Fitch Rates Vale's Proposed Senior Unsecured Notes 'BBB(EXP)'

CHICAGO--()--Fitch Ratings has assigned a 'BBB(exp)' rating to Vale Overseas Limited's proposed benchmark-size senior unsecured notes due 2026, which will be unconditionally guaranteed by Vale S.A (Vale). Proceeds from the issuance will be used for general corporate purposes, including the repayment of Vale's USD1.25 billion bonds outstanding due January 2017. Fitch currently rates Vale's Foreign Currency Issuer Default Rating (IDR) 'BBB' and Local Currency IDR 'BBB+'. The Rating Outlook is Negative, which reflects the Negative Outlook on the sovereign rating. A complete list of the company's current ratings follows at the end of this release.

KEY RATING DRIVERS

Leading Seaborne Iron Ore Producer

Vale's investment grade ratings are underpinned by its flagship iron ore business, with a market share of approximately 22% in the seaborne iron ore trade. Reinforcing the company's position is its ongoing production expansion of high grade and low cost iron ore, which should allow it to gradually increase output to more than 430 million tonnes of annual output from approximately 345 million tonnes in 2015. The main driver of the increase in volumes is the company's S11D project - a USD14.4 billion project which is slated to produce around 90 million tonnes annually.

Net Leverage to Remain High Until 2018

Fitch projects Vale's net leverage to remain high for the rating category, despite improvements in cash flow generation due to increased commodity prices in the second quarter of 2016 (2Q16). Based on an average iron ore price of USD49 per tonne for 2016, which includes Fitch's mid-cycle price assumption of USD45 per tonne for the remaining five months during the year, Vale will generate approximately USD7.8 billion of EBITDA and USD5.4 billion of cash flow from operations (CFFO) for the year. As a result, net leverage is projected to be around 3.5x for 2016, inclusive of asset sales around USD2 billion. For 2017, using USD45 per tonne as the iron ore price, Fitch's base case projects that Vale will generate about USD8.5 billion of EBITDA and its net leverage will be 3.0x.

Additional Asset Sales Would Accelerate Improvement in Capital Structure

Vale has expressed its intent to reduce net debt to around USD15 billion over the next 18 months. This can be achieved through the sale of core and non-core assets, as well as streaming transactions. Fitch conservatively estimates Vale to sell approximately USD2 billion in assets over the next six months. Should Vale sell USD5 billion over the next six months, net leverage would likely fall to around 3.1x in 2016 and 2.7x in 2017. Additional asset sales over the next 12-18 months would further accelerate improvement in the company's capital structure and reduce net leverage below Fitch's expectations.

Low Cost Position to be Reinforced

Vale's large scale and low cost iron ore business position continues to be a key consideration for its investment grade ratings despite deterioration in its credit metrics and a decreased outlook for long-term prices. Vale's production cost is among lowest in the world. Its cost position will be further enhanced by S11D, a high grade project with low impurities that relies on truckless mining. Iron ore at Vale's S11D mine has a higher grade - above 66% iron ore content - and lower impurities than its average ore bodies. Due to low freight prices, Vale's delivered cost to China is relatively close to that of the second and third largest producers of iron ore globally, Rio Tinto (RT; rated 'A-'/Negative Outlook) and BHP Billiton Plc/Ltd (BHPB; rated 'A+'/Negative Outlook).

High Exposure to China

Like most commodity producers, Vale is highly exposed to China both directly and indirectly. The company's ferrous minerals business accounted for 83% of its EBITDA in 2015. China was the key market for Vale's iron ore, accounting for 35% of sales. Prices are expected to weaken in the future due to extensive increases in production capacity by Vale, BHPB and Rio Tinto that will erase a scarcity premium that has existed for much of the past decade. Against a backdrop of rising supply, demand from China for iron ore continues to grow at a declining pace, further exacerbating pricing pressure. Vale's considerable investments in nickel, coal, fertilizers and copper will only partially mitigate the impact of the increase in iron ore mining capacity globally.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

--Sales volumes of iron ore fines and pellets increasing to 354 million tonnes in 2016, and over 400 million tonnes in 2017.

--Nickel sales volumes at 300 thousand tonnes in 2016.

--Copper sales volumes around 450 thousand tonnes 2016.

--Coal continues to produce negative EBITDA in 2016.

--Fertilizer sales volumes grow between 3%-5% annually during 2016 to 2019.

--Prices for iron ore, copper and nickel follow Fitch's mid-cycle commodity price assumptions.

--Total capex of around USD6 billion in 2016, USD5 billion in 2017 and below USD5 billion in 2018 and 2019.

--Asset sales of USD2.0 billion in 2016.

RATING SENSITIVITIES

Vale's international ratings are two notches higher than the 'BB+' country ceiling rating of Brazil. This reflects Fitch's view that Vale has significant offshore assets e.g. Vale Canada Limited, substantial and recurring foreign exchange earnings relative to the company's foreign currency and overall debt burden, and committed undrawn credit lines available from highly rated international banks, especially credit lines without a MAC clause, versus its semi-annual debt service obligations. Significant weakening of these factors may lead to the company's ratings being capped at the country ceiling level.

A downgrade of Brazil's sovereign rating and country ceiling could potentially lead to a negative rating action for Vale's Foreign Currency IDRs and its international bonds. While the company has characteristics that allow it to be rated higher than the country ceiling, the heart of the company's profitability remains its iron ore business, which is Brazil based.

A negative outcome regarding Vale's joint venture, Samarco Mineracao S.A., could also result in a downgrade. A material judgement against Vale which would result in net leverage increasing by around 1.0x for the next three to four years would be viewed negatively.

Vale's Local Currency IDR could be downgraded if it fails to bring online volumes as currently projected. These volumes, which are expected to be a lower cost than current operations, are key to free cash flow (FCF) generation and leverage reduction in 2017 and beyond. A change in the approach by Vale's management philosophy regarding its conservative through-the-cycle capital structure that would lead to net leverage remaining above 2.5x on a sustained basis would also be viewed adversely.

Positive rating actions are highly unlikely in the medium term as Vale concentrates on completing its large investments while preserving its liquidity position and safeguarding its capital structure at a time of lower commodity prices.

LIQUIDITY

Vale held readily available cash and marketable securities of approximately USD4.3 billion as of June 30, 2016 compared to USD3.6 billion as of Dec. 31, 2015. Liquidity is further enhanced by Vale's remaining undrawn USD2 billion revolving credit facilities with maturities of two to four years and by its strong capital markets access. Interest coverage improved to 5.1x for latest 12 months (LTM) June 30, 2016 compared to 4.8x for year-end 2015.

FULL LIST OF RATING ACTIONS

Fitch currently rates Vale S.A. as follows:

Vale S.A.

--Foreign Currency IDR 'BBB';

--Local Currency IDR 'BBB+';

--Senior unsecured debt rating 'BBB';

The Rating Outlook is Negative.

Vale S.A.

--National Scale Long-Term rating 'AAA (bra)';

--National Scale unsecured debt rating 'AAA (bra)'.

The Rating Outlook is Stable.

Vale Overseas Limited:

--Senior unsecured debt guaranteed by Vale 'BBB'.

Vale Canada Limited:

--Senior unsecured debt guaranteed by Vale 'BBB'.

SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS

--Leases: Fitch has adjusted the debt by adding 5x of yearly operating lease expense of USD56 million for 2015.

Date of Relevant Rating Committee: May 10, 2016.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009879

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Phillip Wrenn
Associate Director
+1-312-368-2075
Fitch Ratings, Inc.
70 West Madison St
Chicago, IL, 60602
or
Secondary Analyst
Debora Jalles
Director
+1-312-606-2338
or
Committee Chairperson
Joe Bormann, CFA
Managing Director
+1-312-368-3349
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Phillip Wrenn
Associate Director
+1-312-368-2075
Fitch Ratings, Inc.
70 West Madison St
Chicago, IL, 60602
or
Secondary Analyst
Debora Jalles
Director
+1-312-606-2338
or
Committee Chairperson
Joe Bormann, CFA
Managing Director
+1-312-368-3349
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com