# Vale SA ADR (VALE) Investment Valuation

January 23rd, 2013 Posted by No Comment yet
VALE is a Brazilian multinational corporation engaged in metals and mining and the largest producer of iron ore and nickel in the world.
VALE Investing Approach
This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

## VALE Investment in Enterprise Value

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise  Value (EV) is the present value of the entire company.  Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.  The formula is given below:

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The market capitalization was erratic in movement with an average of \$137 billion.  Its total debt represents 18 percent average, while its cash and cash equivalent represent 5 percent. Thus, enterprise value was greater by 13 percent against the market capitalization. Buying the entire business of Vale would be paying 13 percent debt and 87 percent equity.

If you are asking how much it would cost you to buy the entire business, then the purchase price of Vale to date, January 21, 2013, would be \$180.6 billion at \$56.96 per share.  The market price to date was\$20.01 per share.

## Benjamin Graham’s Stock Test

### Net Current Asset Value (NCAV) Approach

The Net Current Asset Value (NCAV) is a method from Benjamin Graham to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks are trading in a bargain, and it is worth buying.

### Net Current Asset Value (NCAV) Method

The net current asset value approach of Benjamin Graham shows that the stock of Vale was trading at an overvalued price because the market price was greater than the 66 percent ratio from 2007 to the trailing twelve months.  The 66 percent ratio represents only 7 percent of the market price, thus the market price was overvalued.

What does it mean? It tells us that the stock of Vale was expensive and did not pass the stock test of Benjamin Graham.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Calculating market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios for Graham to buy stocks.

Market Capitalization / NCAV = Result (must be lesser than 1.2)

The MC/NCAV valuation tells us that the stock price of Vale was overvalued from 2007 to the trailing twelve months because the ratio exceeded 1.2. The result of ratios was 24.55 against 1.2 ratios, thus the price was considered very expensive. From here, we can say that it did not pass the stock test of Benjamin Graham.

### Benjamin Graham’s Margin of Safety (MOS)

The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.

Margin of Safety = Enterprise Value – Intrinsic Value

#### Explanation

The margin of safety for VALE resulted at a 67 percent average which is equivalent to \$166 average. Enterprise value was \$46 average. As seen in the table above, there was a margin of safety from 2007 to the trailing twelve months except in 2009, where there were zero margins of safety.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)

wherein;

EPS is the company’s last 12-month earnings per share.  G: the company’s long-term (five years) sustainable growth estimate. 9 stands as the constant representing the appropriate P-E ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, but we changed it to 9). And, 2 is the average yield of high-grade corporate bonds.

By looking at the table, intrinsic value result was \$207 average. This is the true value of VALE’s stock. The formula factors the earning per share and the sustainable growth rate. The earning per share was \$2.93 average while the sustainable growth rate was \$28.56 average.

#### Earning per Share (EPS)

The term earnings per share (EPS) represents the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock.

Sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio.

#### Sustainable Growth Rate (SGR)

The formula is Sustainable growth rate = ROE x (1 – dividend-payout ratio).

The table above stated that the average return on equity was 31.55 percent. Payout ratio garnered 12.47 percent average.

Moving on, Return on Equity (ROE) is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. It shows how many dollars of earnings result from each dollar of equity.

As you can see, the relative approach in calculating Vale’s sustainable growth rate, produced almost the margin of safety compared to the average approach. The margin of Safety was greater when an average approach is a concern.

#### VALE Intrinsic Value Graph

During 2009, the revenue and net earnings of Vale went down by 38 and 60 percent, respectively. During the 2010 period and the following year, its revenue and net earnings soared up to 94 and 229 percent, respectively. Then, in 2011 it soared up by 30 percent both in revenue and net earnings. The margin of safety was high in 2011 at 89 percent. For Vale, the average margin of safety was 67 percent using the relative approach.

## VALE Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare market values with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

### Price to Earnings/Earning Per Share (P/E*EPS)

This method will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.

#### Explanation

The enterprise value per share was lesser than the P/E*EPS ratio by 71 percent. It was overvalued for the rest of the periods because the price was higher than the P/E*EPS ratio. The market price was 175 percent of the P/E*EPS ratio, therefore, the stock price is considered expensive.

There are two approaches also in calculating the P/E*EPS valuation. It is the relative P/E approach and the average P/E approach. I have summarized the results of these two approaches in the table shown below.

### The Enterprise value (EV)/Earning per Share (EPS) or (EV/EPS)

The use of this ratio is to separate price and earnings in the enterprise value by dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E). The difference will then represent the earnings (EPS).

#### Explanation

The price (P/E) was 44 percent average and the Earnings (EPS) was 56 percent average. This is the price a certain investor would pay in buying.

### Enterprise Value (EV)/ Earnings before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

#### Explanation

The EV/EBITDA tells us that it will take 9 years to cover the costs of buying the entire business of Vale.  In other words, it will take 9 times the cash earnings to cover the purchase price. This valuation shows the profitability of the company. The net income of Vale was 33 percent average.

In conclusion:

The market capitalization for Vale was erratic in movement with an average of \$137 billion. Its total debt was 18 percent average. While the cash and cash equivalent were 5 percent average, thus the enterprise value was greater by 13 percent. Buying the entire business the investor would be paying 13 percent of its debt and 87 percent of its equity. The purchase price to date, January 22, 2013, for the entire business, is \$180.6 billion at \$56.96 per share. The current market price was \$20.02 per share.

#### Net Current Asset Value (NCAV)

The stock price was overvalued from the period 2007 to 2012 because it exceeded the 1.2 ratios.  The NCVA approach indicates that the price was expensive and did not pass the stock test of Benjamin Graham.

In addition, the margin of safety for Vale was 67 percent average and its intrinsic value was \$207 average. While the growth represents 29 percent for sustainable growth rate. And 66 percent in the annual growth rate. While the return on equity was 31.55 percent average.

#### P/E*EPS

Furthermore, the P/E*EPS indicate that the stock price was overvalued because the P/E*EPS ratio was only 57 percent market price. Therefore, the price was expensive overall. On the other hand, the EV/EPS valuation indicates that the price (P/E) was 44 percent. Moreover, the earnings (EPS) was 56 percent average.

#### EV/EBITDA

EV/EBITDA valuation tells us that it will take 9 years to cover the costs of buying the business of Vale.  In other words, it will take 9 times of the cash earnings of Vale to cover the purchase price.

Further, I recommend a HOLD in the stock of Vale SA (ADR).

Researched and Written by Criselda