As I've mentioned in other recent pieces on Investopedia, these are tough times for commodity producers as the incremental Chinese demand that pushed prices so far for so long has faded. With that, demand for steel inputs in particular (met coal and iron ore) has come into much better balance with supply and prices have weakened considerably. Although high-cost iron ore suppliers are looking at some tough times in the coming years, Vale's (Nasdaq:VALE) low-cost assets should serve the company well. Investors don't really want anything to do with this giant iron miner today, but patient investors who can take the risk of conditions getting even worse in the short run may like the long-term potential offered by this company. Is The Super-Cycle Dead Or Sleeping?The “commodity super-cycle” that dominated most of the last ten years spurred billions of investment spending into new mines and logistics facilities. Now, though, it looks like China's appetite for resources has stabilized and markets that saw chronic shortages for years are now seeing ample supply. That, in turn, has led to many of the major miners like Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) to curtail capital investment plans, while smaller miners with higher cost structures are nervously comparing the trend in resource prices to their looming debt repayment schedules. SEE: Commodities: The Portfolio HedgeThe real question now is whether the cycle can reignite. At this point, it looks like the answer is “probably not”. China will still need raw materials to continue its plans to industrialize and run its economy, but China's resource intensity appears to be declining simultaneously with new supplies coming on line. While modernization and industrialization in India (and, to a lesser extent, countries like Vietnam and Indonesia) may generate another upward cycle at some point, that's not likely to happen in the next couple of years. Vale Will At Least SurviveAs Vale produces such a significant percentage of the world's iron ore, these issues are not trivial to the company or its investors. The good news, though, is that like Freeport McMoRan (NYSE:FCX) in copper or Teck Resources (NYSE:TCK) in met coal, Vale has exceptionally low-cost assets that will help it maintain profitability and cash flow even in a lower-price environment. Analysts (as well as Vale management) have estimated long range cash costs of about $15/ton to $20/ton for the company's iron ore mines. With recent prices around $120/ton, that's a meaningful spread. What's more, the general consensus in the industry is that smaller producers (particularly those that opened/expanded mines over the last five years) cannot operate very long at prices below $100/ton. All of that said, investors need to be prepared for substantial volatility. Unlike other commodity industries, the iron ore industry is not really set up for flexible production – these companies build their mines and logistics infrastructure to operate all-out all the time. So while it may seem logical for Vale, BHP, Rio, and Fortescue to operate as rational oligopolies and curtail production when prices weaken, that may be much easier said than done Vale Looking At Returns More Than GrowthIt wasn't so long ago that Vale seemingly wanted to do everything. Iron, nickel, copper, coal, potash – you name it, and Vale wanted to mine it. While the company still has operations outside of iron ore and ongoing plans to expand production, the company has become a great deal more returns-focused recently. SEE: How To Invest In CommoditiesSome of this can, perhaps, be tied to the Brazilian government's never-ending interference in the management of the company, which has included actively discouraging operations outside of Brazil. But I believe the change in management (precipitated by the government) has also brought a change in priorities, as we've seen at some of the other large global miners. With Vale recently punting on a potash project in Argentina due to insufficient likely returns, I do think shareholders can have more confidence that management will not spend recklessly on new mining projects in the coming years. The Bottom LineVale's valuation today seems to presuppose iron ore prices of $90/ton or below within the next two years. Such a price certainly won't be great for Vale's EBITDA, but the company would still be profitable and capable of both making its debt and dividend payments. Since I don't believe $90/ton iron ore is sustainable for the long term, I think Vale is undevalued. Whether investors look at EV/EBITDA, price/book, or NAV, the shares look too cheap today. Long-range NAV analysis suggests a fair value near $20, while a 5.5x forward EBITDA (lower than has been typical for the company) suggests a mid-teens fair value. While I do have concerns that building worries about global growth in the second half of 2013 could pressure commodities further (and with them, the price of Vale's stock), I think this stock is priced attractively for a two-to-three-year horizon.

Related Articles
  1. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  2. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  3. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  4. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  5. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  6. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  7. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  8. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  9. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  10. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center