Summary
The iron ore outlook suggests a short-term rebound in iron ore prices, followed by gradual easing in the medium to long term due to slower demand growth and increasing supply.
Global steel demand is set to rebound, driven by growth in China, developed economies, Japan, and emerging markets.
Vale anticipates meeting global iron ore demand through increased production and favorable weather conditions, while focusing on improving product quality and cost competitiveness.
Rio Tinto expects sustained growth in production, driven by solid iron ore operations. It emphasizes cost control, resource diversification, and strategic partnerships for long-term value creation.
Vale outperforms Rio Tinto with robust profitability and efficient resource utilization. Its operational strategies and market adaptability contribute to its better performance.
Blast furnace iron
Investment Thesis
A few months ago, I urged investors to consider exiting positions in iron ore producers Vale S.A. (NYSE:VALE) and Rio Tinto Group (NYSE:RIO) as we were heading to another short-term downward cyclical trend. Today, there are reasonable grounds to believe that the market can rebound in the following months, suggesting a buy rating for Rio but a strong buy rating for Vale due to its larger upside potential.
Vale's fundamental advantage over Rio supports the outperformance. While Rio also has positive prospects in the iron ore market, Vale's focus on production performance, quality enhancement, and strategic approaches indicate that it performs fundamentally better.
Both are commodity-driven stocks and highly cyclical that trade in tandem with iron ore prices. Nevertheless, despite the weakening global iron ore outlook, the recent pullback has sufficiently reflected the commodity downtrend, and at this point, both stocks offer an attractive entry point to capitalize on the upside.
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Iron Ore Prices Will Ease Soon
While short-term prices may experience some volatility, the medium- to long-term outlook suggests a gradual easing of iron ore prices due to slower demand growth and increasing supply.
Short-term outlook (1-2 years):
Iron ore prices rebounded in early 2023 due to the recovery in Chinese steel production and the reopening of the Chinese economy. Accordingly, Fitch revised its iron ore price forecast for 2023 upward to $125 per tonne, reflecting market optimism regarding the Chinese economy. In addition, the supply side is expected to grow steadily, with major producers posting more robust production levels quarter-on-quarter.
The supply disruptions in the raw material market may ease in the second half of 2023 due to the recovery of supplies from Brazil, India, and potentially Russia and Ukraine. Macquarie's analysts suggest that spot prices could fall by approximately $30 per tonne, but some factors could support prices, such as restocking by mills taking advantage of lower iron ore prices.
Medium-term Outlook (3-5 years):
Despite the weak short-term outlook, an additional mild decline is expected in total steel production in China over the next five years, leading to a softer global iron ore demand growth rate. Thus, iron ore prices will ease over the next five years based on weaker demand growth and increasing supply.
China's efforts to reduce carbon emissions and reach peak steel output by 2030 are expected to decrease iron ore demand. As a result, global iron ore demand is projected to have a softer growth rate, with China accounting for a significant portion of the decline. Global supply is expected to grow by 3.1% annually until 2028, driven by new online supply in Australia, Brazil, and Africa.
Australia is projected to see a ramp-up of greenfield projects from significant producers like Rio Tinto and emerging producers. Brazil is expected to grow iron ore exports by around 6% annually until 2028. In addition, Guinea's restart of the Simandou mine in Africa is anticipated to contribute significantly to global supply.
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Long-term outlook (beyond 5 years):
Fitch forecasts a decline in iron ore prices to $50 per tonne by 2032 due to a slowdown in supply and demand growth. The steel industry's outlook for the next decade remains weak. Global DR-grade iron ore demand is projected to be in deficit by 2031, sustaining high premiums.
The high-quality iron ore and metallics supply is projected to be concentrated over the next decade, highlighting the importance of securing long-term partnerships or upstream integration for industry leaders. For example, Vale is actively working with these partners to offer them low-carbon metallics by implementing innovative practices like using biochar in blast furnaces, co-developing low-carbon solutions, and supplying higher-quality iron ore.
Steel Outlook Remains Relatively Soft
The global steel industry is forecast to rebound over the long term, per the World Steel Association (WSA). Global steel demand is expected to increase by 2.3% in 2023, reaching 1,822.3 million metric tons (Mt), and further grow by 1.7% in 2024, reaching 1,854.0 Mt.
China, the largest steel consumer, experienced a decline in steel demand in 2021 and 2022 due to lockdowns and a slowdown in construction. However, it is expected to see 2.0% growth in 2023 after a decline of 3.5% in 2022. The manufacturing sector is also projected to moderately recover in 2023-2024, though with slowing exports.
Steel demand in developed economies such as the EU, the UK, and the US contracted in 2022 due to monetary tightening and high energy costs. However, a recovery is expected, with a 1.3% increase in demand in 2023 and a further growth of 3.2% in 2024. The EU and the UK are expected to rebound in 2024, while the US will experience subdued growth due to recessionary pressure and negative factors in the residential construction sector.
Japan's steel demand contracted in 2022, but is projected to increase by 4.0% in 2023 and grow moderately by 1.2% in 2024. As a result, the construction sector is expected to expand, and manufacturing sectors like industrial machinery and automotive will show growth as supply constraints ease.
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Emerging and developing economies, excluding China, show varying dynamics. Developing Asia, excluding China, is expected to grow by 3.6% in 2023 and 3.9% in 2024, after a slight decline of 0.3% in 2022. India is expected to have healthy growth in the infrastructure, capital goods, automotive, and consumer durables sectors. ASEAN countries will also experience growth in steel demand due to the revival of tourism, construction projects, and infrastructure development.
While the steel industry faces volatility and risks, long-term trends indicate challenges and uncertainties. For example, the distribution of global steel demand may become uneven, decarbonization efforts will accelerate, and supply chain disruptions will continue to impact the industry. As a result, the steel sector will need to make long-term decisions, adapt to trends, coordinate with stakeholders, and navigate volatility.
Furthermore, the steel markets are decoupling, and international trade is gaining significance. Shifts in regional overcapacity, such as increased overcapacity in China, could affect trade flows. The demand for green steel is expected to outpace supply, and regions with low-cost energy may play a crucial role in meeting the demand. Protective measures and trade restrictions, like the Carbon Border Adjustment Mechanism, are expected to tighten global trade.
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Despite potential challenges, there are pockets of growth in sectors like energy and transportation, and certain steel product groups may need more support due to constrained supply. Finally, the growth of renewable energy projects and the increasing demand for low-CO2 steel are expected to drive demand for these specific steel products.
To that effect, regarding the iron ore market, the expected rebound in the steel industry implies an increased demand for iron ore, as iron ore is a crucial raw material in steel production.
Vale Ramps Up Production Levels
In terms of production, Vale expects to capitalize on the more robust performance at its S11D mine and the favorable weather conditions in Minas Gerais that contributed to a 6% year-on-year increase in iron ore production. Additionally, the company experienced a 20% increase in pellet production, driven by higher availability of pellet feed and reduced maintenance activities. These positive trends indicate that Vale is well-positioned to meet the growing global demand for iron ore.
However, Vale also faced a 7% year-on-year decline in iron ore fines and pellets sales, primarily due to loading restrictions in the Northern System during the rainy season and the need for supply chain rebalancing after robust sales in Q4 2022. Despite this setback, Vale is confident in offsetting the impact and maintaining its annual sales plan in the year's second half.
Moving forward, Vale is focused on enhancing the quality of its products while gradually recovering its capacity. The company has outlined specific initiatives for its critical assets, such as improving asset reliability at S11D, advancing licensing processes at Serra Norte, developing tailings filtration solutions and advancing licensing in Minas Gerais, and creating capacity buffers through various projects. These measures demonstrate Vale's commitment to operational excellence and ensuring a reliable and sustainable supply of high-quality iron ore.
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Regarding pricing, Vale experienced a decline in realized prices for iron ore fines and pellets. Iron ore fines realized price decreased by $32.8 per metric ton year-on-year, primarily driven by lower benchmark prices, adverse effects of pricing adjustment mechanisms, and lower fines premiums.
Similarly, iron ore pellets realized price decreased by $32.1 per metric ton year-on-year based on lower benchmark prices and the net impact of reduced market premiums. While these price declines present challenges, Vale remains focused on improving its cost competitiveness and operational efficiency to mitigate the impact on profitability.
Overall, Vale anticipates potential contributions to its EBITDA and overall value addition. By 2026 and beyond, the company projects a potential EBITDA contribution of $4-$10 billion, indicating its confidence in future revenue growth. Additionally, Vale envisions a value addition of $20-$50 billion, highlighting its commitment to expanding its high-quality capacity to capture higher premiums and maximize its market opportunities.
Rio Tinto's Strong Momentum
Rio's strong momentum in the Pilbara iron ore operations, with record operational results in the last two quarters, indicates a positive outlook for its iron ore business. In terms of production, Rio expects to experience a sustainable lift in operating performance driven by the ongoing deployment of its Safe Production System. In addition, the company's focus on disciplined growth in materials needed for the energy transition is evident in its progress with projects such as the underground mine at Oyu Tolgoi in Mongolia and the Rincon lithium project in Argentina.
Additionally, Rio Tinto has advanced the Simandou high-grade iron ore project in Guinea and entered into a joint venture to unlock the potential of the La Granja copper project in Peru. These initiatives highlight the company's commitment to strategic growth and diversification.
In the Pilbara region, Rio is positioning its iron ore portfolio to be resilient to how steel decarbonization could unfold. Pilbara Blend Fines will continue to serve as a base load for conventional steelmaking, while Pilbara Lump Ore will be increasingly valued as a low-carbon substitute for sinter. The company also sees potential for further beneficiation of Pilbara ores, along with its technology partnership approach, to deliver significant value in the long run. The high-grade iron ores of Rio Tinto's IOC products and the potential of Simandou as an effective direct reduction iron feedstock further support its outlook for value creation.
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In terms of pricing, Rio experienced a good market in the first quarter, with an average iron ore price of $125 per tonne. As a result, the company supplied the market with the needed iron ore, reflecting a robust demand environment. While Rio Tinto emphasizes that it will not produce more than the market requires, the current demand has allowed the company to increase production and meet market needs. This positive pricing dynamic and the company's focus on cost control and operational efficiency positions Rio Tinto favorably in the market.
Looking beyond iron ore, Rio Tinto recognizes the importance of the energy transition and ongoing urbanization as drivers of commodity demand. As a result, it expects a CAGR of 0.6% in global demand for steel through 2050. This long-term growth outlook supports Rio Tinto's strategy of securing replacement and potential growth tonnes in its Pilbara operations and its focus on projects like Simandou, which tap into high-grade resources and leverage strategic partnerships.
Vale Vs. Rio: A Clear Winner
Vale has demonstrated several fundamental advantages contributing to its superior performance compared to Rio Tinto. Firstly, Vale's focus on product performance and quality enhancement positions it well to meet the growing global demand for iron ore.
The company's initiatives to improve asset reliability, develop tailings filtration solutions, and create capacity buffers highlight its commitment to operational excellence and sustainable supply. Additionally, Vale's strategic approaches, such as actively working with partners to offer low-carbon metallics and supplying higher-quality iron ore, showcase its proactive measures to adapt to evolving market demands and mitigate risks.
Vale outshines Rio Tinto in terms of financial performance. With an EBITDA margin of 45.38%, a net income margin of 38.57%, and a return on common equity of an impressive 39.45%, Vale demonstrates robust profitability and efficient use of its resources. In comparison, Rio Tinto lags with an EBITDA margin of 40.24%, a net income margin of 22.36%, and a return on common equity of 24.45%.
Vale's lower P/E ratio of 3.77x, around its 1-year average, compared to Rio's multiple of 7.9x, suggests a better attractive entry point for capitalizing on the upcoming uptrend. Finally, Vale's undervaluation in the market, effective operational strategies, and commitment to delivering superior financial results indicate that it is a better candidate to capitalize on the iron ore cycle.
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Takeaway
In conclusion, Vale's financial performance metrics, including higher EBITDA, net income margins, and a more substantial return on equity, underscore its profitability and efficiency compared to Rio Tinto. Lastly, while both companies operate in the iron ore market, Vale's focus on production performance, quality enhancement, and strategic approaches make it a great candidate for capitalizing on the uptrend.
$Vale SA(VALE)$ $Rio Tinto PLC(RIO)$
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