Why Vale is more sensitive to iron ore prices

So, it isn’t the cost position that’s the real deal breaker for Vale (VALE). We already discussed that freight rates are declining. Vale should be able to compete with the other Australian seaborne companies—BHP Billiton (BHP) and Rio Tinto (RIO).

Huge debt position

There are two reasons why Vale is more sensitive to iron ore prices. One is the huge debt it accumulated over the years. Most of the debt is denominated in the US dollar, or USD. Vale took the debt in USD to take advantage of the lower interest rates. However, with the local currency depreciation and USD strengthening, this advantage is going away.

The main debt repayments start becoming due in 2016. The market isn’t doubting Vale’s ability to repay its debt obligations. It’s the interest service charges that are putting pressure on its margins. The commodity price scenario is already weak. This is worrying for investors.

Cliffs Natural Resources (CLF) is a North American iron ore producer. It has a huge debt position. For some time now, the debt position has been a major overhang on its shares.

Ambitious capex plans

The second reason that Vale is more sensitive to iron or prices is its ambitious capital expenditure, or capex, plans. Its capex plans are more stretched out than Rio Tinto and BHP’s plans. While BHP and Rio Tinto plan to complete their iron ore expansion plans by 2017, Vale is planning to complete its full expansion by 2019.

Vale still has a huge expansion capex budget in place for this targeted capacity increase. So, the cash flow it earns demands debt servicing and capex. Vale has the weakest balance sheet and the highest debt among the three major players. This makes Vale’s share price more sensitive to any moves in iron ore prices.

There are other reasons why Vale is more sensitive. Vale is less diversified. Also, there’s more government interference in Vale’s affairs—than in BHP and Rio Tinto’s affairs.

Investors can consider investing in ETFs that invest in the metals and mining sector—like the SPDR S&P Metals and Mining ETF (XME).