Vale Proves Too Rich for Barclays on Iron’s 30% PlummetJuan Pablo Spinetto and Julia Leite
The biggest drop in iron-ore prices in five years is a signal to Barclays Plc and Seaport Group that Vale SA’s outperformance in the bond market is about to end.
The $2.25 billion of bonds due 2022 returned 9 percent in the past six months, exceeding the 7.4 percent average gain for notes from emerging-market mining companies with investment-grade ratings. The Vale bonds yield 4.06 percent, the least relative to similar securities from London-based Rio Tinto Group since September, data compiled by Bloomberg show.
Vale, which gets about 95 percent of earnings from its ferrous business, posted a bigger-than-forecast drop in first-quarter profit after selling its ore for 25 percent less than the benchmark global price, which fell to the lowest since September 2012 on May 30. Investors should sell after the bond rally as reduced demand cuts prices for iron ore, according to Michael Roche, an emerging-market strategist at Seaport Group, which this month started recommending clients buy debt from Southern Copper Corp. instead of Vale securities.
“I’m still worried about China, I’m still thinking global growth is very muted, I’m still worried about Europe,” Roche said in a telephone interview from New York. “I am going to take that superior performance over the last six months and take a profit.”
Prices for iron ore entered a bear market in March and have dropped every month since December in the longest run of losses on record as the world’s biggest mining companies expand production in Australia and Brazil. Ore with 62 percent content delivered to the Chinese port of Tianjin has dropped 30 percent during 2014 to $94.30 a dry ton today.
Vale bonds yield 0.54 percentage point less than notes from similarly rated Latin American companies, making them unjustifiably expensive given lower iron-ore prices and plans for the company to increase investment during the year, Christopher Buck and Autumn Graham, analysts at Barclays Plc, wrote in a May 19 report.
“Considering tight valuations, negative momentum in iron-ore prices, and expectations for modestly increasing leverage, we think investors should tactically lighten exposure in Vale bonds,” the analysts wrote. The company “is the most exposed major Latin American miner to falling iron-ore prices.”
Buck didn’t reply to an e-mailed request for comment.
Brazil’s real gained 0.9 percent today to 2.2273 per dollar as of 2:46 p.m. in New York.
Debt at the world’s largest iron-ore producer rose 2.1 percent to $30.3 billion at the end of the first quarter. The ratio of net debt to earnings before interest, taxes, depreciation and amortization, a measure of indebtedness, dropped to 1.12 times, the least since 2012. That’s still above Melbourne, Australia-based BHP Billiton Ltd.’s 0.85 ratio and Rio’s 0.86, according to data compiled by Bloomberg.
Vale declined to comment on the performance of its bonds in an e-mailed statement from its press office in Rio de Janeiro.
“The first quarter, traditionally, is a quarter where we see some decrease in accounts receivable due to the receipt of large sales volumes that normally occur in the fourth quarter,” Chief Financial Officer Luciano Siani said April 30 during a conference call. “We are working to continue with incremental improvements in working capital.”
Lower iron-ore prices don’t necessarily mean the bonds will suffer as the company’s credit profile is strong and there’s little risk of default, according to Peter Lannigan, a managing director at broker-dealer CRT Capital Group LLC in Stamford, Connecticut.
“I’m not concerned,” he said in a telephone interview. “If the company’s credit risk measures change a lot, the bond spreads could adjust, but it’s a very strong credit.”
Vale is also deepening efforts to cut costs and selling assets as it seeks to boost profitability. The company this week announced the sale of its stake in a Brazil reforestation fund for 205 million reais ($91.2 million), which follows sales of aluminum, logistics, energy and copper assets in the past 12 months.
The advances made by Chief Executive Officer Murilo Ferreira in streamlining operations and cutting costs have been already incorporated by investors in the valuation of Vale’s bonds, Seaport’s Roche said.
“The valuation is becoming exhausted at these kinds of spread levels,” he said.