The initial public offering (‘‘IPO’’) deal of the premium industrial metals & minerals giant Vale S.A.’s VALE base-metal minority stake seems to be in hot water; as nickel and copper prices continue to plunge, coupled with lower productivity in 2015.

Thirst for Higher Cash Generation

Vale encounters threats of stiff rivalry from other mining conglomerates such as BHP Billiton Limited BHP, Rio Tinto plc RIO and Platinum Group Metals Ltd. PLG. This compels the company to invest heavily in mega projects that aims at greater productivity, lower costs and superior innovation. However, such expensive programs call for higher liquidity in business as well.

Excess supply over demand, economic downturn in China and severe price-cutting wars among mining rivals continue to weigh on the market prices of iron ore, a major product offered by Vale. As per media reports, iron ore was priced at $128.51 per dry metric ton (dmt) as of Dec 31, 2012; while its spot price decreased to $60 per dmt as on May 31, 2015.

Slump in the prices of iron ore continue to hurt revenues, margins and liquidity of Vale. In order to offset the negative impact, in Dec 2014, the company had expressed an intention to sell 30% minority stake in its base-metals business through an IPO.

The decision was based on the assumption that the unit’s yield and profitability would improve in the quarters ahead. Vale estimated earnings before interest, taxes, depreciation and amortization (‘EBITDA’) of its base metals business in a range of $4–$6 billion at 2015-end.

Vale had claimed that the IPO deal would materialize, if the price of nickel exceeds $20,000 per ton. The company had speculated that higher growth in booming economies and ban of nickel exports from Indonesia as well as Philippines would create shortage and increase demand for metals such as copper and nickel, thereby lifting the prices.

Waning Nickel Productivity

In both the first and second quarters of 2015, Vale’s nickel output missed the estimates. Aggregate nickel production for first-quarter 2015 stood at 69.2 metric tons (mt), down 6% sequentially; while the same for second-quarter 2015 fell 3% to 67.1 mt, missing the Bloomberg analyst’s estimation of approximately 73.9 mt.

A research report by BMO Capital Markets stated that Vale’s gross nickel output of 136 mt, ensued in the first half of 2015 was a facsimile of “poor” production; as the volume was almost 45% lower than the company’s initial target of 303 mt.  

The metal’s yield was soft due to lower efficiency in the Sudbury and Thompson mines, fire in Sudbury and Ontario manufacturing facilities, mining disruptions in Indonesia and closures in New Caledonia as well as Brazil.

Declining Nickel Prices

As per media reports, nickel price was $12,600 per mt as on May 2015, down 10% from Apr 2015. From Sep 2014 onward, the price of the metal had started declining, due to lower market demand and excess supply. Economic recession in China, abolition of nickel-export banning policy in Philippines, a strong U.S. dollar and greater nickel reserves in China are major factors which led to the fall in price.

Feeble IPO Prospects

Declining productivity of nickel, coupled with weakening market price, has rendered Vale’s base-metal IPO deal less lucrative. Further, lower price and productivity of copper has added to its dismay.

At present, the company forecasts EBITDA for its base metal trade within $3.1–$4.6 billion at 2015-end, lower than the previous guidance of $4–$6 billion. The estimation is arrived at after assuming that nickel price will be within $14,500–$21,000 per ton and copper value within $5,800–$6,800 per ton, at the end of the current business year.

Going forward, we expect this Zacks Rank #3 (Hold) stock to bank on the IPO deal, only if nickel and copper prices reach the desired levels.