An Iron Grip on Iron Ore

03/04/2009 1:00 pm EST


John Christy

Founding Editor, Forbes International Investment Report

John H. Christy III, editor of Forbes International Investment Report, says Brazil’s top mining company is cheap and has a formidable competitive position in key resources.

Imagine a business with the following characteristics: You supply a product that is essential to economic activity. Your largest customer is China, which has nearly insatiable long-term demand for the product. Along with your two major global competitors, you control more than 70% of the world’s supply, essentially forming an oligopoly with considerable pricing power. Not a bad business model, right?

In a nutshell, that describes Brazil’s Companhia Vale do Rio Doce (NYSE: RIO). Better known simply as Vale, it is the world’s second largest mining company after Australia’s BHP Billiton (NYSE: BHP).

The company’s name means “valley of the sweet river,” a reference to Brazil’s Carajás region, home to some of the richest iron ore deposits in the world. While its principal business is iron ore, Vale also mines a full range of commodities, including nickel, copper, and other industrial metals.

For the first 55 years of its history, Vale was owned by the Brazilian government. After its privatization in 1997, the company unloaded its noncore assets in steel and pulp and paper to focus on mining. Vale also gobbled up smaller ore producers and now dominates the local market, accounting for 85% of Brazil’s ore exports. In October 2006, Vale bought Canadian nickel producer Inco for $19 billion. With the Inco deal, nickel accounts for about 15% of Vale’s revenue.

Vale has long been a well-known name in emerging markets circles. But in the past decade, the company has developed into a truly global player. In 2008, Vale’s revenues were $39 billion—a nearly tenfold increase since the start of the decade. Over the same stretch, EBITDA (earnings before interest, taxes, deprecation, and amortization) has ballooned from just $1.5 billion in 2001 to $15.7 billion last year.

Only 18% of Vale’s revenue is generated in Brazil. Asian customers account for 40% of revenue, with 19% going to China. Another 24% of revenue comes from Europe. The US counts for less than 14% [of revenue].

On February 19th, Vale reported fourth-quarter and full-year 2008 earnings. While full-year results weren’t bad—revenue rose 16% and EBITDA was up 19%—the last quarter of the year was ugly. Revenue fell 38% compared to the same quarter a year ago, while earnings per share fell nearly 50%.

Vale’s ADRs plunged nearly 20% in two trading sessions following the news.
At {Tuesday’s closing price above $12], Vale looks cheap at around seven times severely distressed estimates of 2009 earnings. It’s also hovering close to book value.

Of course, if the global economy continues to deteriorate, Vale could be in for more short-term pain. There’s no getting around its cyclical exposure. But Vale is clearly positioned to emerge from the slump as one of the survivors. With a world-class collection of mining assets, Vale will no doubt fetch a premium valuation again once the recovery begins.

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