DBRS Confirms Vale Ratings at BBB (high) with Stable Trend

DBRS has today confirmed the ratings of Vale S.A. (Vale or the Company) and its subsidiaries at BBB (high). The trend on the ratings is Stable. Vale is one of the largest mining companies in the world, with a solid business base as the world’s largest iron ore producer, as well as rising outputs of nickel, copper, fertilizers, coal and other materials.

The Company, with its sound financial profile and good liquidity, generated record operating cash flow after working capital of $24.5 billion in 2011 on the strength of record-high iron ore and pellet sales and realized prices for these key commodities. Vale also reported record-high capital expenditures ($16.1 billion, excluding research and development expenses of $1.7 billion) and shareholder payments ($12.1 billion) in 2011, leading to an increase in net debt including Vale debentures and loans from related parties of $4.5 billion. Nonetheless, Vale’s credit metrics remain robust and generally stronger than in 2010.

Vale’s earnings have grown steadily since 2001, with a single sharp dip during the 2009 recession. Organic growth in sales volumes of iron ore and pellets has been supplemented by major acquisitions in nickel, copper, fertilizers and coal and their ongoing internal growth. Price increases in many of Vale’s outputs, particularly iron ore (up 240% since 2006) and pellets (up 158% since 2006), have been instrumental in driving higher earnings. Iron ore and pellets have provided about 79% of divisional operating income before depreciation over the last five years. Higher earnings continued in 2011, with earnings before non-recurring items up 26% over 2010 to $22 billion, a record for the Company.

Vale’s strong credit metrics are based on robust operating cash flows, which are currently reliant on its highly profitable ferrous metal (iron ore) operations combined with moderate debt levels. The Company’s current credit metrics are strong for its rating and are considered to reflect “top-of-the-cycle” conditions in the iron ore business. Gross debt leverage was 23.4% (24.1% including capitalizing operating leases) at year-end 2011; cash flow-to-total debt stood at 116% and EBITDA-to-interest coverage was 20.0 times.

The strength of Vale’s iron ore business has tended to overshadow its efforts to diversify its operations by acquisition and organic growth. A significant management shuffle in 2011 leads to the expectation of a more conservative approach to setting growth targets, but DBRS expects investment activity to remain aggressive in both its core businesses and, potentially, new businesses. With uncertainty in the outlook for commodity prices in 2012/2013 and the potential for a large tax bill (currently under litigation), Vale will need to remain prudent in its growth initiatives if it wishes to maintain its balance sheet strength.

DBRS expects commodity prices to be on average lower in 2012 than in 2011, resulting in flat-to-down earnings for Vale as production increases through the ramp-up of organic growth projects are not expected to be sufficient to offset the lower commodity prices, persistent cost inflation and increased takes by government entities. Slower growth in Brazil and China (about 8%) and other Asian countries is not expected to be offset by the impacts of continuing progress in the U.S. economic recovery, leading to slower growth in world commodity demand. Over the longer term, DBRS remains concerned about the large-scale expansion plans of many iron ore producers, which could result in lower iron ore and pellet prices critical to Vale’s earnings. Similar concerns are evident in the nickel and potash fertilizer businesses.

Accordingly, DBRS expects Vale’s credit metrics to weaken but remain solid despite reduced operating earnings and cash flow in 2012. The Company’s 2012 capital budget has been set at $19 billion before research and development expenses ($2.4 billion budgeted) and a $6 billion minimum dividend reducing flexibility for share purchases. Additionally, if large acquisitions are to be made in 2012, which DBRS does not anticipate, external financing may be required and DBRS would expect Vale to use an appropriate mix of debt and equity to preserve balance sheet strength.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The Senior Unsecured Debt of Vale Overseas Limited and the Guaranteed Mandatory Convertible Notes of Vale Capital Limited and Vale Capital II are irrevocably and unconditionally guaranteed by Vale.

The applicable methodology is Rating Companies in the Mining Industry, which can be found on our website under Methodologies.