Brazil’s iron ore industry in murky water

Brazil’s iron ore industry has seen better days.

RIO DE JANEIRO, BRAZIL - NOVEMBER 16:  A protestor washes muddy water over the Vale logo at the entrance to Vale headquarters on November 16, 2015 in Rio de Janeiro, Brazil. The bursting of two dams at the Samarco mining operation, jointly owned by Vale and BHP Billiton, unleashed a flood of muddy waste which mostly levelled a village in Minas Gerais state. The massive mudflow left ten people dead and an environmental aftermath polluting downstream waters.  (Photo by Mario Tama/Getty Images)

RIO DE JANEIRO, BRAZIL – NOVEMBER 16: A protestor washes muddy water over the Vale logo at the entrance to Vale headquarters on November 16, 2015 in Rio de Janeiro, Brazil. (Photo by Mario Tama/Getty Images)

On November 5 in Amapá, Brazil, a massive dam collapsed. The ensuing damage killed at least 13 people, and more are still missing. The dam is property of the Samarco mine in the Amazon region, and that mine is shared 50/50 between two of the world’s largest iron ore firms: BHP Billiton and Vale. Both companies hit 10-year valuation lows on November 30.

Brazil is now poised to make the companies pay up to the tune of $5.2 billion, according to a BHP statement. The Samarco joint venture mining operation will be closed for months. It annually produces more than 12 million tons of Brazil’s iron ore, one of the country’s main exports.

BHP is based in Australia, the world’s biggest iron ore market. But Vale, the world’s biggest iron ore producer, is based in Brazil and has a lot more skin in the game. Samarco makes up 3.5 percent of BHP’s revenue, but 9 percent of Vale’s revenue. Brazil had 31 billion tons of iron ore reserves in January 2015, which is 16.3 percent of global reserves. In 2014, Brazil’s iron ore production brought in $25.9 billion.

So, even if we assume Vale produces all of Brazil’s iron, which it doesn’t, the fine by Brazil’s Ministry of Mines would take out 20 percent of revenues for the year.

On the production side, however, Vale might have gotten lucky with a closed mine – China, a major global steelmaker, isn’t buying enough iron as their economy slows its growth. Vale was already trying to cut production for a time, because demand is not high enough to sustain current production levels. It shows on the income statement – Vale posted a $2 billion loss in the third quarter.

At the same time, Vale is building a $19.4 billion mine in Sera Sul, in the Amazon region, that would add 90 million tons of low cost iron ore to its output, while reducing costs from $12.70 per ton to around $10. So, Vale pumped a significant chunk of capital into a bet on China’s growth, meanwhile the opposite occurred. Add in the Samarco disaster, and Vale can count on several quarters of losses before turning around in the latter half of 2016.

6 thoughts on “Brazil’s iron ore industry in murky water

  1. My main question is how much cash does Vail have? Over two billion in fines and committed to a multi-billion dollar mine as your sales slow certainly doesn’t look like a pretty picture.

    Even if they manage to complete the new Amazon mine, will the $2.70/ton saved be enough to combat crashing prices?

  2. Vale is sitting on $4.4 billion USD as of September 30 this year. That’s a $400 million increase this calendar year, from $4 billion on December 31, 2014. Let’s assume Vale has to eat half the fine, $2.6 billion. That still leaves wiggle room with cash and cash equivalents, as per the balance sheet.

    I’m not sure how fines like this are paid in Brazil. I’m assuming they’ll finance it in some way; but, even if they paid lump sum, bankruptcy doesn’t seem likely.

  3. What sort of impact will this dam collapse have on Brazil’s iron ore market and the Brazilian economy as a whole. In other words, how dependent on iron ore output is Brazil’s economy? Additionally, are BHP and Vale the two dominating players, or are there other companies that can pick up some of the slack?

  4. In the background, mining has lots of fixed / sunk costs: roads, railroads, processing facilities, and … dams. So my guess is that a look at these firms’ financial statements will find lots of debt, at a time when cash flows are dropping because both price and volume are down. What has happened to these firms’ bond prices? Someone should take a look…

    • http://quicktake.morningstar.com/StockNet/bonds.aspx?Symbol=VALE&Country=usa

      It looks like Vale’s Debt has increased by 10% since 2012 and its equity has decreased by 25%. This does not sound good for the company. This website has a lot of good data with respect to Vale’s financials. one aspect that seemed weird was that the coupon rate for 2018 was higher than that of 2023. This is odd because generally companies will have a higher coupon rate the farther out they predict allowing room for random shocks and thus less making the risk less than the reward. This higher coupon rate suggests that they instead think that the near future does not look good as for the company as the long term does.

  5. This mining disaster has brought attention to rising mining fatalities amidst cost reductions. There had been a general trend downward in fatalities due to technological advancements, however this improvement has been halted as the drop in commodity prices have forced large mining companies to enact heavy cost cuts. The pressure on mines in increase productivity and reduce staffing could divert focus away from both safety and environmental improvements.

    http://www.wsj.com/articles/brazil-dam-breach-casts-spotlight-on-safety-at-major-miners-1446990333

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