China Going From Drag to Boon Helps Vale Close Bond-Market Gap

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China is finally giving bond investors in the world’s biggest iron-ore producer a reason to cheer.

Rio de Janeiro-based Vale SA said May 19 it sold four iron-ore ships to Chinese companies for $445 million and agreed to divest four additional carriers. It also signed an agreement with Industrial & Commercial Bank of China Ltd. to receive as much as $4 billion in loans.

For a company hurt by plunging iron-ore prices amid slumping demand from China -- the world’s biggest consumer of the metal -- the deals are a welcome boost. Vale SA’s $2.25 billion of notes due 2022 now yield 1.50 percentage points more than those of London-based rival Rio Tinto Plc. That’s down 0.24 percentage points since Vale unveiled the agreements with Chinese businesses.

“Vale is paying a nice yield and is correlated to the potential turnaround of China,” Danilo Onorino, a money manager at Dogma Capital SA, said by telephone from Lugano, Switzerland. “So you have the angle of the yield, the angle of the potential growth of the company and the compression of the spreads.”

Onorino said he bought bonds of Vale last month, without providing further details.

Vale’s press office declined to comment on the performance of the company’s notes.

Ore Slump

The company struck the China deals after Moody’s Investors Service cut the outlook on Vale’s Baa2 rating to negative on May 12, citing the decline in iron-ore prices. The move followed two downgrades by Standard & Poor’s this year.

The outlook change reflects “Moody’s view that the company’s credit profile and operations remain solid, but incorporate the deterioration in market fundamentals for iron ore and base metals,” analyst Barbara Mattos said in the May report.

The benchmark price for ore with 62 percent content delivered to Qingdao, China, has dropped 9.7 percent this year to $64.34 a dry ton Monday after reaching a decade low in April.

The tumble in the steelmaking ingredient caused Vale’s adjusted earnings before interest, taxes, depreciation and amortization to fall 61 percent in the first quarter to $1.6 billion from a year earlier.

Top global miners including Vale, Rio Tinto and BHP Billiton Ltd. have been lifting output of iron ore to capture market share from smaller, higher-cost rivals. The strategy has coincided with the contraction in Chinese steel demand, resulting in a supply glut that’s depressed prices.

Underperform Outlook

Brazil’s real gained 0.7 percent to 3.1197 per dollar as of 3:05 p.m. in New York.

While Vale is spending $10 billion this year to expand production, it will trim capital expenditures starting next year, a move that will help shore up the company’s finances, according to research firm Gimme Credit.

“Vale has definitely improved their funding-gap situation in recent months with the Chinese deals,” Cedric Rimaud, director of emerging-markets research at Gimme Credit, said by telephone from Bangkok. “The capex is going to come down.”

Still, given weak iron-ore prices, Rimaud said he expects Vale’s bonds to underperform.

Banco Itau BBA SA analysts say the worst of the declines in the metal are over. Plus, with Vale poised to generate as much as $8 billion through asset sales in 2015 and 2016, investors should be positive on the company, they wrote in a June 1 report from the Sao Paulo-based bank led by Marcos Assumpcao.

“We now believe the scenario is clearer for Vale,” they wrote. “Asset sales will likely equal or exceed financial expenses and dividends. We are confident that iron-ore prices will not collapse.”

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