Vale Stock: trades at 2.71x EV/EBITDA and returns capital aggressively (NYSE: VALE)

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The price of iron ore hit a two-week low yesterday ahead of a widely expected interest rate hike from the US Federal Reserve. We got the interest hike, and the market is now taking the idea that Powell will keep raise rates to fight inflation with a more serious downturn. As bad as that sounds, keep in mind that iron ore rarely hit current “lows” between 2015 and 2019:

iron ore price history

iron ore price history (Commercial Economics)

The Brazilian presidential elections are approaching next month, and Lula appears to have around a 70% chance of winning (I pull these odds from betting sites, so take him for what it’s worth). He threw some creativity mining royalty ideas campaign, which may have put some pressure on Vale (NYSE:VALE) as well.

In terms of valuation, Vale SA still seems very cheap to me. I readily acknowledge the risk of recession on continued rate hikes. I agree that this could lower iron ore prices and EBITDA/earnings to an amplified extent due to operating leverage. Still, 3.63x forward earnings or 2.71x EV/EBITDA remains quite attractive. Peers like BHP Group Limited (BHP) and Rio Tinto (RIO) are subject to the same risk but trade at slightly higher multiples (arguably low multiples as I say here).

Vale reviews

Vale reviews (Seekingalpha.com)

Meanwhile, Vale has repurchased more than 100 million shares in the past two months and implemented an aggressive policy. According to the CEO during the most recent earnings call:

Last quarter, we announced the third buyback program of up to 500 million shares. We completed nearly 22% of this program in just over two months. After completion of the third buyback program, you will have bought back nearly 20% of the company’s outstanding shares. This means that we are concentrating future earnings per share by 25%. We see this as a form of growth with no supply pressure and less execution risk.

The company has also agreed to pay a dividend equal to 50% of cash flow. Commodities are under pressure due to recession fears. I understand that the recession will materialize if the Fed continues. At the same time, I am not entirely convinced that a recession translates into a deep collapse in commodities, as we have seen after the GFC and recent downturns.

I recognize that China will not experience such explosive growth. Yet even modest growth on what is now a huge economy (the 2nd largest GDP in the world) still requires massive absolute growth in the supply of commodities.

Mature economies like the United States and the Eurozone combined are on a decades-long trajectory to transition from fossil-fuel to renewable-fuel economies. This transition requires massive amounts of raw materials to provide the materials needed to adapt networks and manufacture wind turbines, solar panels, electric vehicles and hydrogen installations. In general, renewable energy sources and electric vehicles require much more copper than their fossil-fueled predecessors. Building the infrastructure means anticipating material investments with the following benefit, as emission-free energy is generated over the following decades.

Vale’s management believes it is considered a mature, low-growth iron ore business. But he sees some potential in its base metal properties which are valuable for the energy transition. Nickel is a metal that is particularly useful to manufacturers of electric vehicles in batteries. Elon Musk more or less begged miners to increase their investment in nickel. Tesla (TSLA) recently signed a supply contract with Vale for Nickel from its Canadian operations.

There is even talk of separating forward-looking base metals businesses from iron ore operations, but I think Vale is highly unlikely to pull the trigger. The President of Finance and Investor Relations responded to a question about a metals division IPO as follows:

… So on the potential transaction, we haven’t decided that, as Eduardo said, if it’s an IPO, non-IPO, but I think basically, what we’re trying to achieve here is more dedicated base metal governance which we see a lot of merit for. We also want to make sure that we create events conducive to growth. This activity is very different from iron ore. We have a lot of growth in iron ore by taking back our capacity with limited CapEx. But as I think you pointed out, we’re all about the money. Today we appreciate that. And we’re happy with that, and we’re continuing to pursue that strategy. But base metals are different, it’s a growing business. There’s a tremendous amount of momentum for the transition to electric vehicles, for the electrification of the world, so all of that calls for a different strategy.

And we think it would make sense to have an event that could support an accelerated growth strategy there. The final format, we’ll see, but that’s how we think, and that’s what we should expect to pursue. Admittedly, the market today does not appreciate a trade, but we will continue to review this and talk to you about it once we feel good. On the divestiture, MRN is the one we’ve talked about publicly. And it is frankly the last. We could therefore continue to look for ways to optimize the portfolio on the margin. But I think we can definitely say that we’ve done most of the remodeling that we wanted to do at this point.

This suggests that there is a non-zero chance of an IPO or split of a base metals segment. The CEO then kind of threw cold water on that prospect (emphasis mine):

And just to complete your points. It’s like a call for growth and a call for youth, but will probably never let go of the base metals sector. OK. If we want to bring partners, even private, even if we go public, it will be a Vale and it will be a goal of growth, raising currencies, nobody has these commodities like us. It’s a question of, because we think better governance, we think better partners would help us grow, but we don’t want to lose our growth, of course, there are enormous opportunities in the world electricity, the transition – the world energy of the transition.

In my opinion, the market is punishing some metals companies far too harshly for a possible recession. Vale’s share price can already (partially) cook in a Lula victory while any damaging policy is still a long way off. Moreover, these policies also tend to deter competition. I agree that it will probably come, but the context is different, and Vale is in very good shape with $8 billion in net debt (about double on a gross basis) and $24 billion in EBITDA. Multiples will likely increase as what is likely an EBITDA spike contracts. However, the company is throwing money away and aggressively buying back stock. I explained how I’m trying to take advantage of the big buyback program in my previous Vale article, although it hasn’t worked out so far. I continue to be long in Vale, thinking its longer term outlook is not reflected in the current share price.

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