Aug 8, 2013
Executives
Murilo Ferreira – CEO Luciano Siani – Executive Officer of Finance and Investor Relations José Carlos Martins – Executive Officer of Ferrous and Strategy Roger Downey – Executive Officer of Fertilizers and Coal Operations and Marketing Vânia Somavilla – Executive Officer of Human Resources, Health & Safety, Sustainability and Energy Galib Chaim – Executive Officer of Capital Projects Implementation Humberto Freitas – Executive Officer of Logistics and Mineral Research Peter Poppinga – Executive Officer of Base Metals and Information Technology
Analysts
Rodolfo De Angele – JP Morgan Carlos de Alba – Morgan Stanley Thiago Lofiego – Merrill Lynch Daniel Rohr – Morningstar Paul Massoud – Stifel, Nicolaus Marcelo Aguiar – Goldman Sachs John Tumazos – John Tumazos Very Independent Research
Operator
Good morning, ladies and gentlemen. Thank you for waiting.
Welcome to Vale's conference call to discuss second quarter 2013 results. If you do not have a copy of the relevant press release, it's available at the company's website at 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 6358517#.
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 at www.vale.com, Investors 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 comments as a result of macroeconomic conditions, market risks and other factors. With us today are Mr.
Murilo Ferreira, Chief Executive Officer; Mr. Luciano Siani, Executive Officer of Finance and Investor Relations; Mr.
José Carlos Martins, Executive Officer of Ferrous and Strategy; Mr. Roger Downey, Executive Officer of Fertilizers and Coal Operations and Marketing; Ms.
Vânia Somavilla, Executive Officer of Human Resources, Health & Safety, Sustainability and Energy; Mr. Galib Chaim, Executive Officer of Capital Projects Implementation; Mr.
Humberto Freitas, Executive Officer of Logistics and Mineral Research; and Mr. Peter Poppinga, Executive Officer of Base Metals and Information Technology.
First, Mr. Murilo Ferreira will proceed with the presentation, and after that, we will open for questions and answers.
It's now my pleasure to turn the call over to Mr. Murilo Ferreira.
Sir, you may now begin.
Murilo Ferreira
Good morning, good afternoon everybody. Thank you for having opportunity to share some views with you.
As you will note Vale had a good performance in the second quarter 2013 again regardless of the performance of the economy in the whole world and declining minerals and metal prices. We have continued to deliver on our promise, with several initiatives underway by producing good improvements mainly total costs and expenses and we can see the numbers that we got in terms of decreasing in costs, just decreasing SG&A, R&D and these cost cutting efforts present us very interesting EBITDA number with the remaining almost the same comparing with one year ago.
The range of $10 billion for the first half of the year regardless of $ 2.1 billion fall in revenues – which is it was mainly regarding the price. We must say that the cost performance of the second quarter 2013 was reached with average Brazilian real US dollar exchange rate of 2.07, then can highlight that we have potential opportunities for the cities.
In terms of the debt, our total debt came in to 29.9 billion from 30.2 billion, then it’s almost the same number compared with the end of the first quarter 2013 despite paying 2.25 billion in in dividends and investing $ 3.6 billion in the second quarter of 2013. We would like to highlight some events, like the permit for the implementation of S11D.
The improvement of the operational performance of base metals we are very happy mainly with the hump of (inaudible). We can stress that in the next coming months we will be able to bring good news in terms of the coal, in terms of fertilizer, it’s substantially stronger in the second half of the year compared with the first half of 2013.
We note some math mainly in terms of the press regarding the hedging account in order to minimize the volatility of our accounting earnings into our financial statements to better reflect economic performance of our company. We are considering using for future periods the implementation of the hedging accounting programs would allow us to our revenues to serve to be used as a hedging for accounting purpose.
We know that we need to work with some key elements in this process and we made it to consider for the future. Regardless of this we did a presentation about what could be at the numbers in case of having using this price since the beginning of the year.
Again it’s mandatory to say that Vale is strongly committed to discipline in capital allocation, to bring return to our shareholders with the good project execution. It’s very important for us in additional to bring mature design and engineering, and to focus in the construction and contractor management in order not having deviations as you had in the past.
R&D expenditures showed a decrease comparing with the 2012, 2011 as a result of the decision to focus on a smaller and more selected pipeline of projects, which at the end will bring us higher rate of return on our portfolio and very – with world class projects. It is very important and as example of this capital discipline, (inaudible) for the whole project S11D is almost completed and we are with contracts and equipment services package almost 70% higher with firm proposals.
And then can bring us the level of confidence about the future in order to complete this project on time and on budget, it’s very important for us. I really appreciate your time and I would like it to share with my executive directors for question and answers and I will be back in the end of the session.
Thank you very much.
Operator
(Operator Instructions) Our first question comes from Mr. Rodolfo De Angele from JP Morgan.
Rodolfo De Angele – JP Morgan
But I wanted to follow up with two things, first, wanted to hear more details in your comments on potential effect of a weaker real on the CapEx budget and in the release you mentioned because of the S11D, 90% of that is in real. Could you comment a little bit more on the other projects, is there upside if you consider FX spend around 30, for the CapEx budget for this year and into next year?
And my second question I just wanted to hear from management if there is anything new, what’s the status of the backs discussion (inaudible).
Operator
Excuse me ladies and gentlemen please hold.
Murilo Ferreira
Okay sorry for everyone, we had an audio problem. So now addressing Rodolfo’s question on capital expenditures, we highlighted share of Brazilian real expenditures for S11D because it’s really a large one, 90%, with a similar share for similar projects here in Brazil.
However you should think about the entire portfolio of projects within V ale, the share is naturally lower, it’s more close to 50% rather than 90%. So it’s not difficult to do the calculation, that includes the sustaining investment as well, that share that I just gave you.
So it’s not so difficult from this share to have an estimation of the impact over any real depreciation over any period of time. On the tax disputes, no, we have not had yet any meaningful development that should be conveyed to you.
Operator
Our next question comes from Mr. Carlos de Alba from Morgan Stanley.
Carlos de Alba – Morgan Stanley
Two questions, first one is on the non-iron ore businesses, clearly the company has been very strong effort to reduce costs and expenses and we have seen the results of it. But the gold, the copper and the potash business continued to lose money at the EBIT level, I assume part of this obviously has to do particularly with nickel with the pretty operating and service costs.
But I would really appreciate if you can give us a sense of when do you expect this business to be positive assuming the nickel prices and copper prices around these levels, can they be profitable and if no, would you consider selling them or at least some of them? And the second question is on the working capital reduction, there you are making very strong results.
Is this new level sustainable, were there some one-offs that affected the development, we can we expect going forward?
Luciano Siani
This is Luciano. If you look at the segment reporting footnote for the financial statements, it’s 25, there we can see very clearly for each business segment and even within the segments the revenues, capital expenditures and R&D into operating idle capacity numbers for each of these segments, if you look at the – we only have base metals on aggregate as a whole.
But if you look at the footnote you have nickel and copper separated and remember that nickel in this case includes all the by-products and copper is just (inaudible) operations in Brazil. So if you look at the performance of this quarter for nickel you have – little under 1.4 billion in revenues and 160 million in costs.
So it’s a $500 million margin on absolute terms and that is basically coming from the assets in Canada and Indonesia. So even at those depressed prices where we have reference for the prices, an average price of 15100 for nickel in the second quarter.
The nickel business so to speak and its by-products was able to generate $500 million in cash. So once we link the pre-operating and idle capacity expenditures and once there is a medium term recovery of nickel prices that this business can be profitable on any accounts.
If you look at copper, we had just our first month of the EBITDA for Salobo, it was very small around $5 million but Salobo will be a very low cost producer. So the Salobo operation is depending on the prices that you are selling for copper and for gold can generate significantly the copper line of the segment reporting.
So Salobo can generate anywhere between 700 and $1 billion of EBITDA depending on the prices that you assume. So going forward we expect the performance of the base metal business as a whole to improve significantly.
Remember that also New Caledonia is not contributing to results, much on the contrary, we are still going to lose money this year from New Caledonia much less than last year and we intend to break even next year. Actually we intend New Caledonia to be cash flow positive next year.
So the prospects for the base metals business are of significant improvement over the next quarters. And we have no intention for now on to do any divestment on this business.
On working capital, yes we believe that the levels are sustainable and as I mentioned before we do have opportunities on the supply of financing side, on the inventory side. Perhaps the accounts is feasible, the improvements are going to be more margin from now on.
Carlos de Alba – Morgan Stanley
And then any comment on potash Luciano?
Roger Downey
Hi Carlos, yes, our potash operation today is a small operation at the end of its life of mine, it’s something (inaudible) 20 years. It is a significant operation in the sense that Brazil is so potash dependent.
So it really keeps our foot in the door in terms of the market that we want to secure. We are – the operations are today impacted by these non-recurring things that we are doing today at the mine.
It is not a mine that we would sustain at loss of cost but it’s something that we want to – it’s a market that we want to invest in. It is very promising.
I consider Brazil being the China of iron ore in terms of potash. There is a lot of potential there, and as you guys know we have been looking at prospects for this business and looking at new opportunities.
But answering your question more directly is, it’s just a means to a greater end. We will maintain the operation at (inaudible) but not any cost.
Operator
Our next question comes from [Andreas Spokenhouse] from UBS.
Unidentified Analyst
Can you give a little bit more clarity on your cost savings, obviously it’s been something much talked about both in Q1 and Q2. I am sort of curious can you break it down for us, just also highlight any currency depreciation savings in that number of – 730 million something dollars?
Luciano Siani
I believe on the press release on each of these segments that – when we comment across that we have separated the exchange rate effect. So we try to convey some color on the changes in the nature of those net of depreciation charges and the exchange rate effect.
What I can tell you is that the exchange rate effects was very modest up until June. So June was a month where we started to kick in, so most of the positive exchange rate effect what you can read over the press release, are related basically to the month of June and as Murilo mentioned, on average for the quarter it was 2.07 exchange rate.
So going forward there should be a meaningful improvement, every 10 cents of depreciation of the Brazilian real means an annual savings of around $700 million. On the nature of the cost saves, there has been a lot to do with the – so far with the simplification of all the company, so a more focused company spends less money and distractions, so we can have leaner support structures, you have less expenditures and R&D, so net SG&A and R&D is a question of focus.
When it will be operations it’s the more comprehensive review of the contract services, internal benchmarking, productivity improvements. We also have an ongoing cost cutting program in place with several hundreds of initiatives as well.
So we are tracking – we believe some have already kicked in, some will take longer time, we mentioned six months ago that we were doing a review of the procurement function. So everything within Vale may be 12, 24 months ago was geared towards speed, was paramount in the old days.
Now we are looking for quality, for doing the right thing regardless of timing. So we are taking the time to plan better and this has a number of implications across the company, from let’s say current investments where you can package different work into a bigger contract and then do a tender, take your time to do a tender, call more suppliers, negotiate more, lower the prices, to better plan your management stoppages to revisit the scope of those maintenance stoppages, in order to spend less than what is necessary.
So everything, when you do it more carefully and planning more ahead, and you get more quality, you get lower cost.
Unidentified Analyst
Maybe ask my second question then is that, well, if we sort of disregard the currency impact on your cost savings, I am sort of curious as to how much longer you can keep on cutting costs, I mean presumably over the past five years in this somewhat horrible macro-economy you have been cutting costs. So I just wonder how much meat is less than on that bone, without basically jeopardizing the future of Vale’s revenues and earnings, from what you are saying, you can still go on for a while longer, is that correct, is that the right interpretation?
Luciano Siani
Yes, all cost cutting measures that we are adopting are sustainable, we are not jeopardizing the future of the company for the sake of the short term. So you shouldn’t worry about the sustainability of the current level of cost reduction, it is here to stay and there is no impact on the future earnings ability of the company, any of the cost reductions, much to the contrary.
Operator
Our next question comes from Mr. Thiago Lofiego with Merrill Lynch.
Thiago Lofiego – Merrill Lynch
The first question is on the regulatory framework definition in Brazil, what’s your take on the recent development, do you think the final documents will be significantly different from your original proposal and also what’s the timing for the new rules to be effective in your view? And the second question just to follow up from the Portuguese call regarding the 150 logistics project, what’s the additional array of asset expected for 2014 and what capacity is actually tied to the S11D project and also what’s the potential additional iron ore tonnage in terms of sales for next year for 2014?
Luciano Siani
On the mining coal, as you saw that there were several amendments to the cost. Obviously without deep knowledge of the political process we cannot anticipate what the outcome is going to be, right.
We remain confident that the ideas that were espoused by the government in the original bill should at the end prevail. That’s our hope – hopefully the government will be able to mobilize its value in order to sustain those.
But we have no forecast on how much it is effect and what the process will take. In terms of the logistics capacity I will hand over to Galib Chaim.
Galib Chaim
Well considering the 150 for 2014, we expect – we have now already 14 million tons added to the logistics CapEx.
Luciano Siani
On the tax dispute as we mentioned there has been no significant recent development on the side of Vale. I will now hand over to legal counsel, Clovis which is on the call to see if he wants to add anything else.
So he is not on the call, so I – sorry for that, I will reassure my last answer which is that there has been no recent development and we haven’t yet had a full assessment on the impact of the CSN sort of administrative win on our tax liabilities. I will hand you over to Martins to speak on the supply demand equation.
José Carlos Martins
We continue to see – I don’t know -- market to balance, sometimes we have – we see some additional supply that later can be absorbed by the market, many signs as we are used to seeing in the last three or four years. We believe next year Europe could be performed better, there is some times of recovery in Europe.
It’s not a big market for iron ore, they have their own iron ore but we see also the economic policy in Japan improving also. We see next year with more supply coming into the market, but on the other hand we see some positive signs coming from Europe and Asian countries not including China.
So we do not see a picture too much different from what we see today. I think the market will continue to perform the same way it’s performing this year.
With some ups and downs this will continue to be there like we see all over this year. I don’t think volatility will change but on average I do not see big changes in the markets situation as far as supply and demand is concerned.
Supply will grow but demand will also grow.
Operator
Our next question comes from Mr. Daniel Rohr from Morningstar.
Daniel Rohr – Morningstar
Just one about the unit cash cost in the iron ore business, the $24 tons figure you gave for second quarter and then for 2012 in that filing you didn’t break out costs versus expenses. So can you let us know what’s the equivalent unit costs would be for full year 2012?
Luciano Siani
We can give you that afterwards. So we don’t have the information here.
Operator
Our next question comes from Mr. Paul Massoud from Stifel.
Paul Massoud – Stifel, Nicolaus
Last week – just a follow up on some of the commentary on potash but last week, some news that came out of Russia that major Russian producers would be exiting its marketing arm and increasing its production by 2.5 million tons, the result of that is I think most expect pricing on the potash market over the next six to 12 months decline by something close to 25%. And so I guess in the context of lower pricing, it seems that developing greenfield potash projects in that pricing environment has become even more uneconomic and so just going back to I think previously stated strategy and I think you even said it today that potash is still a big focus in terms of growth and then in terms of Brazilian demand, has M&A become an even bigger part of this strategy in terms of growing in those businesses and given what pricing is at today does it make more sense now to buy established production as you have been trying to build?
Roger Downey
This is Roger Downey here. I guess we always have to keep everything in mind, I think we have to be anchored in the long term, that’s really where our business is, have to look at always.
There is no doubt that the recent developments in the industry have put a lot of pressure on prices, we can’t look at our business from sort of a very short term quarterly or annual prospectively, we really have to focus on what’s out there in terms of an opportunity for our shareholders to make money with. We are looking at business from a perspective that we sit in a market that we think is probably one of the most promising markets for that commodity, potash.
Brazil can significantly increase its demand. We have a competitive advantage and a sustainable competitive advantages at that in terms of reaching our customers especially in the north-western Brazil with all the warehousing logistics, our sales clientele and of course, especially our ports into Brazil.
So if we can find ourselves in a business that is in the lowest quartile of CFR costs into these markets, and specific into Brazil into the promising market and specifically Brazil, I think we should certainly look at being in this industry. Brazil has a tremendous potential in terms of growth, if you just compare our productivity levels in terms of agriculture productivity, today we could be doing – we talked about 4 to 5 times as much agricultural output.
And Brazil is totally dependent on potash and they can’t get enough, our farmers can’t get enough. So certainly I think we have to be conscious of what’s happening in short term but focus on the long term.
I think that’s really what it comes down to. And of course we will balance our entry into that business if it really is something we want to get into as to what is the best boat to get into.
Paul Massoud – Stifel, Nicolaus
Maybe just as a follow up and trying to understand how you guys go about that process, I mean do you have a long term potash price that you think is reasonable, I certainly understand that current market dislocations may very well be temporary but if you are looking I would say call it 24 months and beyond, what sort of reasonable price – what’s the right price that you guys are looking at in terms of being a long term price?
Roger Downey
Yeah, we go much farther out in the next 24 months of course, especially given that our mines – even if we are going to get into the potash business or not, we have to think about – probably development or whatever will take you more than 24 months and then operating a mine is 20 years. So we have a long term price that we work with and which is our threshold.
If we can be in a business that’s in the lowest quartile of the price into the promising market, and we certainly should be in there. And if it makes a decent margin we should be there.
So I think the process – especially after the development we’ve had in – development of our potash project in Argentina we are in a stage where we are viewing the whole thing. So – but look, as I said it is the promising market and we are taking a cautious stand, cautious approach to it and again we certainly – short term issues may well result -- in short term issues in supply may well result in higher prices in the long term.
Operator
Our next question comes from Marcelo Aguiar with Goldman Sachs.
Marcelo Aguiar – Goldman Sachs
First question will be on future development and sustaining CapEx, you guys have been running below your targets for the annual gold and research and development and spending CapEx, is this first half level for both expenses and CapEx sustainable for the next let’s say second half and the future or should we expect you guys to reach the budget that you outlined to us at the end of last year, that would be the first question.
Luciano Siani
On aggregate we should expect to reach the budget that we outlined for last year, if you consider R&D sustaining and CapEx.
Marcelo Aguiar – Goldman Sachs
And the other one will be little bit more color on the VMC comment you made earlier Luciano that you see the VMC already generating positive EBIT in 2014. Can you just walk us what’s – not what happened, but what were the negative EBIT impact on the VMC in 2012 so we can have an impression on the magnitude of that turnaround?
Luciano Siani
I will hand over to Peter Poppinga but just before he talks a little bit about the perspective, just to give you a few numbers, VMC lost $750 million in 2012 and we were expecting for this a significant swing although we are still going to have a loss you can expect a swing a several hundred million dollars. Won’t give a precise figure but the order of magnitude will be still in the loss but several hundred million dollars less than last year.
For next year we are going to – so we are looking forward to breaking even as Peter Poppinga will explain.
Peter Poppinga
In VMC, as you know there is a major turnaround going on although it’s taking its time. There is no fit or flow anymore expected in terms of new technology that’s for sure.
Ramp up is progressing well and we had in the month of June you don’t see that because you only see the quarter results but I am very pleased to report that month of June we had a very successful production in VMC because for the first time we continue to run with other players at an average full capacity is meant to2.5 on average because all this one is maintained with something. So we ran this two other plants for continuity for long term.
So this means that – can it be cash flow positive in 2014, because you need to be placed under the current price environment, you need to – cash flow positive in 2014 that’s what we are aiming at. That was the major milestone we achieve and so we are positive that in 2014, we are still looking at this company to be positive.
Operator
Our next question comes from Mr. [Tony Robison with Cowen and Colt LLC].
Unidentified Analyst
I guess I want to drill down a little bit firstly in your assumptions on the global steel supply chain a little bit if I may and you talked about a floor 410, per metric ton, I was wondering if you could tell us what you are assuming for Chines crude steel production and pig iron production and maybe your assumption for Chinese order rates, depletion rates in the west and how you view India?
Luciano Siani
We believe that steel production in China will continue to grow around the – between 3 and 7% ending from the year, this year we will grow near 10%, I am talking with you about 700 and 80 million tons. Pig iron production it continues to be the bigger part of the production in China.
We don’t believe scrap will have any kind of influence in the near term, we believe scrap we only have some influence after 2025 or later. So steel production in China continues to be based on pig iron production.
I don’t see there is impact on the scrap. But you have to believe that China will continue to develop, now it’s 51% something like that, we believe that until 2030, we don’t read 72% which is the Chinese government target for 2030.
So one year will be better, another year we will be worse, but on average China steel production will continue to grow based on pig iron. And I don’t know – internally domestic demand in China everybody knows that the quality is becoming worse, depletion rate is increasing, iron ore content is decreasing, so we know a lot of those effects and that’s the reason we believe that price will be sustainable in the range of 100 to 110.
We do not see big difference from what we see and – In the presentation that’s in our website, on page 25 we make an estimation for global demand and supply on the seaborne market for 2020, and we do see 160 tons of high cost produce is being displaced from the market of the starting level of over 350 and that includes the opportunistic exporters to China such as US, Iran, Kazakhstan, so several non-traditional countries that supply. So if you take the cost curve even if you displace 150, 160 million tons of high cost production if you consider the variable that he mentioned, cost increases both geological and internal because of the increase in labor cost China, appreciation of the renminbi, you get a very clear picture that 110 type for support.
Unidentified Analyst
And looking out a little bit longer term over the medium term should we still think about your CapEx levels being in the ballpark of 15 billion per year and is there the potential there for some scope of reduction and of that amount what would be the sustaining level that we should think about?
Luciano Siani
The ballpark that you mentioned should prevail over at least 14 and 15 in which we have the bulk of our expenditures and S11D. Sustaining investment we have seen an overall direction of not increasing it so we believe that it’s a fraction of – it should be at stable or decline but we don’t have a precise figures to give you.
After the expansion of – after 14 and 15, so after the bulk of the expenditures on S11D, have been realized, one can expect a decrease in CapEx but again the details will be given to you in Vale day in November.
Operator
Our next question comes from [Terence Orslein from TSO and Associates].
Unidentified Analyst
The mining is such a big component of Brazil, why isn’t Vale and Argentina – all companies why more involved in the process, even at this scale.
Luciano Siani
There is an industry body that represents the entire industry which is called [EBRAT] which is actively evolved with the government and discussions and Vale is one of the members of this body.
Operator
Our next question comes from John Tumazos with JP Independent Research.
John Tumazos – John Tumazos Very Independent Research
What are the nickel and copper prices you used for your balance sheet analysis?
Luciano Siani
We are working very close to the industry average forecast. We are – slightly lower price than the current one but on --- we are distinctly above 20,000 because we think the export plan in Indonesia will work in the long term – there is no new supply risk coming –
John Tumazos – John Tumazos Very Independent Research
30% increase in output in China last year and this year is not sustainable? There is more suffering in the nickel business as China increased output 30% last year and 30% so far this year, 70% -- you are planning as I would that will be not import ore.
Luciano Siani
We have views on the long term prices for commodities for driving the opportunities and in our capital allocation process we have very high hurdle rates and very high – we stress all the assumptions to make sure that the projects and the planning is robust and they are – so the long term prices we are not so mean for us in terms of approval of projects which is more meaningful is the stress that in the hurdle rate, the long term prices have more of a central sizing opportunity rather than influence on the approval process.
Operator
This concludes today’s question and question session. Mr.
Murilo Ferreira, at this time you may proceed with your closing statement sir.
Murilo Ferreira
I would like to highlight again that we are not so far guidance into the future of the company with the cost cut program. We must live with the simplicity, austerity and very focused.
We are not leaving super cycle, we must provide good return to our shareholders and their simplicity and austerity goals key elements in our strategy. Regarding the mining law, I think that the government is very conscious in order to maintain the competitive in us of the mining sector in Brazil.
I think that this is very important and the Brazilian mine, is helping to depart on that in order to provide elements to the people to see and to have the process. Regarding M&A, we must say that we are very focused into big projects , S11D in Mozambique and the next few years we will spend roughly 26 billion in both projects and we can pursue with these two big projects, high return and to bring return to our shareholders.
We are not able to forecast about the level of the cash flow that we would spend right after 2016 but in our strategic planning we must consider just world class project, we are not looking for to increase our volume annually. We must have good projects, worldclass project low cost that we can expand in the future looking for brownfields with the good technology in order to stay in our business.
Again thank you very much for your time and thank you very much for your support and we are very happy to see the results and the price of our stock. Thank you very much.
Operator
That does conclude Vale's second quarter 2013 results conference call for today. Thank you very much for your participation, you may now disconnect.