Since bottoming at the end of October, the MSCI Emerging Market Index (MXEA) and MSCI Asia Ex-Japan ...
Is the Discount Big Enough?
11/20/2013 11:00 am EST
With a government settlement offer on the table, this mining company has to decide if it's enticing enough to end a tax dispute, writes MoneyShow's Jim Jubak, also of Jubak's Picks, who shares his take on what might happen if the offer is accepted.
The Brazilian government has reportedly offered to settle its tax dispute with iron ore miner Vale (VALE) for about half of the $14 billion the government has claimed the company owes in taxes, on the sale of foreign subsidiaries from 1996 through 2008. And under the settlement, Vale would get to pay the $8.5 billion in the settlement over 15 years.
The company has maintained that it doesn't owe the taxes the government claims and has been fighting the case in court. The company could continue that fight or it could take the offer.
This hasn't been a great year for mining stocks, and for iron ore miners in particular, as slower growth in China has cut into demand, while past investments in new mines have added to supply. But shares of Vale have decidedly underperformed shares of competitors such as BHP Billiton (BHP) and Rio Tinto (RIO) because of the uncertainty of this tax case. The amount of the government claim is, after all, three times net profit from 2012. In the last 12 months, shares of Vale were down 5.03% as of November 19, while shares of BHP Billiton were up 4.04% and shares of Rio Tinto were ahead 10.37%.
If Vale takes the deal, it would remove substantial uncertainty from the stock and close the valuation gap with BHP Billiton and Rio Tinto. Vale traded, as of November 19, at 7.04 times projected 2013 earnings per share. BHP Billiton traded at 12.18 times projected earnings and Rio Tinto traded at 10.37 times.
I certainly wouldn't suggest that the slowdown in the Brazilian economy is over, or that the real—one of the world's worst performing currencies—has stabilized, or that the Banco Central do Brasil has given up on its inflation-fighting interest rate increases. But, with China's financial markets in rally mode—because of enthusiasm for the policies announced by the recent meeting of the Communist Party's Central Committee—it's likely that there is enough global economic optimism to push commodity prices and the prices of commodity shares higher in the short to mid-term.
And Vale could join that rally if the company decides to take the government's offer and end its tax uncertainty.
At the November 19 close of $15.69, buying Vale is essentially a play on the company taking the deal and putting its tax uncertainty to rest. If the stock were to move up to Rio Tinto's multiple on that event, Vale shares would trade at $23.44. (There is, of course, no guarantee that Vale's multiple would move up to completely close the gap with Rio Tinto.)
I'm going to take advantage of yesterday's (November 19) pull back in the Brazilian market, to add Vale to my Jubak's Picks portfolio. I could well be early, but I think the economic reforms out of China will give that market some upward fuel that will drag Brazil—a huge source of commodity exports to China—along with it. I also think there's a good likelihood that Vale will take the deal.
So how likely is it that Vale will take the deal?
It would eliminate the possibility of losing in court and paying the full $14 billion of the government claim.
Vale has stepped up its asset sales recently, so that the company would easily be able to pay its first installment, under any settlement, out of proceeds.
The deal would cut $5.5 billion off of Vale's potential liability.
And it would vastly improve the company's relationship with the government. And since Vale needs government licenses to expand domestic production, a better relationship has considerable value.
The deadline on the tax settlement is November 29.
My target price is $19 a share by July 2014.
Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of any company mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund's portfolio here.
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