What are some of the major strategic initiatives on the horizon at Vale?
With the slowdown in China, everyone is taking a very similar strategy: reducing capital expenditures, improving competitiveness, and reducing indebtedness. There is a consensus in the industry that indebtedness is fairly high. Many companies are addressing this by reshaping their portfolio and selling assets. Vale announced its intent to deleverage back in February 2016. We had the intention of reducing net debt by US$10bn, which entailed a major broad re-evaluation of the portfolio and serious discussion on the kinds of assets that we would have to sell to have the greatest impact on valuations and debt reduction while preserving our strategic footprint. Vale’s focus is on iron ore, nickel, copper, coal, and fertilisers. We are world leaders in nickel and iron ore.
While we are still focused on our execution agenda, in our case completing the largest project in our history – a new Iron Ore mine and associated railway and port logistics project at a cost of US$14bn, which starts up this year – we are looking at regaining strategic flexibility through asset sales that will lower our indebtedness ratio.
Brazil’s markets have been highly volatile in the past year. How have the market conditions impacted the company’s outlook, its capital markets strategy, and risk management more broadly?
The impact of Brazilian market volatility hasn’t been as significant because Vale derives 90% of its revenues from outside of Brazil and 90% of its cash flows outside of the country in terms of destination of its sales, though 60% of our asset base is in Brazil. But while the impact has been muted in a sense, volatility in Brazil’s markets does affect access to the capital markets. Our capital markets base is split between typical metals and mining investors on the one hand, and more Latin America or EM-focused investors on the others. That’s the major channel of contagion between what happens in Brazil and in how Vale is impacted. Overall, we have to be very mindful of windows of opportunity when they arise.
The outlook for the resource industry is the dominant factor influencing our market outlook. Chinese demand for minerals and metals is the single major factor that determines the outlook for Vale and the entire industry. The country consumes nearly half of every commodity, and has been responsible for over 100% of the growth over the past decade. Because of the transition in China’s economy, there has been a shakeup in the industry – and a great deal of volatility accompanying that.
The market’s assessment of the industry has also been changing quite dramatically. Some believe China will suffer from a hard landing, which means demand will suffer greatly, and that prices should be much lower; there are also those that believe in a smooth landing – where demand will adjust without a collapse in prices. In January this year the prevailing view was that we would see a hard landing – we saw 16-year lows in commodity prices, and Vale’s share price hit multi-year lows; today, markets are more optimistic towards the outlook in China, and our share prices doubled.
Risk management is a vast and challenging exercise. The dominance of variations in the price of iron ore, nickel, and the value of the BRL is hard to understate. You have to manage risk in a very strategic way, and you have to ensure a high degree of flexibility in managing your cash flows and assets. You also need to learn from your mistakes and anticipate correlations before they manifest. For example, we depend on roughly 10 million tonnes of oil annually to take our iron ore to the Far East. Before foreseeing a shock drop in oil prices three years ago, we decided to hedge our oil at very high price levels – and as a result, we are living with expenses beyond what we would have expected because our mark to market was way off. The lesson learned for the industry as a whole, and the models used to manage risk, is that these variables are much more correlated than many anticipate – in this case, when the price of commodities went down, oil prices dropped as well.
Having solid relationship banks are crucial, especially in times of crisis. How does Vale go about selecting its relationship banks? Can you shed some light on the core criteria you pay attention to?
It is clear what banks like and don’t like – they typically favour transactions where they don’t have to deploy capital. New regulation is significantly reducing returns on lending activity, so banks are much less willing to put their balance sheets to work than before. For us, we look for the opposite.
Because markets are so volatile, and because we cannot always rely on the market being open for our funding needs – whether due to the volatility in the mining industry or in Brazil – the key value proposition for us is the ability to smooth over those windows of opportunity in the capital markets. This is key for us given the cyclical nature of the business, and we are fortunate to have a strong name and great relationship banks that support us in times when more opportunistic players would not. We tend to favour full-service banks over capital market boutiques.
The company recently issued a US$1.25bn bond that saw very strong demand. Can you walk me through the strategy for that deal and how the outcome compared with expectations?
We needed to tap the US because we had to focus on a very liquid market in order to take advantage of a narrow window. We’ve been away from the market since 2012 so there was quite a bit of pent up demand for the Vale name. We were mindful of that, and some of the big names in Brazil have been under stress more recently. So for investors that are searching for yield with a bit of security, we knew we were in a privileged position, and wanted to leverage that.
We had a preference for the 5-year notes instead of 10 or 7 year notes, in part because we have no maturities that extend to the 5-year mark, and we have a preference for lower yield. Regarding the size, we initially wanted to go even smaller – our initial intention was to seek US$1bn because we wanted to tighten pricing as much as possible. We knew that after 4 years we would establish a new reference to the kinds of transactions Vale would be willing to execute in this market. But demand was so strong and at attractive pricing levels, so we decided to upsize the notes. Our main goal was to price below 6%, and we satisfied that.
How does this sit in the context of the company’s broader funding strategy? Does the company have other funding needs at the moment or in the near future?
To date, there is a gradual shortening of the maturity on our debt because the cost of funding is more important. We are moving form a capital intensive phase to a less capital intensive phase. So as we free up cash in the years to come, the need to issue longer debt decreases.
Additionally, because the outlook for the mining industry as a whole has deteriorated gradually since late 2011, there was an arbitrage between bank funding and capital markets funding. To give you an example, yields for Vale’s 7-year bonds in 2014 were approaching the 5% mark; by comparison, I would be able to do a 7-year transaction with banks at LIBOR + 120bp. That’s one of the main reasons why we have skewed our debt portfolio towards bank funding in previous years, and one of the main reasons why we are trying to rebalance our portfolio in favour of the capital markets. There is less bank capacity available for the mining industry, less bank capacity in Brazil, and less bank capacity because of regulations. In the medium term, Vale will tend to rely more on a relative basis on the capital markets then on the bank market.
We have issued two infrastructure bonds in the local markets, which carry tax incentives for investors – so you can issue below the benchmark Brazilian rate, take a swap in dollars and still price inside the curve. But the size of the market is still limited, we are talking BRL1bn and BRL200mn. We want to continue to foster this market, but it is small when compared to our needs. We have a great deal of local bank domestic funding, and have a long and fruitful relationship with global ECAs.
How do BRL and USD funding compare at the moment? Are you spotting new opportunities in order currencies?
We have very healthy levels of BRL funding. When you tap the capital markets locally it tends to compare favourably with the US dollar curve. You can often get funding from banks using inflation-linked rates. But when you get shorter term funding, it’s often a percentage of the Brazilian interbank rate, so at the moment it’s not competitive.
More recently, we have been monitoring Japanese and Chinese markets closely because of our very long term relationship with those two markets, and we are very interested in doing a deal in those markets if the size and tenors are appropriate. We would love to develop a more direct relationship with Japanese and Chinese investors, and become pioneers in the JPY and RMB markets, be it onshore or offshore.
