By Ron Haruni · · Seeking Alpha
November 12, 2007
The Brazilian mining giant Companhia Vale do Rio Doce (RIO) is the largest global producer and exporter of iron ore and pellets with over 40% of the seaborn market. It is the second largest mining company in the world, with a market capitalization of almost $180 billion and actively engaged in mineral exploration efforts in nineteen countries worldwide.
CVRD (Companhia Vale do Rio Doce) is involved in the production of nickel, copper, manganese, ferroalloys, precious metals, cobalt and other products.
In addition, the company is recognized for its excellence in elaborating and providing logistics systems for national and foreign customers, integrating company-owned assets such as rail transportation for its mining products, general cargo and passengers, bulk terminal storage, coastal shipping and port handling functions that are integrated with its mining operations. The company, through affiliates and joint ventures has investments in the aluminum, coal energy and steel businesses, including seven hydroelectric power plants operations and one under construction in Brazil, assuring the power supply for CVRD operational activities.
CVRD is well diversified through its subsidiaries. It is present on five continents and operational primarily under three principal lines of businesses, consisting of mining, aluminum, and logistics operations.
The Mining side of the business, includes the steel-making ingredient iron ore operations and production. It is concentrated in three systems in Brazil – the Southeastern System, the Southern System and the Northern System.
The Southeastern system is located in the state of Minas Gerais, in a region known as the Iron Quadrangle. The iron ore mines of this system are divided into three mining areas: Itabira, Centrais Mines, and Mariana. From these particular mines, the iron ore is mined by open-pit methods, means of standard crushing, classification and concentration steps, while producing sinter feed in the beneficiation plants located at the mining sites. In fiscal ’06 CVRD produced 100% of the electric energy consumed in the Southeastern system via its own power plants.
The Southern system, which consists of the Oeste mines and the mines of MBR, is located in the Brazilian states of Minas Gerais and Rio de Janeiro. The iron ore produced from this specific system, is transported by a company called MRS Logistica in which CVRD holds directly and indirectly, 37.2% of the voting capital and 40.5% of the total capital to the Guaiba Island and Itaguai maritime terminals, both located in Rio de Janeiro. In fiscal ’06, CVRD produced 22% of the electric energy consumed for the southern operations.
The Northern System is comprised of open-pit ore mines and an ore-processing complex in the Carajas region of the state of Para. The mines are located in the north of Brazil on public lands for which the company holds concessions. The Northern system’s reserves are among the largest iron ore deposits in the world. Because of the high iron content – almost 70% on average – in the Northern system deposits, CVRD does not operate a concentration plant at Carajas. The beneficiation mining process consists simply of sizing operations, including crushing and filtration among other things. This allows CVRD to produce marketable iron ore at a lower cost in comparison to the Southern and the Southeastern Systems.
Companhia Vale do Rio Doce is developing iron ore pellets projects in Brazil and in China. In September of fiscal ’06 CVRD’s subsidiary MBR acquired a 25% stake in a joint venture to build a new pelletizing plant in Zhuhai, Guandong, China. The expected investment for the project stands at around $4 million, with CVRD providing a supply of at least 70% for the iron ore to feed the plant, based on a 30-year contract. The plant is expected to become operational in fiscal ’08. In February 2007 Vale purchased the Australian coal mining company AMCI Holdings for 835 million Australian dollars.
Through subsidiaries and joint ventures, the Company Albras-Aluminio Brasileiro S.A. (Albras) and Valesul each produces and conducts operations in the production of aluminum-related products. The Albras plant which has been operational since 1985, is located at Barcarena, in the Brazilian state of Para. It is one of the largest aluminum plants in the Americas, with a nominal capacity of 445.000 metric tons per year. Valesul operates a plant in Rio de Janeiro with a nominal capacity of 95.000 metric tons per year. It produces primary aluminum in the form of ingots and billets. Valesul’s aluminum products are sold primarily in the Brazilian market on a spot basis.
CVRD’s logistics business is conducted at the parent-company level and it comprises the transportation of customers’ products and passengers. This operation includes railroads, such as Vitoria a Minas and Carajas among others. The Vitoria a Minas railroad links the Southeastern Systems mines in the Quadrangle region with the Tubarao Port, in Vitoria, in the Brazilian state of Espirito Santo. The second railroad, Carajas, is located in the Northern System and starts at Carajas iron ore mine in the state of Para, extending 892 kilometers to Ponta da Madeira maritime terminal complex facilities, near the Sao Luis Port in the state of Maranhao. The Carajas railroad has a daily capacity of 255.000 metric tons of iron ore. On March 31, 2006, Companhia Vale do Rio Doce took over Caemi.
CVRD has also a large capacity of operations concentrated in three distinct shipping areas: seaborne dry bulk transportation services, coastal shipping liner services and tug boat services. It also operates Ports and Maritime terminals, such as that of Tubarao port complex, covering an estimated area of 18 square kilometers, principally used and operated as a means to complete the distribution of its iron ore and pellets to seaborne vessels serving the export seaborne market.
For the transportation of the cargo for fiscal ’06, the company operated a fleet of bulk vessels, which comprises three capesize vessels owned by the company and a few other capesize and panamax vessels chartered on a spot basis. Its capesize vessels have been trading worldwide carrying primarily iron ore.
The coastal shipping liner service is operated by five vessels and a fleet of 19 tug boats (seven owned and 12 chartered) in the ports of Vitoria. The ship liners are chartered on a bare boat basis and cover the South American east coast.
The Company competes in the segment with BHP Billiton PLC (BHP), Rio Tinto (RTP), Kumba Resources, Alcoa (AA), Rusal, Alcan (AL) and Chalco among other companies.
The high level of activity currently in the metal markets, continues to reflect advanced price movements and optimism in the prospects of a more robust fiscal 2008. This optimism is based and driven primarily, by confidence in long-term global fundamentals, but most importantly by strong levels of demand, especially from Chinese steelmakers together with a modest expansion in other markets.
According to International Iron and Steel Institute, the global demand for steel will increase by 15% into 2010 to over 1.2 billion t/a. Steel consumption is forecasted to grow between 12-13% during the next two years, with the Chinese steel industry continuing to have a vast consumer base thus remaining the largest steel-consuming nation. Furthermore, Chinese imports of iron ore shot up by 23% in ’06 yoy with current steel production growing at 7.3% in the first 3q’s of 2007. Iron ore prices in the Chinese spot market posted $172 per metric ton, rising more than 100% compared to prices prevailing one year ago, while the Indian ore surged to almost $180 per ton.
This specific and strong demand pertaining the metal markets, especially the iron ore segment which is closely interlinked with the shipping industry under which, among other aspects, CVRD heavily operates and extracts the bulk of its revenues from, in terms of its business lines remains particularly strong from China and other emerging economies, with no imminent slowdown.
Since fiscal ’01, global demand for iron ore has grown at an average annual rate of 9.8%. In 2006 the price of iron ore increased further compare to that of 2005, due to imbalance between global demand and supply. During this fiscal ’07 year, iron ore prices have increased by almost 10% and based on recent reports, contract of iron ore prices may increase an additional 25% in 2008, followed by a 10% hike the following year – again, due to robust demand and constrained supply issues.
Certainly, there is no implying of end in segment cycles due to strong demand. There will always be room for speculation and uncertainties around future market conditions and price projections however, a fact deserving attention is that considering price developments into the next two years – the key issue remains and will undoubtedly continue to persist – whether metals supply would be able to meet rising demand in an environment of continued global growth.
One thing worth pointing out is that, we are not including into this analysis the global iron ore segment alone. The consumption of other metals such as non-stainless steel application for nickel remains strong , aluminum and copper demand continues to grow averaging 5.6% and 4.8% a year respectively – based on rapid expansion of industrial production in other markets – with China again, contributing about 50% to average future demand growth.
Also, there are two important factors to take under consideration when forecasting the future of the Chinese steel market, in terms of its continued demand projections. With the first one being, China ‘s two major projects – the 2008 Olympic Games in Beijing, and EXPO 2010 Shanghai – coming up ahead. Furthermore, the demand of steel per capita has already surpassed the 100 kgs, which suggests that China has already entered a phase of full-fledged period of steel diffusion from expansion period. Although, there may be some fluctuation based on these two factors, the likelihood of constant growth on the part of China remains, in optimistic terms, quite high.
It is fair to say, that based on positive outlook regarding the industry and its overall performance so far with such favorable market conditions, global industry leaders such as CVRD will strategically exploit actual market conditions to expand profitability.
Companhia Vale do Rio Doce (RIO) has a market cap of $172.50 billion with an attractive .90 peg ratio. Profit margin trailing twelve stands at 28.69% with an impressive 46.11% in operating ones. Revenues stand at over $37 billion for a gross profit of $9.50 billion with a net income of almost $11 billion. Operating cash flow $12.53 billion with 17.30% growth in quarterly earnings yoy.
CVRD showed a solid performance in 3q’07. On October 25, ’07 the company delivered through its earning report a steady and strong growth. Gross revenues came in at $8.12 billion, the highest ever for a third quarter, up 9.9% from $7.39 billion compared to 3q’06. In the first nine months of this year, revenues posted $27.7 billion compared to $18.22 billion in the same period of fiscal ’06. Return on capital investment in the last twelve posted effectively 52.1%. Revenues from sales of ferrous minerals represented over 50.5% of this quarter’s gross, against 34.7% for non-ferrous minerals.The aluminum chain products contributed 8.3% while logistics posted 4.8%.
In nine months of fiscal ’07, net earnings amounted to $9.9 billion, as compared to $5.6 billion in the same period of nine months of fiscal ’06.
Companhia Vale do Rio Doce (RIO) has delivered strong and steady growth by a rapid increase in its cash flow prompting a significant increase of company’s market capitalization. A key component of this company is the consistent and the right strategy approach in relation to production growth through organic means.
CVRD is planning to spend $59 billion over the next five years pursuing the goal of accelerating investments, with a massive investment in the development of world class assets such as iron ore, pellets, coal and nickel.
By 2012 iron ore production capacity is planned to increase to 450 million metric tons per year from actual 300 million. Nickel production will double in 2012 reaching 500.000 metric tons, with significant rises scheduled to take place in production of coal, aluminum, pellets, copper etc.
This investment program is global in scope, including Canada, Indonesia, Peru, Chile, United Kingdom, Australia and Europe to mention a few, aiming to solidify CVRD’s logistic side of the business, along with power generation infrastructure, in order to support expansion.
Companhia Vale do Rio Doce shares, at current levels, are very attractive in my view based on the company’s consistent track record of pursuing organic growth. Its cost and return metric are one of the best in the industry. I believe that the company’s long-term growth prospects, particularly its expansion ambitions, are excellent and continue to be indicative of the company’s strength.
From a TA perspective the stock market has experienced a fairly strong sell-off in the last two weeks, however, RIO has maintained a sustainable and a fairly tight trading range, oscillating between $34 and mid $36 levels. During this period, prices have continued to test the upside and apply pressure with a tendency to accelerate and explore new territories..
Stock is recommended as a 12-18 months long-term hold, not to be watched on tick by tick basis with a $52 -$54 price target.