DBRS Downgrades Vale Ratings to BBB, Changes Trend to Negative

DBRS Limited (DBRS) has today downgraded the ratings of Vale S.A. (Vale or the Company) and its subsidiaries to BBB from BBB (high) and has changed the trends to Negative from Stable. Vale is one of the largest mining companies in the world, with a solid business base as the world’s largest iron ore and nickel producer, as well as rising outputs of copper, fertilizers and other materials. Nonetheless, Vale’s credit metrics have deteriorated significantly, due mainly to a sharp drop in commodity prices and a high level of capital expenditures. The Company faces the ongoing challenges of low commodity prices in the near-to-medium term and the costs remaining to complete major capital projects, and it now must deal with the ramifications of a major tailings dam failure at its jointly owned Samarco operation in Brazil.

Vale has been aggressively enhancing its business profile, spending $49 billion on efficiency and expansion projects from 2010 to 2014. 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 earnings power and diversification, as well as increase its cost competitiveness. As such, new productive capacity is expected to add to cash-generation power in 2016 and beyond, but it will take commodity price improvements to reverse the current downtrend in Vale’s credit metrics.

Vale had a $4.3 billion net free cash flow deficit YTD 2015. Vale’s earnings before non-recurring items has declined sharply since achieving a record $23 billion in 2011, following a general and large decline in commodity prices. The price declines have accelerated to date in 2015, with iron ore and pellet prices down by about 42% and 38%, respectively, from YTD 2014 levels.

The Company’s financial metrics have deteriorated, with an increase in indebtedness in the face of reduced earnings and operating cash flow brought on by significant declines in key commodity prices, such that key credit metrics are now weak for the Company’s ratings. Net indebtedness (including obligations related to settlement of disputed tax matters with the government of Brazil) grew by $16.4 billion from the end of 2009 to September 30, 2015, despite record operating cash flow in 2010 and 2011, as the Company spent heavily on capital expenditures (capex), large shareholder payments and acquisitions, mainly earlier in the period net of dispositions, more recently ($3.1 billion YTD 2015).

For the rest of 2015 and into 2016, DBRS expects ongoing depressed commodity prices will continue to overcome the benefit of higher production levels, lower costs due to efficiency programs and currency devaluation, to yield lower earnings at Vale. The potentially large added cost of the Samarco tailings dam failure (net of insurance recoveries) will add downward pressure on earnings. Over the medium term, the added productive capacity of $59 billion in project and research and development expenditures since the end of 2009 will significantly increase the Company’s earnings power, but it will take higher commodity prices to reverse the decline in earnings since 2011.

DBRS expects Vale will remained challenged to stem the growth in its net debt in 2015 or 2016 as the impact of lower commodity prices reduces earnings and cash flow, although cost-saving efforts, lower capex and dividends and asset sales are expected to mitigate impacts. Even though Vale has made progress in reducing costs and paring back capex and new project approvals, the continuing weakness of key commodity prices is expected to provide further earnings and cash flow challenges, leaving credit metrics depressed. As well, a recent major tailings dam failure at its 50%-owned Samarco operations is expected to entail significant costs (only partially to be recovered from insurance programs) and loss of pellet and iron ore output for at least a year.

Management of debt levels in an environment of weakening commodity prices remains a clear concern. Although Vale has solid liquidity, the challenges it faces are strong and any further deterioration in commodity prices or an extended period of weak credit metrics is likely to lead to further negative rating action.

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 S.A.