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Companhia Vale An Ironclad Opportunity

Posted: May 22, 2008 09:48 AM by Gregory S. Davis

Tickers in this Article: RIO, RTP, BHP, MT

Long before a piece of steel is fashioned into cables for a bridge or molds for kitchen cooking pots a price was paid for the iron ore needed to bring it into existence. Mining companies Companhia Vale do Rio Doce (NYSE:RIO), Rio Tinto (NYSE:RTP) and BHP Billiton (NYSE:BHP) are the dominant global giants of raw material extraction. Investors banking on emerging market development and reconstruction themes should not let these miners escape unnoticed.

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Market Environment
While record oil prices continue to lead headlines steel prices have quietly risen 50% so far this year. Steel prices are in the $1,000 to $1,150 per-ton range which is well above the $400 per-ton price available last year. Infrastructure needs from countries ravaged by natural disasters, demand from the emerging market BRIC countries, and the rising cost of iron ore are the main culprits. In 2007 China alone represented 49% of the demand for iron ore transported by sea. (For related reading, check out Build Your Portfolio With Infrastructure Investments.)

Top Iron Ore Producers
Brazilian based Companhia Vale (Vale) along with Australian based Rio Tinto and BHP Billiton control 75% of the global market for iron ore. Vale is the world's largest producer of iron ore by far. For the first quarter of 2008 Vale produced 82 million metric tons of iron ore, doubling the output from its nearest competitor Rio Tinto.

Why Should Investors Care about Iron prices?
When the price of iron ore increases steel producers like ArcelorMittal (NYSE:MT), the world's largest steelmaker, feel the pinch and eventually pass these cost on in the form of surcharges to their customers. For example, ArcelorMittal, Vale's largest single customer for its iron ore, has already informed U.S. auto manufactures of an additional per ton surcharge directly related to an increase in raw inputs. Toyota has made similar concession for its sheet metal from Japanese based Nippon Steel.

Even though ArcelorMittal, signed a record 10-year contract with Vale for 480 million tons of iron ore and pellets this past April, there is still the threat of customers entering the mining business. In May ArcelorMittal made their intentions clear by announcing an $8 billion dollar investment in Indonesia aimed at securing iron ore reserves to help limit its dependence on Vale.

Valuation
Vale has an attractive price-to-earnings growth (PEG) ratio of 0.40. Investors looking for a bargain can use the PEG Ratio as a guide since it takes the price-to-earnings ratio and divides it by the expected five-year future growth rate. A PEG ratio below 1 suggests that the stock is undervalued. (For further reading on valuations, head over to our related article Relative Valuation: Don't Get Trapped.)

Now the Right Time?
With busy lives it's easy to overlook how much steel surrounds us in our daily lives. From the cars we drive to the houses people live in, steel is here to stay. Steel prices will not run toward the sky forever, but investors seeking companies that are in-line with global themes of reconstruction and emerging market growth can keep Vale in mind. Since Vale is trading just below its 52-week high investors would be wise to utilize a dollar-cost averaging approach to build up a position over time.

To learn about an easy way to go global, read Go International With Foreign Index Funds.

By Gregory S. Davis

Gregory S. Davis is an investment writer and consultant for his company G.Davis Capital Inc. His core methodology for choosing investments include patience, diversification and asset due diligence. Gregory is a graduate of the Wharton School of Business. He is also a board member of StoriesWork, a non-profit organization based in Durham, NC that uses storytelling to empower youth and individuals to utilize alternative dispute resolution tactics.

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