Brazil’s Vale S.A. (NYSE:VALE) is among the world’s largest mining companies, operating across multiple countries and as a major iron ore and nickel producer. In recent years, dividend-oriented investors have favored Vale for its consistent and substantial dividend payments, even during various commodity cycles. This consistency in dividends is the main reason I’m bullish on VALE.
The mining sector is characterized by volatility and challenging forecasting since it is directly linked to global supply and demand. For Vale, iron ore is the company’s main product, and the Asian market (particularly China) is its primary consumer due to its substantial steel production.
Vale’s operations are, therefore, closely tied to commodity prices and the performance of the Chinese economy. However, Vale distinguishes itself among international peers as a low-cost producer, allowing it to remain profitable even when iron ore prices are low, a point at which many other companies struggle.
As a result, Vale has highly robust cash flows, enabling it to regularly remunerate shareholders through dividends and share buybacks. This is particularly advantageous, given the company’s minimal need for significant new investments and its low debt relative to cash generation.
The investment thesis for VALE hinges on its status as a compelling income stock, coupled with its derisked valuation compared to its peer group.
Recent Performance Reflects Trends in the Chinese Economy
VALE stock has declined by around 20% this year, directly correlating with fluctuations in iron ore prices. For reference, in April, iron ore dropped to around $100 per ton, the lowest level since November 2022.
The decline in Vale’s share price has resulted in a derisked valuation, with a P/E ratio of 6.9x compared to the sector average of 18x. However, it’s important to note that Vale’s discounted valuation reflects some political risk, as the Brazilian government holds a golden share, granting them voting rights on certain decisions.
Although the price of iron ore rebounded to around $120 per ton in May, it remains well below the $140 per ton seen at the beginning of the year. This recent weakening in iron ore prices contrasts with signs of a general recovery in the Chinese economy, particularly as the Chinese government seeks new growth drivers in renewable energy and advanced technology sectors.
If iron ore prices were to stay below $100 per ton, it would likely cause higher-cost producers to cease operations. This would reduce supply and establish a price floor in the short term.
However, long-term demand is more concerning. The Australian government, China’s largest supplier, forecasts iron ore prices of $95 per ton this year, $84 per ton next year, and stabilization of around $70 per ton by 2029.
Why Vale Is Still Competitive
Vale has an excellent competitive advantage in the Asian market compared to smaller miners and some of its international peers for two main reasons.
First, Vale’s iron ore has a low level of impurities. This results in lower processing costs for Vale and reduced greenhouse gas emissions.
Second, Vale is one of the most competitive mining companies in terms of price, with one of the lowest production costs in the world. This allows the company to generate cash and remain profitable despite adverse market conditions. In contrast, less efficient companies, especially smaller ones, struggle to operate under such conditions, as seen in 2015.
When iron ore prices fell below $50 per ton, many small mining companies exited the market, allowing Vale and other Australian mining companies, such as Rio Tinto (NYSE:RIO) and BHP Group (NYSE:BHP), to increase their market share.
Following this period of low ore prices, the price quickly rebounded, exceeding $100 per ton, where most mining companies could operate profitably.
According to management, even if iron ore prices decline in the coming years, Vale’s breakeven production costs for iron ore are estimated to be $53-57 per ton in 2024. This is low compared to China (typically above $100 per ton) but higher than Australia’s costs. The key point here is that Vale should remain profitable, even in low-commodity price scenarios.
Except for 2019 and 2020, when provisions for the Mariana environmental disaster significantly impacted the company’s margins, Vale has maintained an average profit margin of about 20% over the last eight years. In 2023, Vale generated $7.98 billion in profits, as you can see below.
Vale Remains a Secure Dividend Play
In addition to Vale’s strong profitability dynamics amid fluctuating iron ore prices, the company’s cash generation is where it truly excels.
Between 2015 and 2023, Vale generated $68.7 billion in free cash flow after investments in expansion, averaging $7.6 billion annually. In 2021, a particularly exceptional year for the company due to product prices reaching their highest levels in recent history, Vale delivered $21 billion in free cash flow to shareholders, marking an extraordinary feat.
With such robust cash generation, Vale has been able to pay its shareholders generously. From 2020 to the end of 2023, the mining company distributed around $42.7 billion to shareholders, including $13.8 billion in buybacks and $28.9 billion in dividends. More recently, in the first quarter of 2024, Vale paid $2.33 billion to shareholders through dividends and repurchased shares for $275 million.
Vale’s dividend policy is to pay out 30% of EBITDA minus current investments. Since the company does not anticipate making significant investments, Vale is delivering a high dividend yield that has ranged from 8.8% to 11.4% this year (see below), which is highly satisfactory for an income stock and should persist in this range with iron ore prices above $100 per ton.
Is VALE Stock a Buy, According to Analysts?
Out of the 10 Wall Street analysts who have covered VALE stock over the last three months, they are evenly split between Buy and Hold recommendations, resulting in a Moderate Buy consensus. The average VALE stock price target stands at $15.84, with a high forecast of $18.50 and a low forecast of $13.00. This price target suggests upside potential of 30.6%.
The Bottom Line on VALE Stock
Vale’s performance is closely tied to the movement of iron ore prices and, consequently, to the Chinese economy, its main consumer. The high quality of Vale’s iron ore allows the company to maintain very low production costs, enabling it to generate significant cash flow, even when commodity prices fall. This allows the company to distribute robust dividends and repurchase shares.
With a derisked valuation and the potential to pay a dividend yield in the double digits this year, Vale remains an attractive addition to a portfolio focused on passive income.
