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

DBRS has today confirmed the ratings of Vale S.A. (Vale or the Company) and its subsidiaries at BBB (high). The trends on the ratings are Stable. The confirmation reflects Vale’s status as 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 and other materials. Its scale and low-cost operations are expected to help it weather the current weakness in commodity prices.

Vale has been aggressively enhancing its business profile by spending, on average, $9.4 billion per year on efficiency and expansion projects for each of the last five years. A number of these projects have been completed and are ramping up, adding to the Company’s productive capacity and more will be completed in the next few years. These projects add to the Company’s product and geographic diversification, as well as increase its cost competitiveness.

Vale’s earnings before items considered non-recurring by DBRS has been volatile since achieving record levels in 2011, falling sharply in 2012, recovering somewhat in 2013, but running behind both years for the first half of 2014. Results from the key Ferrous Metals unit have weakened, with iron ore and pellet prices down by about 40% and 30%, respectively, from record 2011 levels, while combined volumes have remained relatively flat at 300 million tonnes per year. Diversification and organic growth into base metals, fertilizer nutrients and coal has only modestly contributed to earnings, with only base metals currently having a material impact.

The Company’s net indebtedness has increased each year since 2008, for a net increase of almost $25 billion to date (including obligations related to settlement of disputed tax matters with the federal government of Brazil (REFIS program)), despite record operating cash flow in 2010 and 2011 due to high capital expenditures (capex), large dividend payments and acquisitions, although gross debt in its capital structure remained below 30% until mid-2013. The Company’s $9.6 billion REFIS settlement resulted in $2.6 billion in tax payments in 2013 and a $7.0 billion increment to indebtedness as calculated by DBRS, raising gross debt above 35% currently. With lower earnings and operating cash flow since 2011 due to declining commodity prices and materially higher debt levels, Vale’s credit metrics have receded from being strong for its ratings in 2010/2011 to being adequate given the point in the commodity price cycle the world is in.

That said, Vale has made good progress in reducing costs and paring back new project approvals and capex resulting in the Company generating positive net free cash flow in the first half of 2014.

Nonetheless, iron ore and other key commodity prices continue to weaken, which DBRS expects will lead to lower earnings and cash flow in H2 2014 and possibly 2015. Although Vale has already charted a decline in project spending over the next few years, the Company will remain challenged to stem the growth in its net debt in 2014 as the impacts of lower commodity prices and a $4.2 billion minimum dividend compete against cost-savings efforts and expected lower capex. Coverage metrics may well decline further until stability of iron ore prices is achieved.

Over the longer term, added productive capacity of $54 billion in project and research and development expenditures since the end of 2008 will significantly increase the Company’s earnings power, which is expected to lead to an improvement in credit metrics as commodity prices reverse their current downward trend.

In the interim, Vale will need to remain prudent in its cash outflows if it wishes to maintain balance sheet strength.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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

The Senior Unsecured Debt of Vale Overseas Limited is irrevocably and unconditionally guaranteed by Vale.