25% Upside Looks Likely For Vale Stock

Vale stock (NYSE: VALE) lost more than 50% of its value – dropping from $13.45 in January 2020 to $6.58 in late March 2020. This was due to the Covid-19 outbreak and the resultant lockdown, which led to expectations of economic slowdown. This then resulted in a decline in global iron ore prices and affected the company’s shipments due to supply bottlenecks. However, the multi-billion-dollar Fed stimulus provided a floor to the stock price as it rebounded from April onward and currently stands at around $11 per share. With the stock still 16% below its level at the beginning of 2020, is the market too conservative or is the price rise warranted? We believe that the stock price increase is justified and the stock could, in fact, jump another 25% from here.

Trefis estimates Vale’s valuation to be around $14 per share, reflecting a sizable upside of close to 25% from its current level. The triggers are the sharp recovery in iron ore prices over recent months and the gradual lifting of lockdowns which is likely to lead to increased production and shipments, along with higher demand from industries. As per the current estimates, though revenues are expected to decline almost 10% to $34 billion in 2020, the outlook for 2021 remains strong with revenues expected to recover to $37 billion. The recovery in revenue is, in fact, expected to begin toward the end of 2020 itself. However, a poor performance in the first half of 2020 is likely to be a drag on the full year 2020 numbers.

This was evident from the recently released Q2 results of the company where the impact of the pandemic was palpable. Vale’s revenues came in at $7.5 billion in Q2 2020, registering a y-o-y decline of 18%. This was mainly due to lower sales of iron ore, pellet, nickel, and copper. Despite iron ore and nickel production seeing an increase compared to Q2 2019, sales of all 4 commodities declined during the quarter due to lower demand from industries and lockdown-induced supply impediments. Vale reported earnings of $0.19 per share in Q2 2020, as against loss of -$0.03/share in the previous year period mainly due to expenses related to the dam accident and higher financial expenses related to debentures in the previous year period. On an adjusted basis earnings remained almost flat at $0.22/share.

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Vale experienced a meaningful slowdown in its business, but recently there have been signs of reopening of the economy and lifting of lockdowns which led to a surge in the stock price. This primarily led to a jump in iron ore prices over recent weeks, which currently stand at $105 per ton, its highest level of 2020 so far. The recent surge in Covid positive cases in the US and Brazil could prove to be an impediment in the path of the company’s healthy growth, as re-imposition of lockdowns will lead to a decrease in the revenue growth outlook. But in the absence of another Covid wave and lockdown, commodity prices are likely to remain strong.

For the full year 2020, total revenue is expected to be close to $34 billion and the margins are expected to rise to around 12%, from a loss in 2019. Once lockdowns are lifted, revenue is expected to rise to around $37 billion in FY2021. Margin could rise to 16% in 2021 as production and shipments increase. With shares remaining stable, earnings per share is expected to turn positive from -$0.33 in 2019 to $0.80 in 2020 and further to $1.16 by 2021. Despite a rise in earnings, the P/E multiple is likely to fall slightly, as the stock price would have somewhat accounted for higher earnings. The multiple could decrease from its current level of 14x to around 12x. EPS of around $1.16 and a P/E multiple of close to 12x in 2021 suggests that Vale’s fair value works out to $14. Projection of higher revenue and earnings and the expectation of iron ore prices remaining elevated post-Covid could provide a potential upside of around 25% from the current level.

So, Vale might see a notable rise from the current level with its share of risks. But, what if you’re looking for a more balanced portfolio instead? Here’s a top quality portfolio to outperform the market, with 170% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk. It has outperformed the broader market year after year, consistently.

For further insight in to the iron ore space, here’s how Vale compares with Cleveland-Cliffs.

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