Tuesday, October 20, 2009

Vale; What to Do?

Vale, the Brazilian mining conglomerate, is the first stock that reached or 30% share profit decision moment. Vale is the second-largest mining firm in the world. It is also the largest producer of iron ore, pellets, and the second largest producer of nickel. The company also produces manganese, ferroalloys, copper, bauxite, potash, kaolin, alumina and aluminum. Vale is also active in the electricity sector, participating in various consortia on the one hand, while operating nine hydroelectric plants as well.

The firm was founded in 1942 as a public entity by the Brazilian government. Within 10 years after its foundation it was already responsible for about 80 percent of Brazilian exports of iron ore. By 1974 Vale became the world's biggest exporter of iron ore. They maintained this position until today.

The stock had a tremendous run with a return of 32.6% in 7 weeks. At the current price of 45.01 and a 2010 consensus earnings per share estimate of 2.65 we can derive a prospective P/E of 17.0. Not really that low anymore, on the other hand it is clear that the Metals and Mining sector will benefit when markets and economies recover in 2010. But we shouldn't forget that the firm went up by 85 percent already over the last 52 weeks. The good performance over the last 7 weeks was part of this longer trend.

We did therefore decide to take profit and sell Vale in the model portfolio that incorporated the stock (MORFAV). Question is then: what to buy?

We went back to the top-10 holdings of Morningstar's Favorite EM managers that we also selected to derive the initial portfolio. We updated the top-10 lists and the idea was to either replace Vale by the 'best' non-selected holding in the combined top-10 list or when we don't like the asset allocation aspect (leaving Brazil for 50 percent with only Bovespa left for this other country), allocate 50 percent to this firm and add the other 50 percent to Bovespa or a Brazilian alternative. The latter is an important alternative, because Bovespa had a tremendous run as well and is also close to its 30-percent increase decision moment.

The favorite stock of the 10 best Morningstar Emerging Markets managers at the moment is Petroleo Brasileiro or Petrobras. Petrobras is already part of our EM Winner portfolio with a total return of 22.25% since incorporation per August 28, 2009. There is still upside potential, and we feel more comfortable with an oil-gas provider at the moment than with a mining firm with prospective PE of 17.0. We will therefore replace one Brazilian stock by the other.

Therefore; in the MORFAV portfolio

SELL: Vale (BRA)
BUY: Petrobras (BRA)

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