Two Scenarios That Could Impact Vale's Stock Price
Iron ore prices have declined sharply over the course of the last year or so. Benchmark 62% Fe iron ore fines prices stood at $63 per dry metric ton (dmt) at the end of February, around 47% lower on a year-over-year basis. Iron ore prices have declined due to a combination of weakness in demand and rising global iron ore production, resulting in an oversupply situation. This has negatively impacted the prospects of major iron ore mining companies such as Vale. Vale is the largest producer of iron ore in the world.
We expect iron ore prices to remain subdued in the near term, with prices recovering gradually only after the global supply glut dissipates. However, there is a possibility of a sharper V-shaped recovery in prices, if sufficient high-cost iron ore supply goes out of the market. The current level of iron ore prices is too low to sustain significant quantities of high-cost iron ore production, particularly from domestic Chinese iron ore producers. Production cutbacks in response to low prices are likely to result in a more favorable demand-supply equation, which would boost iron ore prices. Such a scenario would significantly boost the prospects of Vale.
However, there is a possibility that regardless of the level of prices, the company is unable to sell its envisioned levels of iron ore shipments. This is because of weakening demand for iron ore due to weak global economic prospects, particularly in China, which is the largest consumer of iron ore in the world. Such a scenario would negatively impact the prospects of Vale.
In this article, we will explore the impact of these two scenarios on the company's stock price.
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Impact of V-shaped Recovery in Iron Ore Prices on Vale
From the perspective of iron ore demand, China is the most significant player, accounting for over 60% of the seaborne iron ore trade. Iron ore is primarily used in the production of steel, and therefore demand for iron ore by the steel industry largely constitutes the overall demand for the commodity. With Chinese economic growth slowing, the demand for steel, which is largely correlated with macroeconomic growth, is also slowing. As per the latest IMF estimates, Chinese GDP growth is expected to slow to 6.8% and 6.3% in 2015 and 2016, respectively, from 7.4% in 2014. As per estimates by the World Steel Association, Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3% in 2013 and 2014, respectively. Thus, demand for iron ore in the near term is unlikely to grow at rates seen over the last couple of years.
The supply side is characterized by an expansion in production by major iron ore mining companies. Companies such as Vale, Rio Tinto, and BHP Billiton are rapidly ramping up their iron ore production, despite weakness in demand. These companies have low-cost iron ore deposits and are able to operate profitably even at current price levels. These companies are betting on the long-term strength of iron ore demand from China, and the curtailment of high-cost iron ore production capacity, to bring the demand-supply equation back into balance. As per projections by major Wall Street banks, the worldwide surplus of seaborne iron ore supply is expected to rise to 300 million tons in 2017, from an expected surplus of 175 million tons in 2015, and a surplus of 72 million tons and 14 million tons in 2014 and 2013, respectively.
http://www.forbes.com/sites/greatspeculations/2015/03/31/two-scenarios-that-could-impact-vales-stock-price/
