The Rising Influence of Rising Affluence

[DewDiligence]

This bullish VALE article from Barron’s is month old, but is still valid.

http://online.barrons.com/article/SB50001424052748703754104577239641292393320.html

›Why Barron’s Digs Vale

The Brazilian mining company's stock trades at just 6.5 times forward earnings and offers a 4.7% dividend yield…

FEBRUARY 22, 2012
By TERESA RIVAS

The past year hasn't been kind to mining companies as worries about a global slowdown and commodity pricing weighed on the stocks. Yet Brazilian giant Vale looks like a cheap way to bet on China's continued growth.

Vale (ticker: VALE), the world's largest iron ore producer and second-largest nickel producer, trades at just 6.5 times forward earnings, cheaper than many of its competitors. Yet it has the fattest profit and operating margins of the group, while also boasting the biggest dividend, at 4.7%, which has room to expand.

"Vale is the lowest cost producer of iron ore in the world, so they should be able to stay in the game longer than others," says Alex Crooke, portfolio manager of the Henderson Global Equity Income Fund. "It's quite cheap with good cash flow, so you're not paying a lot for a company that…should see a recovery in iron ore prices come through a little more quickly [to the bottom line] than competitors."

It's undeniable that a bet on Vale is a bet on China, and lumpy demand in recent months have pressured the shares on fears that a slowdown in the region will weigh on iron ore prices and suppress profits.

Yet the situation in Asia seems far from dire as large infrastructure projects in China and elsewhere require a great deal of steel: Vale management says it expects sales of iron ore and pellets to grow 4.3% in 2012, while continued demand from the Asia and tight supply supports pricing as well. Moreover, with about 60% of its business coming from Europe and North and South America, Vale does enjoy diversity of end markets.

Vale is investing in a fleet of ships to send its iron ore to China more cheaply, yet it also has numerous opportunities closer to home, given Brazil's rising affluence and booming economy. The country is preparing to host both the World Cup and the Summer Olympics in the next four years and has seen direct foreign investment more than triple in the five years ending in 2010. All this has led its lower class to shrink to just over 30% this year, from more than half the population a decade ago, spurring building and infrastructure projects in the public and private sector.

Some have worried that Brazil's new government, which took power in early 2011, will pursue unfriendly business polices, but Vale is still more insulated than most: "While Vale's assets are concentrated in Brazil and Canada, the company has a better overall country risk profile than miners with significant operations in less-developed nations that lack political and economic stability and thoroughly institutionalized property rights," according to Morningstar analyst Daniel Rohr.

Although Vale has a fair amount of debt, it is cash rich—with $9.2 billion on its balance sheet—and has little trouble paying creditors while also increasing its generous dividend. Management has said it is taking steps to maintain its shareholder-friendly policies and will pursue more opportunities to return excess cash to shareholders, which could boost the stock as Vale pays investors to wait for more clarity on China's steel demand and commodity pricing trends.

Another potential catalyst for Vale in the months ahead could be the preliminary license for its Carajas Serra Sul project, the largest greenfield iron ore mine in history. The project is positioned, "at the very bottom of the world cost curve," writes Deutsche Bank analyst Rodrigo Barros. "In addition to the low cost, iron ore quality from this project would be extremely high (approximately 67% iron) and therefore price would command a premium compared to Vale's average product mix."

Still, despite Vale's bright prospects, the stock could see volatility ahead, given ongoing jitters in Europe and concerns about global growth. Furthermore, if Asia were to see a meaningful slowdown, the stock would certainly take a hit, and any interference from Brazil's government would also serve as an overhang.

Yet Vale pays investors handsomely for their patience, while its economies of scale and robust pipeline of projects should allow it to wait out any slump more comfortably than smaller peers.

Thus, trading near its historical valuation lows, Vale makes a cheap gamble that China and other nations will forge ahead in 2012.‹