Moody's changes Vale's outlook to stable
Moody's Investors Service affirmed Vale SA's Ba3 ratings and related ratings, including Vale's senior unsecured rating and the ratings on the foreign currency debt issues of Vale Overseas Limited (fully and unconditionally guaranteed by Vale). The outlook was changed to stable from negative. Moody's also affirmed the B2 rating and changed to stable from negative the outlook for the senior unsecured ratings of Vale Canada Ltd.
RATINGS RATIONALE
The stable outlook reflects the improvement in Vale's credit metrics throughout 2016, supported by the initiatives taken by the company to improve its liquidity and expand production volumes at lower costs, and Vale's financial discipline regarding capex and dividend payments, which enhance its operating resilience. Vale's adjusted EBITDA margins increased to 31.5% in the LTM ended September 2016, from 21% in 2015, while adjusted leverage (measured by total debt/EBITDA) declined to 4.0x from 5.5x in the same period. The improvement in credit metrics also reflect the recovery observed in iron ore prices, base metals and coal relative to the levels evidenced in 2015 and early 2016.
We expect Vale's leverage to decline further in the next 12-18 months considering prices at Moody's sensitivity medium-term ranges (USD 45-55/ton), as the company continues to undertake cost saving measures and reduces its annual capex to around USD 4.5 billion from 2017 onwards, which will reduce debt requirements and lead to positive free cash flow generation. We also expect Vale's metrics to benefit from the additional sales volume coming from the S11D project, with total iron ore production capacity of 90 million tons per year at a lower cost base after full ramp-up by 2020.
Vale's Ba3 rating is supported by the company's diversified product base and competitive cost position, and substantive portfolio of long lived assets. While Vale has diversified its geographic footprint through various acquisitions in Canada, Australia and elsewhere, the dominant revenue, earnings and cash flow driver continues to be its Brazilian-based iron ore operations and its major position in the seaborne iron ore markets. The rating acknowledges Vale's more focused and disciplined approach to project development, capital allocation, resizing of its asset portfolio to strategically important business segments, divestiture of non-strategic assets, and focus on cost reduction, which better positions Vale to withstand volatility in the prices for its major products over the next twelve to eighteen months.
Constraining the ratings are the challenging fundamentals for iron ore, a key earning driver, and base metals prices, and our expectation that prices will remain at lower levels for a prolonged period, as a consequence of the slowdown in China's economic growth and steel demand, which the World Steel Association (WSA) forecasts to decline to 652 mm tons in 2017, a 8% decline over 2014 levels, bringing heightened uncertainty over demand for iron ore and base metals in the next few years. Lower prices relative to 2011-2014 levels will prevent a faster recovery in credit metrics for Vale and the company will likely continue to pursue asset divestitures and other liquidity alternatives to strengthen its capital structure and reduce debt levels at a steady pace. Vale's ratings also incorporate the long term overhang represented by the uncertainties regarding the level of support Vale will provide to Samarco and the impact it would have on the company's liquidity and debt profile.
Vale Canada's B2 senior unsecured rating rank two notches below Vale's rating to reflect the weaker operating performance of its business, and the fact that Vale does not guarantee the notes. The rating continues to reflect this subsidiary's major position in the global nickel market, its asset base and strategic importance to its parent.
An upward rating movement would require that Vale maintains a strong liquidity position and continues with its asset divestiture and partnership strategies, which will allow Vale to materially reduce debt levels. In addition adjusted total debt/EBITDA below 3.5x and EBIT/interest expense above 3.5x times on a sustainable basis are necessary for an upgrade.
The ratings or outlook could suffer negative pressure should conditions for iron ore and base metals deteriorate, leading to lower profitability, and Vale is not able to make meaningful progress in cost reduction and debt levels, with leverage ratios (total debt to Ebitda) trending towards 4x or above. A marked deterioration in the company's liquidity position could also precipitate a downgrade. Negative pressure would arise to the extent Vale is required to provide material financial support to Samarco, or faces liabilities from litigation and class actions resulting from the Samarco's accident, in addition to the amount related to the Framework Agreement set with Brazilian Authorities in March 2016 and the announced support to Samarco's working capital needs.
Source : Strategic Research Institute