Vale S.A. (VALE) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Vale's conference call to discuss the third quarter 2012 results. If you do not have a copy of the relevant press release, it's available at the company's website, www.vale.com at the Investors link [Operator Instructions] As a reminder, this conference is being recorded. To access the replay, please dial 55 114 688 6312, access code 6213907#. The file will also be available at the company's website at www.vale.com at the Investors section. This conference call and the slide presentation are being transmitted via Internet as well. You can access the webcast by logging on to the company's website, www.vale.com, Investor section or at www.prnewswire.com.br. Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Actual performance could differ materially from that anticipated in any forward-looking statements as a result of macroeconomic conditions, market risks and other factors. With us today are Mr. Luciano Siani, Executive Officer of Finance and Investor Relations, CFO; Mr. José Carlos Martins, Executive Officer of Sales and Strategy; Mr. Galib Chaim, Executive Officer of Capital Projects Execution; and Mr. Peter Poppinga, Executive Director of Base Metals and Information Technology. First, Mr. Luciano Siani will proceed to the presentation. And after that, we will open for questions and answers. It is now my pleasure to turn the call over to Mr. Luciano Siani. Please, sir, you may now begin.

Thank you. First of all, Mr. Murilo Ferreira apologizes for not being here. He had an emergency. He could not attend. Thank you all for attending. We have a presentation that was put on our website. It has 3 parts. I'm not going to follow it on a slide-by-slide basis. I'm just going to remark some of the information, which is in there. It starts with an overview of the approach that we're having, to strategy and to our capital discipline, then we will go into the details of the performance of the second quarter. In the end of the presentation, you see also a few figures on China, which is our main market, which displays additional data points and information for yourselves to make up your own opinions about how this important market will develop going forward. Well certainly, we will have the opportunity to talk more about this during the Q&A in the session here. Now the very first thing that I would like to start is to reemphasize that we will prioritize only investments in world-class assets going forward, which can provide the best return to shareholders. This is very important at a moment where we face the challenge of matching our cash flows to our investment program. So in that respect, we're not pursuing diversification per se anymore. Diversification will be a consequence of us having world-class assets in different commodities, but it's not a goal, per se. Having this goal also of operating and developing world-class assets means that we are going to reassess very carefully all of our assets which do not fit that characteristic. And we would like to reemphasize our commitment to returning cash to shareholders and maintaining our investment grade and a prudent leverage on our balance sheet. So for us,…

[Operator Instructions] Our first question comes from Mr. Felipe Hirai from Merrill Lynch.

I have 2 questions. The first one is related to the potential divestment of the assets that you mentioned that you could sell if they are not adding any value. I'd just like to understand, when would you make these decisions? So if you -- if there is a deadline for this asset to become profitable or not? And my second question is related to the potential impairment of assets that we still haven't seen any significant impairment on some of your like nonperforming assets. So could we see that happening until the end of this year? If you could give us some idea of which assets we should think of, of this impairment?

Okay. The first question of sale of assets, I would say that we have a clear idea of what assets we want to divest or look for partners. Now we are in a question of these are transactions that, as you know, they require time to be developed, and they have their normal course of business. But in terms of a decision, we already made those. One exception that you might be having in mind is New Caledonia, which, as I mentioned, we are resuming ramp-up successfully. So we're still not in the position to make any decision about the assets. We need to wait for the next development, and we're probably going to make that decision by the end of first quarter or beginning of second quarter of 2013 with respect to New Caledonia. On the other fronts, I think the decisions have been made, but we're not -- we're still, I would say, exploring the markets to see what's the possibility to realize value on the sale as well. We're not going to fire sale any asset. We know what their values are. So it's a question of -- I believe we have many possibilities, but we will manage those very, very carefully. In terms of impairment. As we pointed out in the press release, we will do an impairment in the Onca Puma asset this quarter. It will not await for the closure of the fourth quarter and the full year financial statements. So we will announce it in the interim basis. We already have a revised business case for Onca Puma, and we are waiting to just confirm our expectations on the values to be received from the insurance providers in order to have the final numbers. And as soon as we have them, we will announce the impairment numbers. But it's very likely that the revised asset value will be below $1 billion. So anything above that will need to be written off. The other impairments, we are having a comprehensive assessment of the assets, which perhaps are less likely to return to full book value. But in that respect, we will probably have an assessment of all those assets and the impairments, if any, made at the moment of the issuance of the full year financial statements.

Our next question comes from Mr. Rodolfo De Angele from JPMorgan. Rodolfo R. De Angele - JP Morgan Chase & Co, Research Division: I just wanted to get back on the pricing discussion and ask, looking forward, there were, as you mentioned on the call, there were a few issues that caused the company to post a better realized price than I think what the investors were expecting. Some of them were related to commercial strategy of Vale. We discussed on the previous calls, specifically on freight and others, such as the level of impurities. Should we expect those to continue in place? I mean, should we work with improved realized prices the next quarters? My second question is on projects. I just wanted to hear from management an update on Simandou and Onça Puma, please.

Okay. I will start by the projects, I will address Simandou, then lead over to my colleague Peter Poppinga to talk about Onça Puma, and then we're going to go back to Mr. Martins for the realized prices. Well, on Simandou, it is an important growth option for the company. As you know, our priority right now is S11D, so the resources of the company will be concentrating on S11D rather than Simandou. However, we are awaiting for the regulatory landscape in Guinea to become clearer. And that includes the logistics solution. It may change according to the government. It may change from what has been agreed like 2 years ago. So that change, if that happens, and it's likely to happen, it will entail additional studies, engineering studies in order to see the value of the new revised project. The stake that the government of Guinea wants to have in the project is also undefined and the royalties. So there's enough uncertainty, I would say, in the regulatory environment in Guinea that prevents us to making any advancement at this stage, and these are preconditions for us to make any more firm decision on the asset. Our expectation is that the time required for these solutions to be reached plus the time required for us to develop the studies for the project will pretty much match the ongoing strategy of the company. So we will concentrate first on S11D on the current iron ore asset that we have in Brazil. And then only if all these assets are resolved, so Simandou will be a growth option for the upcoming future. With regard to Onça Puma, I would like to ask my colleague, Mr. Peter Poppinga, to address the project.

The answer is pretty straightforward. The furnace problems at Onça Puma turned out to be more serious than we have anticipated. And we have had significant refractory damage due to some design flaws related to the refractory quality, and this led to some refractory hydration in certain layers, and so the furnace must be rebuilt. And we are anticipating that production will occur only towards mid of next year. That's the reality of Onça Puma.

Jose Martins? José Carlos Martins: Rodolfo, actually, we have much better performance in this quarter than the last quarter. The reasons are mainly freight performance almost $2 better than last quarter in terms of cost. So then we have a much better FOB price after deducting the lower freight. Also, the silica penalty that we saw appearing since we start selling in the spot basis is reduced also, is almost disappeared. And we have in our sales, mainly of Carajas ore on a spot basis, we get even a better premium than Platts index show. So the $2.30 that normally you deduct -- you add as DIU. In case of our sales on a spot basis of Carajás ore, we are able to get a better premium from that. So at the end, we got price realization that was most in line with plants after deducting freight, deducting humidity, moisture and also after adding the VIU. Part of this performance was really caused by better market conditions and also because we learned. We had to recognize that Vale was a newcomer in the spot market. So we are used to sell 100% of our sales on a contractual basis. After a benchmark system, we continued to sell on a quarterly price basis, but kind of diminished pricing. And now, we are entering more decisively on sales on a spot. So we are learning, month after month, how to operate better on this market. I made this comment before. Time-to-market is becoming a very important issue, that on the fixed price system, we don't have this. Okay? But now the pricing is mainly based on the market and daily pricing, so the time for sales is very important, so we are managing better times-to-sale. We are managing, better, the quality that we offer in the market. So even the volume of our ships, we needed to better manage quantity that we sell when we sell on a spot basis because sometimes the customers want to buy lower volumes than big ships can deliver. So all of these things, we are considering in our marketing strategy. But every quarter, every month is a different story. So you needed to adopt very fast, and that's what we are doing. So as time goes by, we really believe that we always can command a premium on iron ore considering our average quality, which is better than our competitor. So those are the main issues that I would like to comment. And also, I believe that our performance may improve going forward.

Our next question comes from Mr. Rodrigo Barros from Deutsche Bank.

I have two questions. First one, I think, if you could do for pellets, the same that you did for iron ore, explain how much you're selling quarterly contracts in the VIM, how much monthly contract and how much in the spot. Because that's a number that we've been getting consistently wrong, in our case. We've been too conservative. And my second question, to Luciano, if I may, is regarding the corporate events. We saw Vale selling a stake in the Oman pellet plant in this quarter. We also saw Vale increasing its stake in VNC. So if you could comment on those 3 events it would be great. José Carlos Martins: Well, as far as the pellet pricing system, we sell -- our average is that we sell 20% on this former quarterly lagged pricing system. Okay? And this helped pellets much more than it helps iron ore, because a big part of our customers, in pellets, continues to buy under this system. So I don't have a specific figure for that. But in case of pellets, we have more than our average of 20%, in this, that we have in this system. So pellet prices were favored by this situation. Okay? As far as the price continues to go down an average, that will help. But when the price move other way around, that will have a negative influence on our price. Our rule of thumb, we always sell our pellets at least with our pelletizing cost, because we could sell the pellet feed. So we always consider what will be the best option to sell pellets or to sell pellet feed. So you always continues to manage this difference. Besides the pelletizing premium, we also have the quality premium because the pellet has, on average, more idle content than you have in the regular iron ore. So those factors create a much better premium for pellets. But they are only effect -- mainly effect of this quarter because of this lag of the system. So, going forward, we cannot expect premium for pellets to be much bigger than $40 and not lower than $35. So that could be the best guess considering a stable pricing situation.

Martins, maybe you could address, as well, our sale of the stake in the Oman pellet plant. That's another question. José Carlos Martins: So when we start building our pelletizing plant in Oman, we have made agreement with the local government, to let them buy 30% of the pellet plant. But this has not an impact on the business in itself, because the pelletizing plant, it works as a service provider. So then we only buy the tolling [ph] of producing pellets there. And it's very important to have local government with us because we depend a lot on the infrastructure that is provided by the government, to our operation, electricity, gas. So we believe it's a very good partnership for us and also does not bring any burden on our profitability. It's something that is fair, based on the return on capital of the pelletizing plant. So we believe that this operation is very good for the company and very good for our shareholders.

Okay. On Vale New Caledonia, contrary to what you might be expecting. So you might be thinking Vale increased its participation, so we put money into the operation, which is not the case. Vale New Caledonia, actually -- we are recognizing, formerly, a situation, the fact, which is that our partners, SMA, a joint venture between Sumitomo and Mitsui, has stopped funding the project as of 2010, after the accident with the column. So Vale already put the money under what should have been put by this partner. So what we are doing here now is recognizing, so they are been diluted in order to -- and our participation is increasing, recognizing that reality. But, going forward, the good news is that they will resume funding the project. They are now confident that the project may succeed. They will resume funding the project at this new participation rate. And so that's the status going forward. That does not involve any outflow of cash disbursement from Vale. Much to the contrary, we should expect, now, the partner resume bringing funding into the project.

Our next question comes from Mr. Alex Hacking from Citibank.

The first question is regards to copper. Can you give us some guidance on how much copper sales we should expect next year from Salobo and also from Zambia? And the second question relates to the possible partnerships. Obviously, this has been discussed with Rio Colorado. But is it something that you're also considering in Mozambique, with the coal? And does it make sense to have some kind of partnership with Rio Tinto on the logistics platform?

So to talk about copper, I will hand over to Mr. Peter Poppinga.

Alex, thanks for the question. So copper, as you know, we are starting up Lubambe, and we just did it in October. This is a 45,000 tons capacity. It's a JV actually between Vale and ARM, and there's some government participation in there as well. It's going very well. But, of course, the ramp up will be -- we expect no big hiccups during the ramp-up. It will be a normal ramp-up. I would be hesitant to say to you how much are we going to produce next years, would be a looking forward statement. But I would expect that we passed easily the 50% capacity. On Salobo, if you take -- we have produced, this year already, 500,000 tons contained nickel. If you take the last weeks of production and annualize that, so you see the rhythm, you see the pace, we are reaching 40% and surpassing probably 50% of the capacity in terms of days, in terms of litmus this year. So what we expect for next year is Salobo to be close to capacity which, actually, is very similar, what happened with our Sossego ramp-up. We have learned some lessons there. The flow sheets are very similar and so we don't expect a major surprise in Salobo. Regarding Canada, as you know, Canadian copper comes as a consequence from our mines in Sudbury, which are gaining momentum again. Going back to the old levels of productivity we had before the strike. We still have some work to do. And so, for next year, copper production, for sure, will be higher in the Sudbury basin as well. Don't know if that answered your question, but that's what we have to say for the moment.

Well, as regards, partnership, as a general statement I would say that, yes, we are looking, actively, forward to partnerships with many of our projects. We understand that this is a necessary condition for Rio Colorado. So it is a necessary condition, we need a partner in order to go forward in Rio Colorado. In Mozambique, it's an idea that we are entertaining as well. The only caveat that I would put is that we already have partners in Mozambique. The government is a partner in the Railway Corridor. There's a few private investors. So all conversations need to involve the government as well.

Our next question comes from Mr. Carlos de Alba from Morgan Stanley.

The first one is on -- what is the rationale to keep the logistics service business? We have seen -- the performance has been subpar. But I want to know if there is anything that is related between this business and your mining operations in Brazil, that may prevent you from potentially divesting this asset beyond the railroads. And the second question is, if you can, Martins, explain a little bit or can we reconcile the fact that as you sell, now, more in the spot market, you may need to use smaller ships with the fact that Vale is getting more Valemax that, obviously, are larger in size. So how does the company think about reconciling these two trends?

Well, in logistics, I will give you the same answer. I would say that, as we are reassessing all of our assets, specifically, the new regulatory environment in Brazil has changed and has incentivized the entity of a logistics operator. So there has been a separation between the entity of the concession holder and the operator. And as you pointed out, the value brought by the business maybe is not in line with the best expectation of shareholders. This is also a business that we are constantly evaluating to see what are the best solutions and to see how we go forward. As for the second question on iron ore, I'll hand over to Mr. Martins. José Carlos Martins: Okay. Carlos, this very interesting question, and I have a great pleasure to answer it. First of all, for sure, that to minimize the freight cost, you really need big vessels. Okay? So the bigger the vessel, the lower will be the freight cost, and most efficient will be more efficient will be the energy consumption. So not only cost but those environmental impact. As you probably know there will be, probably, a new taxation on carbon emission on ships. So that would add additional advantages of using big ships with lower energy consumption. But the other side is that, mainly in the spot market in China is more customers. They prefer to buy lower quantities. And our competitors are closer and they sell, normally, 80,000 tons. So that make them more palatable for those customers. So what we are doing is, as you know, we are building a distribution center in Malaysia that will went in operation by end of next year, beginning of 2014. So the big ships would make the big part of the journey, optimizing the freight…

Our next question comes from Kelsey Cosgrove [ph] from TIAA-CREF.

I was just wondering if you could please discuss what is driving greater demand for sinter feed versus pellets in the market. And when do you expect this to be reversed and for you to start operating your pelletizing plant that you closed down again?

Mr. Martins. José Carlos Martins: Well, pellet feed is always -- sorry pellets are more volatile than sinter feed, because customers use pellets mainly when they need the high productivity in the blast furnace. In a scenario, that many of our customers are operating at low rates, the use of pellets is not so convenient for them. So the answer to your question will depend on the market behavior. And as long as they need more productivity, they will come back to pellets. But I cannot say for sure when that will happen.

Our next question comes from Ms. Marina Melemendjian from Credit, Suisse.

My question is related to Vale warranty [ph] volumes. Year-to-date Vale has reached the amount of 420 million tons of fines and pellets. You have been guiding volume of 310 million tons for the year, which already implies from volume increase in the last quarter. I'd just like to know if you believe that this guidance is likely to be achieved, and if yes, when could we see production picking up? José Carlos Martins: We keep our targets. Okay? As Mr. Luciano Siani explained before, we did extend an enterprise. Besides the quantity that we can produce in the last quarter, we also have some iron ore available. And then we can invoice a little bit more if the market conditions allow us. And if you don't have any unforeseen impact in our production. So we keep our target, and we expect to reach it.

Our next question comes from Mr. Jonathan Brandt from HSBC.

The first question relates to the CapEx pressure and operating cost pressure. We've seen a lot of headlines from, not only Vale but some of the other majors and some of the minor companies as well, talking about cutting CapEx. Have you seen or do you expect to see CapEx disinflation coming up or are things like trucks and tires still experiencing a lot of CapEx pressure? I guess, related to that, on the operating cost side. If you could expand a little bit more what plans you have in place to cut operating costs. Or should we think of it more as tied to the BRL and the potential weakness of there? And secondly, if you could touch upon the debt levels, they've been increasing little bit over the past few quarters. Is there a maximum level that you would take those to? Is there a maximum level that the rating agencies would allow you to take those to? And I guess lastly, would you consider -- if you need to read raise more debt, would you consider doing another convertible?

Okay, let me start by CapEx. It's a different situation in the equipment market than the services market. In the equipment market, we are seeing some softness and possibly the easing of cost inflation, maybe even some disinflation. However, on the service side, especially in Brazil, we haven't seen it that clearly. So the market for construction services in Brazil continues to be very, very tight. In terms of operating cost, beyond the BRL depreciation, we're targeting structural initiatives. And beyond the usual, more granular cost-cutting programs, I would say there are some structure initiatives in place. The first one is the reassessment of low value-adding assets. So it's the same thing that we mentioned on the nickel mines, the Birchtree and the Frood mines. So that kind of assessment is being conducted to all our mines and process plants. So we believe there's room for optimization of the flow sheets, the flows of materials to take the most, and maybe halt nonperforming assets and get the most value off the operations. The second one would be on the procurement side, Vale traditionally has paid a lot of attention on the big-ticket items, which are the ones are usually procured globally. Now we're turning our attention to the small items that, although are more, as I mentioned, small items. Together they amount to a sizable spending. About 50% of our total OpEx spending comes from smaller items. So now we're addressing this internally and trying to change our approach to that as well. In terms of debt levels, I mentioned in the presentation that the net debt has increased slightly over the last 9 months, so just $1 billion. It is true that gross debt has increased more, but we had made war chests, in terms of cash going forward.…

Our next question comes from Mr. Marcos Assumpção from Itaú BBA. Marcos Assumpção - Itaú Corretora de Valores S.A., Research Division: My next question is on nickel. If you could comment a little bit, on the production expected for VNC and also Puma in 2013. And also, on the pre-operating expenses. How do you expect that line to behave in 2013? And my second question is related to the Sesain [ph] provision. If you could provide an update on the discussions between Vale and the government difference in the calculation from past cash royalties. Is this increase in provision is showing that the company is closer to a resolution in the short term, with the government, and if this value on the provision is likely to be maintained at this level where it could be increased at any point in time?

Well, nickel, I'm going to pass it over to Mr. Peter Poppinga.

Marcus, thanks for the question. In terms of nickel, you mentioned specifically Onça Puma and VNC. So I as I told you Onça Puma is rebuilding the furnace. And due to a design flaw, this furnace was build in 2008. And for safety reasons, we must rebuild the furnace. So If we start mid of next year, roughly, we expect a normal ramp-up for profile and this would be not very different normal ramp-ups in furnaces like that, now that the furnace would have the problem solved. In terms of New Caledonia, we have, as I said and as Luciano mentioned, we have successfully restarted the production. All the affected [ph] columns are repaired. The design has been changed. We started up some weeks ago, filling the pipeline still. And now, in November, the acid plants start up again and finally nickel will be produced. And Q1 2013, we are going to assess, to decide if this is a viable operation in terms of capacity and how the ramp-up goes. But, for sure, if you produce with 2 autoclaves -- there's 3 autoclaves. If we produce with 2 autoclaves like we are forecasting to do, we should have nickel production next year, which should be close to half of the capacity. And then the rest would come in 2014.

In terms of preoperational expenses, just to highlight that, if you can see, in our balance sheet that, that has been drag on results. It's around $300 million every quarter, I guess. If I don't have the numbers in the top of my head. But we will not tolerate this situation as an ongoing situation. So we're committed to reducing that level of -- and that pertains mostly to the 2 operations mentioned, Puma and New Caledonia. So the reason why we're going to have an assessment in the first half of next year, for new Caledonia, is really not to perpetuate that situation going forward. In terms of the Sesain, [ph] so the provision was made when we -- our talks with the authorities, we recognize that amount of BRL 1.2 billion, the provision in dollars, $540 million, was really part of our discussion. That became very clear, that the likelihood that we will lose this dispute is really high. Talks and conversations continue. I don't know if we should expect a big bang in terms of a comprehensive agreement that will be finalized. it would say that the talks continue. The mutual understanding of the theses involved continue, but we're quite confident that the amount that has been provisioned is the expected disbursement outcome. But, yet, the discussion have not been finalized.

This concludes today's question-and-answer session. Mr. Luciano Siani, at this time you may proceed with your closing statement, sir.

Well, I believe -- we believe that the message that we have been voicing recently, of capital discipline value to shareholders and cost consciousness, has been very vocal and we made a point in repeating that over and over. But that has to be underscored with results. And we believe that we have started to show a few instances and a few actions, and also, preliminary results in the numbers and in our decisions and actions that are quite well aligned with the strategy, the direction, that we've been telling investors. So our belief is that, going forward, we will be able to generate a continuous stream of additional improvement in the numbers and additional decisions that are aligned to our directions, and let say, deliver on our promises to be succinct. So I hope investors and shareholders, they give us -- with this preliminary result, they give us that confidence vote. And now we're sure that Vale will deliver amongst this newly established direction and approach. Thank you all for attending, and our Investor Relation teams is available for further questions after.

Thank you, that does conclude Vale's Third Quarter 2012 Results Conference Call for today. Thank you very much for your participation. Have a good day.