In general, markets are extremely sensitive to news. Knee-jerk reactions provide investors with a good entry opportunity in quality stocks.
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Vale (VALE) stock seems to be a victim of market overreaction. In June, VALE stock reached its high of $23.18. The stock has since dropped by 38%. (See Insiders’ Hot Stocks on TipRanks)
There are fundamental factors that have been a catalysts for correction. First and foremost, there were fears of an Evergrande (EGRNF) crisis spill-over. Furthermore, China announced a curb on steel production that translated into a sharp correction for iron ore.
However, even with these factors in consideration, VALE stock seems undervalued. To put things into perspective, the stock trades at a price-to-earnings-ratio of 4.2. Clearly, the selling seems overdone. I am bullish on VALE stock for a reversal as the company’s fundamentals remain strong.
Healthy Cash Flows to Sustain
Vale benefited from a surge in iron ore prices in Q2 2021. For the quarter, the company reported a record an adjusted EBITDA of $11.2 billion, and free cash flows of $6.5 billion.
The recent correction in iron ore prices will impact the company’s free cash flows.
However, Jefferies analyst Chris LaFemina believes that an average iron price of $86.37 per metric ton would lead to a P/E ratio of 10, and a free cash flow yield of 10% for major iron ore producers.
Therefore, with iron ore trading at $118 per metric ton, Vale is still positioned for strong free cash flows.
Further, with a total cash buffer of $14.6 billion, Vale has a negative net debt position. With an improving credit profile, dividends seem sustainable.
Vale is also positioned for iron ore capacity expansion. For the current year, the company expects capacity at 343 metric tons per annum (mtps). Capacity is expected to increase to 400 mtpa in 2022. Therefore, even if iron ore prices remain flat, Vale is positioned for incremental cash flows in the coming year.
Wall Street’s Take
According to TipRanks’ analyst rating consensus, VALE stock comes in as a Moderate Buy, with five Buys, four Holds, and one Sell assigned in the past three months.
The average VALE price target is $20.43 per share, implying 42.5% upside potential from current levels.
Bottom Line
Vale is also likely to see additional growth and cash flows from base metal projects. In particular, the company is bullish on the outlook for nickel.
As EV adoption increases globally, high nickel content batteries will ensure that the demand for nickel remains robust. The company’s Reid Brook and Eastern Deeps projects are likely to reach annual production rates of 40,000 tons of nickel concentrate by 2025.
Vale has maintained a strong financial profile, and the company has growth investments for the coming years. This provides clear visibility for higher cash flows, and will ensure that dividends and share repurchase continues.
Disclosure: At the time of publication, Faisal Humayun did not have a position in any of the securities mentioned in this article.
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