Vale (VALE) and Cliffs Natural Resources (CLF) are the two companies most exposed to the iron ore mining industry. Their revenues from iron ore mining account for 54% and 85% of their total revenues respectively.
Even though both companies are highly sensitive to iron ore prices, sell side analysts are bullish on Vale but bearish on Cliffs. Here’s a look at the endogenous and exogenous factors that are leading sell side analysts to think differently about two companies that otherwise seem very similar.
Credit Suisse believes that Vale’s management is serious and committed to reducing costs, considering that the company managed to reduce expenses by $1.6 billion YoY in the first half of 2013. Credit Suisse estimates that Vale’s management will cut costs by a further $800 million in the second half of 2013, and by $400 million in 2014. Vale also seems more likely to be able to deliver higher returns to shareholders in the future, and its management is divesting from its CSe VLI and Norsk Hydro businesses, which will lead to an improvement in the company’s balance sheet and cost savings.
Vale has an attractive EV/EBITDA multiple of 5.3x, according to Credit Suisse. It is trading at an 11% discount to Rio Tinto (RIO), one of its major competitors, which is four percentage points higher than its average discount to the stock over the past three years. Vale also has the best dividend yield of 4.3% among all major global miners in 2013.
However, there are a few risks investors should watch out for before investing in Vale. Credit Suisse believes that even if China achieves its GDP target of 7.5% for 2013, iron ore prices will continue to decline due to an increase in supply of the base material in the next twelve months. This could hurt Vale’s performance due to its high exposure to iron ore price. Secondly, Vale faces tax litigation charges on its overseas subsidiaries, which could range between $14 billion to $22 billion and impact Vale’s stock negatively.
Morgan Stanley is advising investors to buy Vale on dips based on delays in a Brazilian Supreme Court ruling on exempting the company from making a $15 billion plus tax payment. Morgan Stanley has a price target of $23.40 for Vale, and reiterates an equal weight rating.
Credit Suisse cautions investors against investing in Cliffs based on a number of different factors. Firstly, Credit Suisse believes that Cliffs’ margins from its core Great Lakes market will normalize from an estimated $50 per ton in 2013, to $15 per ton in the next few years. The 70% drop in margins will be insufficient to support Cliffs’ over-leveraged balance sheet, which has $3.1 billion in debt, as long-term iron ore prices drop to around $85-90 per ton.
Cliffs has also renewed its contracts with AK Steel (AKS) and Essar based on fixed prices instead of volumes, which will limit its earnings potential. Cliffs recently renewed its contract with AKS for 2014 through 2023, although details about pricing and volumes have not yet been released.
Goldman Sachs also expects lower earnings for Cliffs due to lower estimated iron ore prices in the US and lower contract prices in its renewed contracts. It also said that Cliffs’ revenues per ton from operations have fallen $6 since the last quarter.
Sell side analysts seem to be more bullish on Vale due to its slightly lower exposure to iron ore prices (iron ore contributes 54% to its revenues, as compared to 85% for Cliffs). Vale also has a committed management looking to reduce costs and improve its balance sheet, whereas Cliffs’s management is currently struggling with high financial leverage which they cannot support with rapidly reducing margins. Therefore, investors should exercise caution when investing in Cliffs, and they can expect healthy returns from investing in Vale.
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