Vale’s Gold Stream Transaction with Silver Wheaton Is Credit Positive
On Tuesday, Vale S.A. (Ba3 negative) announced that it had entered into a gold stream transaction with Silver Wheaton (Caymans) Ltd. (unrated), a wholly owned subsidiary of Silver Wheaton Corp. (unrated), to sell an additional 25% interest of the gold extracted as a by-product during the estimated 50-year life of the Salobo copper mine in Brazil. Vale will receive an $800 million upfront payment, plus $400 per ounce, or the prevailing market price, whichever is lower, for gold delivered from the mine. The transaction is credit positive for Vale because the company plans to use the proceeds to repay debt. We view this streaming transaction as a forward sale of future production, and although it will reduce future cash flow generation, it provides immediate liquidity to Vale, which is a more important credit driver in the current environment. Pro forma for this transaction, Vale’s adjusted gross leverage will decline slightly to 4.9x from 5.0x for the 12 months that ended June 2016. Furthermore, the deal improves the company’s liquidity at a time when capital expenditures remain high at about $5.8 billion for 2016. Despite the transaction’s benefits, Vale is not likely to see a material improvement in its margins, cash flows and debt protection metrics until the completion later this year of its S11D mining project. The project will add 90 million tons of lower-cost, higher-quality iron ore capacity, and should accelerate deleveraging beginning in 2017. The gold stream transaction with Silver Wheaton is an add-on to the contract signed in February 2013, and upsized in March 2015, which collectively pledges the sale of 50% of the Salobo gold production to Silver Wheaton (Caymans). Vale received upfront payments of $1.3 billion in 2013, when gold prices were close to $1,700 per ounce, and $900 million in 2015, when the price of gold was $1,200 per ounce. But under the latest agreement, Vale will receive an upfront payment that is $100 million less than in 2015, even though the price of gold has since improved to about $1,350 per ounce. To compensate for the lower upfront payment, the new agreement reduces the strike price of 10 million warrants in Silver Wheaton Corp. held by Vale, which increased the warrants’ value by $23 million. Nevertheless, the increase in the options’ value does not constitute immediately available liquidity for Vale. In all three transactions, the production risk lies with Silver Wheaton – that is, there is no firm commitment from Vale to deliver production, and Vale still gets the upside of additional production after the ramp-up of Salobo I and II. If Salobo processing capacity is expanded within a predetermined period, Vale will receive an additional amount that could range between $113 million and $953 million. We view such features as additional credit positives for Vale. With the new agreement, Silver Wheaton (Caymans) is now entitled to 75% of the gold production at Salobo. For the 12 months that ended June 2016, Vale’s total gold production reached 444,000 ounces, with Salobo accounting for roughly 65% of the total. Vale continues to adjust its operations and resize its asset portfolio in a challenging business environment, but the timing and magnitude of asset sales remain uncertain. Asset sales and additional liquidity transactions, which Vale expects will reach $4-$5 billion in 2016 and potentially $10 billion in 2017, are key to addressing the company’s high leverage of 5.0x total adjusted debt/EBITDA for the 12 months that ended June 2016. Furthermore, there are still uncertainties regarding the level of support that Vale could provide to Samarco Mineração S.A. (C no outlook)1 and the effect that additional lawsuits against Samarco in connection with a dam accident in November 2015, will have on the company’s liquidity
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