In some respects, Brazilian iron giant Vale (NYSE:VALE) should be sitting pretty. After all, it controls huge iron ore reserves, has a pretty compelling cost structure and has successfully grown a non-ferrous business centered around nickel and copper.

On the other hand, there's just not enough demand from the Brazilian steel industry to change the fact that Vale rises and falls with Chinese demand. Making matters worse, the Brazilian government has not been shy about influencing (some might say "interfering") the company's internal operations. Although Vale's valuation is not really that extreme today, investors need to appreciate the risks that go with this name. (For more, see Earning Forecasts: A Primer.)

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No Major Surprises in the Fourth Quarter
For better or worse, there weren't many surprises in Vale's fourth quarter. Revenue fell about 3% from the prior year and about 12% from the prior quarter as the company absorbed a 20% sequential decline in iron prices. Non-ferrous revenue rose 3% sequentially, but makes up less than 20% of revenue.

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Profitability was not bad all things considered. Gross margin did slide a few points from the third quarter, and EBITDA dropped nearly one-quarter on a sequential basis. Iron ore costs rose almost 3% on a sequential basis, but were held down in part due to the movements in the Brazilian real estate (a weaker currency helps Vale).

Tussling with the Government
Forget about the formal ownership structure of Vale, the reality is that Vale has to deal with a level of government involvement in its affairs that rival miners like Rio Tinto (NYSE:RIO), BHP Billiton (NYSE:BHP) and Cliffs Natural Resources (NYSE:CLF) largely do not. The government has forced major changes in management (including the CEO) and forced the company to change its plans with respect to how it allocates capital overseas and domestically.

Now there are two new issues on the horizon. Brazil is contemplating a change in its resource royalty laws that would more than double Vale's obligations (from about 2 to 5%). The government is also pushing a tax dispute that alleges Vale owes in the vicinity of $20 billion including fines. Vale has thus far done relatively well against the government in tax court, but cynical investors know that this is a case where Vale can "win" in court and still ultimately lose.

Vale's China Syndrome
Unfortunately for Vale, steel companies like Gerdau (NYSE:GGB), ArcelorMittal (NYSE:MT) and U.S. Steel (NYSE:X) just don't matter much as customers. Instead, it's all about China - so much so, in fact, that Vale has acquired its own ore carriers to better control costs and compete with mines operated by Rio Tinto, BHP, and Fortescue in Australia that are much closer to Chinese customers.


As more Australian iron ore mines have come online, China has gotten more aggressive in its dealings with Vale (including blocking Vale ships from docking). This is not exactly unusual behavior from this customer - when they feel emboldened, they push very very hard and there's little Vale can do about it.

The Bottom Line
Like many primary metal producers, Vale has come down considerably from former highs. Although Vale has (over the last five years) carried a bit of a premium to other miners, assigning it the same five times enterprise multiple as Freeport-McMoRan (NYSE:FCX) and other miners suggests a target price in the high $20's.

Here too, though, there is room to play a bit with the numbers. There seems to be two strata of analysts - the $28 billion crowd (that is, a $28 billion estimate for 2012 EBTIDA) and the $33 billion crowd. The difference between those estimates creates a valuation range between $26 and $29, while throwing a multiple of six times (closer to its recent history) extends that into the mid-$30's.

The bottom line? Unless the bottom falls out of the global economy, Vale is probably no worse than fairly valued. All of that said, a demanding primary customer and an intrusive government do up the risk in this name. Vale is by no means a bad name to own, but investors need to appreciate these risks before buying the shares. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.