Citi Upgrades Vale, Positive On Free Cash Flow And Seasonal Iron Ore Demand

Vale SA (ADR) VALE faces seasonal tailwinds in the near term and would likely be FCF positive in 2017, Citi’s Alexander Hacking said in a report. He upgraded shares from Sell to Neutral, while raising the price target from $4.40 to $7.30.

“We downgraded Vale to Sell in 2014 on the thesis that 2014-16 would be a cash crunch, and this now appears to be in the rear-view mirror,” Hacking commented.

Seasonality

Iron-ore prices are typically elevated from November through February, since this period witnesses seasonal supply disruptions. Iron-ore production has continued to decline and output from majors have risen by less than 2 percent year-over-year through the second and third quarters.

Hacking added that Vale would also benefit from higher Chinese steel prices, which would be boosted by rising coking coal prices, as well as from increasing iron-ore quality premiums.

“Chinese steel production and iron ore prices have surprised on the upside this year – and we likely missed the cyclical floor in Vale, which now looks like 1Q16,” the analyst wrote.

Cost Estimates

Hacking expects Vale to generate ~$1 billion in FCF in 2017, even with a relatively conservative iron-ore price estimate of $46 per ton. In case prices rise to $55 per ton, the company would generate $3.5 billion in FCF.

“Vale should be able to hold current costs relatively stable despite headwinds from FX, oil and freight (~$32/ton delivered in China in 3Q16),” the analyst added.

The rally in Vale’s shares could continue after the company reported strong Q3 results last week.