DBRS Confirms Companhia Vale do Rio Doce at BBB (high)

DBRS has today confirmed the ratings of Companhia Vale do Rio Doce (Vale or the Company) and its subsidiaries, Vale Overseas Limited, Vale Capital Limited and Vale Inco Limited (Vale Inco), at BBB (high). The trends are Stable. The Company’s financial profile has continued to strengthen as expected, supported by the strong results in its ferrous minerals business.

As anticipated, the Company has been actively paying down debt since the spike in the first quarter of 2007 following the completion of the mostly debt-financed acquisition of Inco Limited (Inco, now known as Vale Inco). The Company has raised a total of about $2.9 billion through asset sales and the issuance of mandatory convertible notes (treated as equity by DBRS) toward debt reduction. At the end of March 2008, Vale’s gross leverage (gross debt-to-total capitalization) was approximately 35%, a level that is acceptable for the current rating. Additionally, stronger operating results and the resulting cash flows have also meaningfully strengthened all the debt coverage ratios.

Vale is well positioned to benefit from a sustained strong demand for commodities driven by growth in developing countries. Over the next few years, market conditions are expected to be favourable for most of the Company’s key commodities, although nickel is facing some near-term challenges. Iron ore is expected to be the primary growth driver of the Company’s profit and cash flow in the medium term. Iron ore (including pellets) accounted for about 53% of Vale’s operating income in 2007. The fundamentals for iron ore are extremely positive, supported by an increasing demand for steel from the growing emerging economies, particularly China. Additionally, Vale is investing heavily to expand its iron ore production capacity, planning to raise its annual output from 296 million tonnes in 2007 to over 422 million tonnes by 2012.

With the acquisition of Vale Inco, nickel is another key commodity for the Company, accounting for 36% of operating income in 2007. Nickel has suffered a correction since mid-2007 amid high spot nickel inventory and a slowdown in stainless steel production and is expected to report weaker results in 2008. In the medium term, ongoing growth and increasing use of stainless steel in developing countries is likely to boost demand for nickel and strengthen prices. Vale is also investing heavily to increase its nickel capacity, targeting to more than double its production capacity by 2012. Overall, the Company’s profitability is expected to show good growth in the next few years, supported by favourable fundamentals in its key commodities, organic growth from planned expansion in production capacity, and benefits from cost reduction initiatives. However, sharp increases in input costs, especially energy and materials, would be the key risks to margin improvement. Moreover, further weakness in the U.S. dollar would also pose a threat to profit improvement.

The Company has a strong pipeline of world-class projects across all of its key commodities. To meet its organic growth objectives, Vale has committed to spend $59 billion from 2008 to 2010 to develop these world-class projects. Even though internal cash generation is expected to be substantially in line with earnings growth, the large capital expenditures budget could pressure the Company’s financial resources. Moreover, the Company is acquisitive, a key growth strategy. Vale has spent about $17.7 billion in two major acquisitions in the last two years, Inco and AMCI Holdings Australia (AMCI). The Company was also in discussion to acquire Xstrata plc (Xstrata), but the discussions were terminated in early 2008 when the parties failed to reach an agreement on the merger terms. The Company has publicly acknowledged that it is on the lookout for appropriate acquisitions. DBRS believes that the Company is not likely to be able to meet its funding needs internally if it pursues the aggressive capital investment program and acquisitions concurrently. A major debt-financed acquisition could lead to negative rating actions. However, the Company has publicly committed to maintain a financial profile appropriate for an investment-grade rating and Vale has demonstrated discipline in deleveraging its balance sheet expeditiously after the Inco acquisition. Furthermore, in July 2008, the Company launched a public offering of common and preferred shares to strengthen its capital structure and liquidity, raising about $11.5 billion. DBRS believes the Company would be judicious in not leveraging up its capital structure to finance its growth objectives.

Notes:
All figures are in U.S. dollars unless otherwise noted.
The debt of Vale Overseas Limited and Vale Capital Limited is unconditionally guaranteed by Vale.