HSBC: Vale Has 45% Upside, Is A Buy

• Vale SA (ADR) VALE shares are down 49 percent year-to-date, having declined steadily from $8.80 on May 5.
• HSBC’s Leonardo Shinohara upgraded the rating on the company from Hold to Buy, while raising the price target from $5.90 to $6.70.
• Excessive investor focus on iron ore prices has resulted in cost reduction and quality premiums being overlooked, Shinohara said.

Analyst Leonardo Shinohara mentioned that investors seem to be “overly focused” on iron ore prices, thereby overlooking the possibility of declining prices being offset by cost reductions and quality premium.

Shinohara commented that there is about 45 percent upside reflected by the revised model that takes into account Vale’s 3Q15 results. Valuation is impacted by “(i) resilient iron ore price realization, driven by quality premium; and (ii) consistent cash cost reduction, beyond BRL depreciation.”

The iron ore realized price forecast for 2016-2018 has been raised by 16 percent, since Vale has been able to “capture a quality premium through its blended product,” Shinohara said. The cash cost estimate has been reduced by 10 percent, after the company reported its second consecutive quarter of cost cuts beyond the FX impact.

These changes in forecasts translate to an upward revision in the EBITDA estimate for 2016-2018 by 23 percent. Shinohara also expects Vale to generate positive cash flows moving forward, “reducing urgency for asset sales.”

In the report HSBC noted, “We think Vale has successfully implemented its blending strategy (adding c0.5% Fe content) with its forward stocking in Teluk Rubiah by increasing its revenue (an additional USD1.50 over the 62% Fe Index) with a combination of time to market advantage for approximately 30m tons (yearly) and by increasing its portfolio of products with Brazilian Blend Fines commanding, on average, a premium of USD3.50 with its competitive chemical features.