SAO PAULO Brazil's Vale (VALE5.SA)(VALE.N) became on Wednesday the latest victim of China's economic slowdown after second-quarter profit tumbled because of slowing demand for iron ore that will spill over into the coming quarters.
Net income at the world's largest producer of the mineral hit its lowest level in more than two years, underscoring its dependence on Chinese purchases of its flagship product. Profit also plummeted after a weakening Brazilian currency lifted debt-servicing and the use of derivatives for hedging.
Vale earned $2.662 billion in the quarter, down 58.7 percent from a year earlier, according to a securities filing on Wednesday. The result, the lowest since the first quarter of 2010, missed the average $2.998 billion estimate of 10 analysts in a Reuters poll.
"I'm struggling to find anything good coming out of this earnings report," said a New York-based mining analyst who declined to be quoted by name before his views were sent to clients. "Most of this is probably related to the China problems and their impact on pricing."
Vale's disappointing earnings performance may continue into next year as the global economy stagnates and demand for metals loses traction. Slowing growth in China, which fueled a commodity market rally for a decade and created a bonanza for Vale, is already weighing on iron ore prices and may create a global surplus of the mineral next year.
Vale charged $103.3 per tonne of ore sold, 29 percent less than a year earlier and 5.5 percent below prices in the first quarter. The analyst said that, at such level, the company is likely selling ore at below-market prices to some customers.
The results pose a challenge to Chief Executive Murilo Ferreira, who, with a little more than a year on the job, has struggled to allay investor concerns that Vale is prepared to weather slower growth in Chine, restore good relations with the government and improve project execution.
Vale's cost of doing business may also climb in coming years as Brazil's government, seeking to assert more control of the nation's natural resources, exacts a greater toll from the country's biggest exporter through taxes and royalties.
Preferred shares of Vale, the company's most widely traded class of stock, have sunk 14 percent over the past 12 months. Concern that second-quarter earnings would be worse than analysts' predictions also fueled a 4.9 percent decline in the stock over the past month.
China's share of Vale's iron ore and pellets sales fell to 43.7 percent in the second quarter from 47.2 percent in the prior quarter, while volumes shipped rose.
In spite of that, company's net revenue rose 7.2 percent to $12.150 billion from the first quarter, when heavy rains dampened production and shipments. The result, however, missed analysts' estimates of $12.596 billion in sales.
Sales growth of the company's main products appear to be cooling, and may cool further. Prices for Brazilian iron ore shipments to China are roughly between 15 and 21 percent lower than a year ago, even though volumes were up from a year ago, according to Chinese customs figures. <MTL/CHINA3>
Although prices for Brazilian ore have slightly improved sequentially, the outlook going forward looks bleak for Vale's sales. Spot iron ore prices extended their losing streak to touch an eight-month low on Wednesday, and are down by more than a third since a record peak in mid-February. <IRONORE/>
The dismal performance was also affected by the rising cost of goods sold, a jump in general and administrative expenses and a surge in the cost of hedging - a strategy used by Vale to protect its balance sheet against swings in the currency or in prices of the products it sells or buys as raw materials.
Limiting the decline in profit, the company booked a $377 million one-off gain stemming from the sale of coal assets in Colombia and had to pay lower income taxes in Brazil during the quarter, the filing added.
The Brazilian real's 11 percent drop helped boost Vale's debt-servicing costs and charges related to fluctuations in currency and derivatives prices, but failed to generate significant revenue gains or cost savings.
An account measuring the impact of currency and monetary fluctuations on Vale's balance sheet reached $1.693 billion, the highest level for the item since the third quarter of last year, reflecting a jump in the cost of interest-rate and currency derivatives contracts, the filing showed.
Earnings before interest, tax, depreciation, amortization and other items, a measure of operational profitability known as adjusted EBITDA, came in at $5.119 billion, below an estimate of $6.265 billion in the poll.
Investors tend to follow Vale's quarterly data more closely than year-on-year numbers because the former helps them visualize operational and sales performance trends.
(Reporting by Guillermo Parra-Bernal and Reese Ewing in SãO Paulo and Sabrina Lorenzi in Rio de Janeiro; Additional reporting by Roberto Samora in São Paulo; Editing by Dale Hudson, Bernard Orr)