By Carlos Azevedo.

Vale S.A. (NYSE: VALE) engages in the exploration, production, and sale of basic metals in Brazil. The company is also involved in fertilizers, logistics, and steel businesses. The Bulk Material segment consist of iron ore mining and pellet production, as well as its Brazilian Northern and Southern transportation systems, including railroads, ports, and terminals. This segment also includes manganese mining and ferroalloys. The Base Metals segment produces nonferrous minerals, including nickel, copper, and aluminum consisting of aluminum trading activities, alumina refining, aluminum metal smelting, and bauxite mining. The Fertilizers segment provides potash, phosphates, and nitrogen. The Logistic Services segment consists of transportation systems, including ships, ports, and railroads for third party cargos. This segment includes 10,179 kilometers of railroad infrastructure, 8 seaport terminals, 5 general cargo ports, and 2 iron ore export terminals. In addition, it generates energy through hydroelectric power plants. The company was founded in 1942 and is based in Rio de Janeiro, Brazil.

A Valuation Analysis

Market capitalization 

Market Capitalization (Market Cap) is a measurement of business value based on share price and number of shares outstanding. It generally represents the market’s view of a company’s stock value and is a determining factor in stock valuation.

Here are the valuations for Vale from 31 December 2007 to August 29th 2012

Revenue Growth

Revenue growth illustrates sales increases/decreases over time. It is used to measure how fast a business is expanding. More valuable than a snapshot of revenue, revenue growth helps investors identify trends in order to gauge revenue growth over time.

If a company generated $75 billion in revenue during 2008 and $100 billion in revenue during 2009, the company experienced roughly a ($100 billion/$75 billion)-1 = %33 increase in revenue.

During the last 5 years Vale had some outstanding results 3q/4q 2010 & 1q 2011. But recently, situation has deteriorated. Market are discounting further losses for the near future.

Future Cash Flows

The future cash flow growth rate for Vale should range between 12% to 15%. These figures are calculated based upon historical performance during the last 10 years. It doesn’t mean that Vale will meet such targets, but based upon the company’s ability to generate profits in the past, one could assume they will be able reach such levels.

At current discount rates, the company is undervalued. The average growth rate for companies at the SP500 ranges between 8 and 10 %.

Valuation by Earnings Power Value (EPV)

An EPV calculates the value of a company from its ongoing operations. This is done by adjusting free cash flows to ignore any capital expenditures used for growth. It assumes that current profitability is sustainable.

With that in mind, the stock price today does not indicate that Vale is overvalued.Vale’s ADR (NYSE:VALE) is trading at 16.10 dollars as of this writing. Under current conditions, the markets believes that the mining giant could trade at lower levels. In fact, the range should be around 12.50 to 13.00.

The graph bellow displays VALE’s daily trading prices during the last 5 years:

In this graph, there’s a clear downtrend that leaves very little doubt regarding the views and opinions of institutional investors about Vale’s shares.

Today in particular, there was heavy activity on the Options markets on options contracts expiring in the near future. trading activity today was heavier on the put side (investors protecting against or betting on further drops) than on the Call side (investors betting that prices will rise). The ratio was 1.74 to 1.

During the trading day on US markets, most transactions took place at 15.98 and 16.07. The upper prices showed very little demand and support came on 15.98

Such a heavy day volume could represent a temporary selling climax considering trading volume was almost twice the normal. Prices could continue to drop, but a temporaty bottom could be formed around this price range.

Net Current Asset Price (NCAV Valuation)

The Net Current Asset Price (NCAP) is an asset-based valuation created by Benjamin Graham, the father of value investing. It subtracts a company’s Total Liabilities from its Current Assets to arrive at an overall valuation. This number is divided by the number of shares outstanding to arrive at the Net Current Asset Price.

Where a company is undervalued according to NCAP, the market is not putting any value on the business’ ability to generate profits, only on its (semi-) liquid assets. This means it’s deeply undervalued. It is very rare to find companies that are undervalued by it’s NCAP, hence this stock should be looked into more carefully. There can be great finds, but there may also be good reasons why the market has depressed the stock price so drastically.

The NCAV for vale is negative. – 9.16 dollars per share.

The Price to Book Valuation

The Book Price is a multiple valuation that focuses on a company’s average historical price-to-book ratio (P/B). This valuation is very straightforward. First, the historical P/B is calculated by taking the average P/B over the past 10 years. This number is then multiplied by the current Book Value (Total Stockholders’ Equity) of the company and divided by the number of shares outstanding to arrive at the Book Price. This value is the price this stock should be traded at currently to achieve the same average P/B that the company has maintained over the past 10 years.

Institutional Ownership

Competitive Advantage over the past 10 years

VALE likely has a competitive advantage which prevents other companies from entering or competing in their industry. This could be strong branding, the ability to keep costs low, or some other characteristic that is hard to replicate. Look at future prospects to determine its sustainability.

Over the past 10 years, on average, $31.36 of every $100 of revenue have been pure profit.

Pricing Power over the past 10 years

VALE has maintained substantial gross margins, suggesting that they have been able to set prices without consideration of the cost of goods sold. This potentially leaves flexibility in inflationary environments to raise prices on consumers and maintain profitability.

Over the past 10 years, on average, $53.54 of every $100 worth of sales have been gross profit.

Capital Expenditures over the past 10 years

VALE spends large amounts of capital buying new equipment or investing in new facilities to stay competitive. Over the long term, those costs may have to be fuelled by debt. Look at the growth of Shareholders’ Equity to see if this strategy is having a positive or negative impact.

87.44% of Profits are being spent on Capital Expenditures, like Property, Plant, & Equipment, required to run the business.

(Figures in USD. Fiscal year ends in December)
CONCLUSION:Given current valuation and the response of market participants, I believe that building LONG positions on Vale could be risky at this stage.Aggressive investors, with risk appetite and willing to carry the possible burdens of holding positions on vale for a period of at least 18 months could start building their positions at this particular stage.

It is important to understand and accept the downside risks involved. I believe that holding stocks should be followed by hedging with options to protect the downside for the near term future (about 90 days).

Those willing to trade the stock, should look at the ranges from the past 90, 60 and 30 days. Envisage the regions where demand and supply are strong and weak. Once that has been established, price zones could be set and according to the sentiment during the particular day they decide to participate, they should determine the respective loss and profit zones.

On the short term, there is a very substantial resistance zone at at 18.80; to pass that zone there has to be catalysts. On the downside, there is a somewhat small resistance established in the past with low supply trading volume is at 15.35. If the prices breach that level we could see a fast drop towards the next stronger trade area found at 14.50 and the strongest one around 13.60. These are the areas with most activity during the last 5 years.

The last time that the shares traded that low was 2008. It breached all the way down in October and recovered in april 2009. From then on it has never looked back until today.

The strong historical support for the last 10 years is at 11.90. So there is some significant drop in sight if one is to reach those levels. At those levels I would start to look for opportunities. That is my view, and It is not an advice on what traders should or should not do.

The zone is outside the two standard deviations zone and if reached, one should be careful and watch the volume of trade and intensity at this particular level.

For those willing to build a position in stages (price averaging), find the ranges in which prices would become acceptable and start the position accordingly. The prices mentioned above reflect the areas in which traders participated actively (demand) and others in which there was lack thereof (no demand).

For Vale, the most active prices zone close to current prices is the zone around 11.50 dollars per share.

I hope this information proves valid for investors looking for some insight on Vale’s shares.

“ERRATA

For those who are reading the Post, I sincerely apologized for a couple of grammar mistakes on this post. 

In the paragraph above, I meant to say that Vale is not Is not a bargain and it is Overvalued according to markets. If readers explore further they will realize that what I am trying to share is the fact that the current perception from Market participants at this point is that VALE’s stock prices are not attractive. Vale stock may appears to be at discount, but not on under the eyes of institutional investors.

Can the situation Change? At any given moment!  It could change tomorrow with some fresh news from the company, it could move straight up without ever coming close to lower prices mentioned above. However, giving the fact that 

The company is a very important company in its sector and above all very important for the International Perception of Investors regarding Brazil’s economy.

Markets are dynamic. Perceptions and sentiments change, What does not change is the fact that on the 30th of August there were heavy transactions indicating that for the foreseeable future the overall perception from participants is results inferior to those expected. 

There was another Typo at “Market are discounting”, where the correct is “Markets are discounting”. 

My sincere apologies to Mr. Haskell and all other readers. I hope readers accept my sincere apologies.

I have no interest on VALE’s stocks. I don’t hold positions on the stock,nor plan to do so. The intention was just to share with readers the perceptions of Market participants towards a very important stock within the Brazilian Bovespa. 

Fact: The volume of transactions on options market were very Unusual. There were 0.6 call contracts traded for each put contract yielding a 1.75 put/call ratio where 78,126 put and 44,611 call contracts exchanged hands.There were 0.6 call contracts traded for each put contract yielding a 1.75 put/call ratio where 78,126 put and 44,611 call contracts exchanged hands.

The strikes most traded were September 16.00,  December 15 & 16 dollars and some heavy activity in January expiration 15 and 10 strikes. Some heavy trades in deep in the money options 22 and 23 dollars.

These are very expensive contracts and show that there is fear of further drops.”

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