurt Vale’s (VALE) first-quarter earnings, reported on April 25.

But when the drop is the third consecutive downward move in quarterly earnings, I think you can be pretty sure something more serious is going on. (Vale is a member of my long-term Jubak Picks 50 portfolio.)

What’s most important, though, to investors who have made money on Vale in the past and have been looking to see when they might be able to make money on Vale in the future is that all these quarterly declines in earnings are setting up a potentially good second half for the stock.

Vale reported net income of $3.83 billion for the quarter. That was down 44% from the record $6.83 billion in net income for the first quarter of 2011. Net income was also down 18% from the fourth quarter of 2011.

Part of the problem was indeed the wet weather. Wet iron ore sells for less than dry ore, and Brazil’s heavy seasonal rains reduce production too. Iron-ore production did fall 2.2% in the quarter. Vale’s production costs rose 2% because the company hired more workers to do dredging and maintenance on its mines.

But the bigger problem was falling iron-ore prices because of lower demand from Europe. In the quarter, Vale sold iron ore at an average of $109.26 a metric ton, 13% less than in the first quarter of 2011.

Average prices for nickel and copper, metals where Vale has been expanding production to diversify from iron ore, fell 27% and 19%, respectively, from the first quarter of 2011. (Vale is the world’s biggest producer of iron ore and the second biggest producer of nickel.)

In the quarter Vale sold 47% of its iron ore and pellets to Chinese customers, up from 41% in the first quarter of 2011. European customers bought just 16% of Vale’s iron ore, down from 20% in the first quarter of 2011. Vale shipped 65.2 million tons of iron ore and pellets in the quarter, a 4.2% decline from the first quarter of 2011.

For the full 2012 year, Wall Street is looking for Vale’s earnings per share to fall by 13.7%.

But the bulk of the damage is concentrated in the first half of the year, when Vale is facing really, really tough year-to-year comparisons. In 2011, earnings per share in the first two quarters of the year were $1.29 and $1.21, respectively. That’s quite a bit better than the 74 cents the company just announced, or the 84 cents projected for the second quarter.

But in the second half of 2011, the company earned $1.82 a share, and right now analysts are projecting $2.01 for Vale in the second half of 2012. If Vale can deliver what Wall Street projects, the second half will see an end to year-to-year earnings declines.

That is a big if, of course. But commodity traders are calling for a stronger second half of 2012 for copper and iron ore.

According to the traders, it’s too soon to get in now, since they expect the declines in prices for copper and iron ore in 2012 so far to continue for a while. Commodity hedge funds, for example, are still betting on further price drops. But after the summer might be a good time to enter.

In the case of Vale, I’d say sometime after second-quarter earnings get reported in July might be a time for thinking about an entry. A reasonable 12-month target price is $30 a share in my opinion. Vale’s New York ADR (American Depositary Receipt) traded at $22.30 at 3:10 p.m. New York time on April 27.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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