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1 February 13, 2015 Vale S.A. (VALE-NYSE) Current Recommendation Prior Recommendation Neutral Date of Last Change 11/16/2014 Current Price (02/12/15) $7.73 Target Price $7.00 UNDERPERFORM SUMMARY We prefer to maintain our previous recommendation of Underperform on Vale. Steep decline in revenues were responsible for reducing the company s earnings in the last reported quarter. A sudden fall in demand over supply might lower the selling price of Vale s primary product iron ore in future, thus weighing further on its top line. Also, being multinational in nature, the company is exposed to threats of adverse political, environmental and economical externalities. At the same time, Vale faces risks of losing market share due to cut-throat competition in the industry. However, we believe scopes for growth still exist for the stock. Industrial growth in U.S and some emerging economies might augment the sales of Vale s products such as steel and iron ore. Furthermore, a superior logistics network might enhance its revenues and margins in the near future, notwithstanding the adversities SUMMARY DATA 52-Week High $ Week Low $6.86 One-Year Return (%) Beta 1.47 Average Daily Volume (sh) 28,778,636 ADR Outstanding (mil) 5,123 Market Capitalization ($mil) $39,601 Short Interest Ratio (days) 6.22 Institutional Ownership (%) 10 Insider Ownership (%) N/A Annual Cash Dividend $0.46 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 8.8 Earnings Per ADR (%) 4.7 Dividend (%) 56.0 using TTM EPADR 5.1 using 2015 Estimate 9.1 using 2016 Estimate 7.2 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page Risk Level * Above Avg., Type of Stock Large-Value Industry Mining -Iron Zacks Industry Rank * 117 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,201 A 11,277 A 12,910 A 13,606 A 48,994 A ,682 A 9,902 A 9,062 A 9,617 E 38,263 E ,861 E 8,022 E 8,384 E 12,171 E 36,438 E ,878 E Earnings per ADR Estimates (EPADR is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.60 A $0.64 A $0.71 A $0.62 A $2.38 A* 2014 $0.40 A $0.38 A $0.13 A $0.36 E $1.27 E 2015 $0.05 E $0.11 E $0.17 E $0.52 E $0.85 E 2016 $1.07 E Projected EPADR Growth - Next 5 Years % 27.8 *Sum of the quarters does not add up to the year Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Rio de Janeiro, Brazil-based Vale S.A. (VALE) is one of the world s largest producers and exporters of iron ore and pellets. It is the biggest diversified mining company in the Americas and one of the largest, in terms of market capitalization, in Latin America. Vale s production facilities are mainly located in Brazil, Canada and Indonesia. The company s chief markets are Brazil, China, Europe and Japan. Vale S.A. engages in mining and production of ferrous and non-ferrous metals and aluminum-related operations. It is involved in iron ore mining, pellet production, manganese ore mining and ferroalloy production, as well as the production of non-ferrous minerals, such as kaolin, potash, copper and gold. Vale s aluminum-related operations include bauxite mining, alumina refining and aluminum metal smelting. It also operates large logistics systems like railroads and ports, integrated with its mining operations. Directly as well as through affiliates and joint ventures, Vale has major investments in the energy, aluminum-related and steel businesses. The company has grown both organically and through aggressive acquisitions. After acquiring the Canadian company, Inco in 2006, Vale became the world s biggest iron ore producer, and a major player in the nickel, bauxite, alumina, manganese and ferroalloys business. Vale s principal lines of businesses include the following: Ferrous Minerals (72.0% of 2013 Revenues): Under this division, Vale operates two world-class integrated systems (the Northern System and the Southern System) in Brazil for producing and distributing iron ore, consisting of mines, railroads, port and terminal facilities, and a system comprising MBR s (a subsidiary of Vale) mines and port facilities. Coal (2.1%): The company produces metallurgical and thermal coal through Vale Australia Holdings (Vale Australia), which operates coal assets in Australia through wholly owned subsidiaries and unincorporated joint ventures. Base Metals/Non-Ferrous Metals (14.9%): The non-ferrous metals business includes exploration efforts related to kaolin, potash, copper and gold. It is the world s third largest producer of kaolin and Brazil s sole producer of potash. Vale s first copper mine, the Sossego copper mine, is Brazil s largest copper producer. Fertilizer nutrients (6.1%): These include fertilizer nutrients like potash, phosphate, nitrogen and others. Logistics Services (3.1%): The segment provides its customers with various forms of transportation and related support services, such as warehouse, port and terminal services. Its iron ore complexes have an integrated railroad network, which is linked to automated port and terminal facilities. They are designed to provide mining products, general cargo and passenger rail transportation, bulk terminal storage and ship loading services. Others (1.8%): This includes sales and expenses of other products and investments in joint ventures, and associate in other businesses. Equity Research VALE Page 2

3 REASONS TO SELL RISKS RECENT NEWS Vale has reported significantly lower earnings in the third quarter. The company s earnings per ADR (American Depositary Receipt) came in at $0.13 per share dropping 81.7% year over year and 66% sequentially. Diminishing revenue is the primary cause for the decline of Vale s earnings. Even so, the share price of Vale has suffered a significant fall due to its poor earnings release. Vale is making concerted efforts to increase its iron ore productivity, but demand for the same is highly volatile in nature. A sudden fall in demand or excess of supply over requirement might lower the selling price of iron ore in the market, thereby, negatively affecting the revenues of Vale. The functioning of Vale depends on licenses and permits issued by the government. Changes in government policies might lead to situations where licenses are not renewed at all. Furthermore, the organization offers products that are less differentiated in nature and hence experiences severe threats of market rivalry. The company continues to run risks of losing brand value or market share under this regime. Vale s business status is highly sensitive to the impending economic uncertainties in the country. Being a cyclical stock, the company is highly affected by interest, exchange rate and currency fluctuations in the market. Moreover, environmental issues such as natural disasters, abnormal rainfall, shortages of skilled workers and destabilizing industrial infrastructure continue to threaten the company s stock performance. Apart from coal, volumes of most of Vale s products have increased in the third quarter. In order to deliver commodities timely and efficiently, the company is building new and better logistics networks. Additionally, a rapid consumption rise in the global economies and urbanization of countries such as China and Japan can increase demand for Vale s products in the coming quarters, hence boosting its growth prospects. Vale expects demand for steel to increase in the near future and hence, improve the global requisite for its primary input, iron ore. Steady growth in the U.S. and some emerging economies are projected to support such outcome. On the back of this assumption, the company has formulated its 2015 capital budget. Further, acceptance of operational extension license from Brazil s N4WS mine pit sustains this strategy of Vale. Backed by these initiatives, the company expects superior top-line results in the upcoming quarters. Minimum Dividend Declaration On Jan 30, 2015, Vale s Executive Board of Directors had approved the tender of a minimum dividend of $2 billion for The dividend was announced for both preferred and common shares outstanding. The distribution process of the same will take place on Apr 30 and Oct 30 of the current year, in equal tranches. Capital Expenditure Budget for 2015 On Dec , Vale announced its investment budget for The company planned to allot $6.358 billion for financing its upcoming growth projects, while $3.809 billion was approved for funding the existing business operations. The budget indicated Vale s extensive focus on its global business projects. Equity Research VALE Page 3

4 Operational License Approval On Nov 6, 2014, Vale secured an operational license for its N4WS mine pit in Brazil. The license would enhance the aggregate iron ore productivity of the company, hence, supporting the aim of its 2015 and 2016 production plans. Third-Quarter 2014 Earnings Highlights On Oct 30, 2014, Vale reported weak financial results for third-quarter Underlying earnings per ADR (American Depositary Receipt) came in at $0.13 per share dropping 81.7% year over year and 66% sequentially. The bottom line also lagged behind the Zacks Consensus Estimate of $0.30 per share. Reduction in revenues was the primary reason behind the earnings decline. Revenues: Net operating revenues declined 26.5% year over year and 8.5% sequentially to $9.1 billion. Revenues came in lower than the Zacks Consensus Estimate of $10.6 billion. Of Vale s total gross revenue of $9.2 billion, sales of ferrous minerals accounted for 64.2% of the aggregate tally; coal 2.2%; base metals 23%; fertilizer nutrients 8.1%; and the remaining 2.6% came from miscellaneous sources. Geographically, 20.6% of revenues were generated from South America, 49.2% from Asia, 8.1% from North America, 17.1% from Europe, 3.9% from the Middle East and 1.2% from Rest of the World. Expenses: In the third quarter, cost of goods sold totaled $6.5 billion, up 3.8% year over year. Selling, general and administrative expenditure stood at $274 million, while research and development expenses were $194 million; declining 8.7% and 4% year over year, respectively. Balance Sheet and Cash Flow: Exiting the third quarter of 2014, Vale had cash and cash equivalents of $7.8 billion versus $7.1 billion in the previous quarter. Long-term liabilities came in at $49.1 billion, down marginally from $50.9 billion in the preceding quarter. In the reported quarter, net cash generated from operating activities amounted to $2.9 billion compared with $4.3 billion in the year-ago quarter; while capital spending was $3.2 billion versus $3.0 billion in the third quarter of Outlook: Management believes that demand for steel will rise globally by 2% in 2014, thereby driving the worldwide requirement for iron ore. Steady economic growth rates in European Union, U.S. and China will support such outcomes in the market. The demand and price for nickel will possibly rise in 2015, taking into account the fall of NPI manufacturing in China due to depleting ore stocks. Production Report On Oct 23, 2014, Vale reported a standard production report for the third quarter. Apart from coal, productivity volumes of most of its products have experienced moderate year-over-year growth. The company s pellets, nickel and copper production volumes have reported double digit growth rates compared with the year-ago volumes. The coal production capacity has slightly slipped, primarily due to power productivity of Integra Coal mine. The maintenance-related activities of the mine are still not complete. Production of iron ore reached a record level since the third quarter of 2011, growing 3.1% year over year to 85.7 million tons. The aggregated output level increased due to a rise in the iron ore productivity volumes in many of its mining hubs located in places like Vargem Grand, Minas Itabirito, Urrucum and Equity Research VALE Page 4

5 Corumba. However, shipment volumes of the mineral fell by 3.6 million for the Carajás Railroad interdiction. Pellet production rose 17.6% to 11.4 million tons owing to better performance of the Tubarão VIII and Oman pellet plants. Coal output reached 2.3 million tons, increasing by 5.9% sequentially, largely backed by stronger performance of Carborough Downs, Isaac Plains and Moatize mines of the company. Nickel production totaled 72,100 tons, 16.5% higher than the previous quarter. The rise was primarily attributable to an improvement in the New Caledonian Operational facilities of the company. Furthermore, manganese production increased by 5.3% year over year to 654,000 tons, backed by a rise in the output level of the Carajás Azul mine. VALUATION Vale ADR has trailing 12-month earnings multiple of 5.1x compared with 5.4x for the peer group and 19.0x for the S&P 500. Over the last 5 years, the company s ADRs have traded in the range of 4.0x to 31.0x trailing 12-month earnings. We expect Vale ADR to trade at a of 8.2x EPADR 2015, to arrive at the target price of $7.00. Key Indicators F1 F2 Est. 5-Yr EPADR Gr% P/CF 5-Yr High 5-Yr Low Vale S.A. (VALE) Industry Average S&P Kumba Iron Ore Ltd. (KIROY) Alderon Iron Ore Corp. (AXX) Cliffs Natural Resources Inc. (CLF) MMX Mineracao e Metalicos S.A. (MMXMY) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B P/B ROE D/E Div Yield 5-Yr High 5-Yr Low Last Qtr. Last Qtr. Vale S.A. (VALE) EV/EBITDA Industry Average S&P Equity Research VALE Page 5

6 Earnings Surprise and Estimate Revision History Equity Research VALE Page 6

7 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of VALE. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121 companies covered: Outperform %, Neutral %, Underperform 7.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Research Analyst Copy Editor Content Ed. QCA Lead Analyst Reason for update Sreya Bhowmick Anuja Mitra Payal Jalan Supriyo Bose Payal Jalan Daily Update Equity Research VALE Page 7