Vale: Emerging market stock of the day

Brazilian iron ore producer Vale (quote) has had a rough two years. Is now time to buy into this beaten up stock?

Image courtesy Vale

Vale iron ore mine of Timbopeba, Minas Gerais, Brazil

As the world’s largest iron ore miner, Vale experienced an incredible run from 2002 to 2008, seeing its share price increase more than 20-fold. As emerging market demand for enhanced infrastructure began to manifest itself, led by the seemingly insatiable commodity needs of China (FXI, quote), commodities like iron ore entered a so-called ‘supercycle.’

However, as the financial crisis has dragged on, infrastructure spending has waned which resulted in a concomitant decline in the price of commodities closely linked to infrastructure. As iron ore continues to drop – the mineral fell to a three-year low in September — iron ore miners like Vale have suffered.

Vale’s shares have dropped more than 50% from their 2010 high. However, the decline in the Brazilian firm’s equity price is not entirely attributable to softening Chinese demand.

Interference from the Brazilian government has had a discernible impact on both Vale’s shares and its corporate structure. Dilma Rousseff’s government has made it clear that the company is to focus more resources in Brazil; disputes over Vale’s role resulted in its previous CEO stepping down. While such projects are ostensibly better for the people of Brazil, such measures put shareholders in Vale at a disadvantage vis à vis other multinationals that do not have to worry about excessive government middling.

While such initiatives are somewhat disconcerting, given the country’s reliance on international credit markets, Brazil (EWZ, quote) indulging in Argentinian-style resource nationalism remains an unlikely scenario. As a result, the worst-case scenario for Vale is off the table. Now that the stock has dropped so far, is there a case to be made for going long the name?

In terms of valuation, the company is very reasonably priced with a forward P/E of 7.2. More importantly, as Chinese manufacturing growth looks to be getting back on track and promised infrastructure stimulus to be implemented in the coming year, iron ore prices, while unlikely to hit their supercyle highs any time soon, could very well strengthen in the medium-term.

With volatility in the name quite low, an out-of-the-money options strategy for March or June could be a profitable way to capture a potential further rebound in iron ore prices.

Disclosure: Author is long VALE calls

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