Introduction
After seeing a volatile and rather lackluster half-decade leading up to 2021 that saw intermittent dividends even at the best of times, the Brazilian major iron ore producer, Vale (VALE) enjoyed booming operating conditions that if continued, would see a massive near-20% dividend yield. When looking ahead this massive dividend yield probably will not last, although the outlook is better than in the past.
Executive Summary & Ratings
Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.
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*Instead of simply assessing dividend coverage through earnings per share cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and also best captures the true impact upon their financial position.
Detailed Analysis
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Following a tumultuous year during 2020 that originally saw their operating cash flow plunge in the first half as the Covid-19 pandemic sent the global economy into a crisis, it quickly recovered back in the fourth quarter to end the year at $14.322b as iron ore prices promptly recovered. Whilst this appeared to be a fortunate turn of events at the time, it was nothing compared to 2021 that saw their operating cash flow surge to a massive $23.799b during the first nine months alone as iron prices reached new heights of over $200 per ton, which sent their free cash flow to a massive $20.237b.
Thanks to their variable dividend policy, this impressive cash flow performance saw their dividend payments follow in tandem and surge to a massive $13.493b during the first nine months of 2021 with more following during the yet-to-be-released fourth-quarter results. If continued, their total dividends for 2021 of $2.7029 per share would provide a massive near-20% yield on their current share price of $14.01, which marks a very desirable change following the last half-decade of intermittent dividends at the best of times. Even though it would be amazing to see this continue, when looking ahead they probably will not last given their reliance upon volatile iron ore prices that are already moderating from their record-setting rally during 2021, as the graph included below displays.
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It can be seen that iron ore prices have taken a volatile ride, which is common for commodities and as a result, it makes it essentially impossible to accurately predict their future earnings and cash flow performance, which by extension also applies to their dividends given their variable policy but not all hope is lost. Even if they were to only generate the same circa $9b per annum of free cash flow as during 2018-2020, this would still leave a very high circa 12.50% free cash flow yield given their current market capitalization of approximately $72b and thus even if operating conditions ease to a more replicable middle-of-the-road level, they still have ample free cash flow to reward shareholders. This makes reviewing their financial position particularly important to not only ensure that they can ride out any potential future downturns but also given their questionable history of dividends, it also provides insights into their ability to continue returning free cash flow to shareholders outside of these recent booming operating conditions.
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Thankfully enduring little to no dividends throughout 2018-2020 was not in vain with their net debt plunging from $9.65b at the end of 2018 to only a mere $769m at the end of 2020, which essentially eliminated their leverage and left their capital structure very clean, especially given their very large cash balance. Whilst their net debt has subsequently crept higher to $2.207b following the first nine months of 2021, this solely stems from their $2.345b NLC acquisition that if not undertaken, would have seen them sporting a net cash position.
When looking ahead, their only modest capital expenditure guidance for 2022 and variable dividend policy should see their net debt and thus leverage continue hovering around these very low levels, if not decreasing even further. This will not only increase their fiscal and operational stability, which is particularly desirable in their volatile industry that experiences widely changing operating conditions. Although even more important, it means the outlook for their dividends is better than in the past since it clearly is not problematic, nor even slightly impedes their ability to return cash to their shareholders.
The lack of net debt within their capital structure means that unless they aggressively increase their capital expenditure or pursue large acquisitions, neither of which are being discussed nor indicated as a likelihood, they have no use for their free cash flow other than shareholder returns. Even if this comes in the form of additional share buybacks, they will still lead to higher dividends in the future by lowering their outstanding share count. Whilst the booming operating conditions of 2021 and the resulting massive dividends probably will not last, this means that they are unlikely to slip back to their disappointing levels seen throughout the previous years when they were often suspended.
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Apart from almost eliminating their leverage, their now very clean capital structure and its very large cash balance also help ensure that their liquidity remains strong with a current ratio of 0.92 and even more importantly, a cash ratio of 0.71. When looking ahead, their ability to continue producing free cash flow, very low net debt and large operational size means that they should have no issue sourcing additional capital if necessary during the foreseeable future.
Conclusion
Whilst the last five years before 2021 were not particularly desirable for their shareholders and only saw intermittent dividends even at the best of times, thankfully their outlook is better now that they have almost completely eliminated their leverage. Apart from increasing fiscal and operational stability, it also leaves them well placed to return relatively more cash to their shareholders as the prevailing operating conditions allow and thus I believe that a bullish rating is appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Vale’s SEC Filings, all calculated figures were performed by the author.
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