As Citigroup remains bullish on long-term iron ore prices, they also remain positive on the long-term outlook for Vale.
In an advisory report published Wednesday, Citigroup metals analyst Alexander Hacking said the near-term outlook for the world's largest iron ore producer remained mixed on a weak nickel price and operational problems.
To elaborate on his concerns, Hacking referred to his May 23rd report on Vale, which noted four emerging problems with the mega-miner including:
1. Nickel has fallen below $11/lb.
2. Iron ore production is suffering from heavy rain in Carajas, Brazil.
3. Freight is now $100/t from Brazil to China.
4. China is trying to force iron ore destocking at its ports.
Nevertheless, Citigroup feel Vale is fairly valued based on 2008 iron ore prices but looks too cheap if the price rises strongly in 2009.
Our buy rating on Vale is almost 100% predicated on medium-term strength in the iron ore price, Hacking wrote. The iron ore market remains under-supplied and only a sharp deceleration in Chinese steel production will change this. We expect iron ore to rise by 30% in 2009.
Citigroup declared, We would be buyers on the current weakness. Should the stock fall below $35, this would be less than 10x PE and represent even more compelling value.
The iron ore price remains the biggest driver of Vale's shares, according to Citigroup's analysis. We reiterate our view than iron ore will rise against strongly in 2009. +30% is the Citi global forecast-but this may be conservative.
Hacking advised that he remains convinced that Vale has left substantial money on the table for the last two years, adding that 2009 is a chance for some catch up.
Citigroup's analysis suggested that the Australians are taking the correct line.
The protracted Australian negotiations is being portrayed as a freight issue-but it is also about Vale's weak settlements, Hacking asserted. The Aussies are also dissatisfied with the current pricing mechanism and are taking the correct line: ‘pay us what it's worth today.
We believe that a big Aussie settlement would be a benchmark for Vale in 2009, he added.
Noting that the nickel price has dropped to $10/lb from a recent rage of $12-$14/lb, Hacking asserts that cuts in Chinese stainless steel production may be the reason. For instance, Tisco and Baosteel have cut their steel production from 30-50% for May/June.
Weak demand for Chinese steel is puzzling, Hacking admitted. We are seeing no such demand problems for other metals being sold to similar customers in China.
The most intuitive answer seems to be that end-users are aggressively substituting into lower cost alternatives, Hacking suggested. Nevertheless, he added any minor rebound in Chinese stainless demand should see nickel trade back up into the $12-14/lb range based on restart of nickel-pig-iron expensive production facilities.
However, Citigroup feels the long-term outlook for nickel is mixed. The good news is that the cost of nickel-pig-iron is expected to increase based on higher ore, freight and energy costs. The bad news is that there is substantial new refined nickel supply arriving in 2009 from Goro, Onco Puma, Ravensthorpe and other projects. The interplay between these two forces is hard to predict-but we expect nickel to be relatively range-bound into the foreseeable future.
Hacking noted that the most common question he gets from investors is Who will Vale buy? While Citigroup agrees that Vale management is hungry to buy someone, they also note that Vale should price restraint on both Xstrata and Alcan.
The most widely discussed acquisitions candidates are Freeport for its copper, Alcoa, and Teck Cominco. Vale's stated preferences appear to be in order: coal, copper, aluminum (and nickel, if allowed). Yet, US$20bn+ options are very limited. The best candidates (like Southern Copper) are not for sale, Hacking explained.
Citigroup's target price for Vale is $48 per share, and the company is rated Medium Risk.