Vale (
VALE
) seems all but certain to report a loss in the fourth quarter of
the ongoing financial year. The company has suffered two major
setbacks in the last few days. Firstly, it announced that it
will book a $4.2 billion fourth-quarter pretax charge after
lowering the valuation of a nickel mine and its stake in aluminum
producer Norsk Hydro ASA. Also, last week the company announced tax
losses of nearly $483 million relating to cases in Brazil and
Switzerland. Of this, $451 million will be booked in the balance
sheet for Q4 and the rest of the amount will be adjusted in the
next financial year.
These two setbacks are only recent additions to a long list.
Tumbling iron ore prices on a weak demand outlook, failure to begin
docking Valemax ships in China due to permission issues, and the
shelving of the Simandou project in Guinea due to an uncertain and
adverse operating environment are some issues which have been
highlighted frequently in the past. The company has been forced to
contract its capital expenditure plans for next year and announce
sale of non-core assets in order to reduce costs and improve
efficiency. However, any gains due to these are certain to be
negated due to the latest charges as far as earnings are
concerned.
See Full Analysis of Vale Here
What Is The Reason For A Writedown In The Nickel
Business?
Vale will take a $2.85 billion pretax writedown on its Brazilian
nickel project Onca Puma. The problems in its nickel business have
been festering for some time.
As reported in its third quarter earnings results, lackluster
performance of the nickel segment has been one of the largest drags
on profit. Vale has been trying to diversify away from iron ore and
hopes that nickel would reduce its dependence on iron ore. However,
it has had little to show for its $10 billion investment in the
business so far. In the last few months, Vale's nickel mines
in Canada have suffered shutdowns. Its Goro nickel-and-cobalt mine
on the French Pacific island of New Caledonia, and Onca Puma, in
Brazil's Amazon, are producing far below expected levels because of
processing problems. The Goro mine, which was supposed to produce
60,000 tonnes of nickel a year, failed to produce any nickel or
cobalt in the third quarter.
Finally, operations stopped at Onco Puma and prices for nickel
declined. The writedown on account of the nickel business was
therefore inevitable.
Why An Impairment In The Aluminum Business?
In addition to nickel, Vale also said that it will
recognize a $1.3 billion pretax impairment on its 22% stake in
Oslo-based Norsk Hydro, an aluminum producer. The company blamed
the impairment on downward volatility in aluminum prices and
macroeconomic uncertainties in the European economy. The rating
agency Moody's cited more or less the same reasons when last week
it placed Alcoa's (
AA
) rating on review for a potential downgrade. ((
Alcoa May Be Cut to Junk by Moody's on Lower
Aluminum
, Bloomberg))
We think that aluminum prices are probably being driven not
by fundamentals but investor sentiment and macroeconomic factors
such as the Euro zone crisis, worries over mounting U.S. debt and
the hotly debated fiscal cliff situation, and the slowdown in
China. Fundamentals alone cannot explain the volatility that
has been observed in aluminum prices this year. In any case, there
isn't much Vale can do about its aluminum business. In an
environment of slow economic growth, it would be a stretch to
expect aluminum prices to trend upwards in the near future because
it is primarily an industrial metal. ((
LME Aluminum Price Graph
, LME))
In addition to these impairment charges, Vale announced the
settlement of two major tax disputes, at a considerably higher cost
than originally envisaged. It settled a dispute with Swiss tax
authorities over differences in interpretation of the federal
tax breaks granted to Vale's international business in 2006 and the
consequent tax liability figure. While the company had already
set aside $37 million for the Swiss claim, it said it would now
have to pay $232 million, which is almost six times that
amount.
Vale settled another tax dispute over unpaid sales taxes in the
state of Minas Gerais, Brazil's traditional mining hub. Here also,
while Vale had provisioned $64 million for the case, its eventual
liability would actually be five times higher at $317 million.
What Now?
This is not even the end of story. Vale said on December 6 that
it will make impairment announcements in two stages. A second
writedown worth around $50-$100 million on several different assets
is expected to be announced with the release of the company's 2012
results. Vale is also contesting claims that it must pay as
much as $14 billion (roughly 30 billion Brazilian reals) in back
taxes on overseas earnings that were already taxed locally in those
countries. The case is currently being reviewed by Brazil's Supreme
Court and represents a mind-boggling potential financial
liability.
Net income last quarter was $1.67 billion and the macroeconomic
factors that caused the steep 66% year-over-year decline in profits
remain largely unchanged this quarter. Thus, it's more or less a
foregone conclusion that the company will report a steep loss this
quarter. What will certainly be distressing for Vale management is
the fact that the assets that the company is looking to sell will
probably have to be used to compensate for these one-time losses.
This will leave less resources for investment in capital projects
next year which may have bearing on future growth. One of the
assets being considered for sale is the company's stake in Norsk
Hydro itself. The recent writedown may fetch a much lower valuation
now.
We have a Trefis price estimate for Vale of $20 after the
third quarter earnings results.
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