At the start of my Real Money Portfolio, I want to address a few key points. I knew that my first pick had to be a company that could be the cornerstone of my portfolio and generate income through dividend payments along with the potential for growth in share price. Global diversification is also a key tenet that I have my eye on. The final criterion that I want to build around is value. When screening for these qualities, Vale SA (ADR) (NYSE:VALE) leapt out at me.
So, why Vale SA (ADR) (NYSE:VALE) and not its larger peers like BHP Billiton Limited (ADR) (NYSE:BHP) or Rio Tinto plc (ADR) (NYSE:RIO)? Well, the biggest reason is that I plan on weighting my portfolio toward energy, at least to a higher degree than the weighting of the S&P 500, and I feel that there are better options out there than the exposure BHP Billiton Limited (ADR) (NYSE:BHP) brings to the table. As far as Rio Tinto plc (ADR) (NYSE:RIO) is concerned, its valuation comes in a bit more highly priced than Vale SA (ADR) (NYSE:VALE) to the point where I eliminated it from consideration. Focusing solely on Vale SA (ADR) (NYSE:VALE), I believe strongly in the fertilizer market’s long-term prospects, and Vale’s growing business here is a welcome diversifier. Now, onto more Vale-specific arguments…
Those winds of change are tailwinds
To cope with soft demand and pricing markets, Vale has chosen to address its cost structure. Boy has it ever: In the firm’s latest quarterly release, its EBITDA margin approached 28%, far exceeding the previous quarter’s 10% mark. Not only was management able to lower its overhead expenses, but costs of goods sold dropped dramatically as well. With these changes expected to be maintained for the long term, investors will likely be handsomely rewarded now that the company casts a wider net from the top to bottom lines. Tie this into the company’s operational strategies to reduce the need for higher capital expenditures, and an already strong cash cow should be able to expand its free cash flow margin even further without sacrificing its ability to meet increased product demand once that corner is finally turned.
Strength in numbers
Through this downturn in the iron and coal markets, Vale has been able to maintain a rock solid balance sheet that should only improve once global markets get their acts together. While the debt level compared to EBITDA has crept up in recent quarters, I believe that the latest margin expansion should quell some investor concern. Another reason to wipe any sweat from your brow is the company’s current ratio (current assets – current liabilities) which stood at two times during the first quarter of 2013. So clearly, near-term solvency is not an issue.
Turning to arguably the most important financial statement – the statement of cash flows – I was quick to notice that Vale’s cash generated by its operations had proven ample enough to cover its dividend payments and a significant portion of its capital expenditures for four of the past five years (I’m sure we can all forgive them for a dip in performance in 2009). For the remainder, debt has been issued but only to the tune of 30% of its total capital. For even great comfort, only 23% is due within the next five years.
Money where my mouth is
Based on this analysis, along with more that didn’t make it into this article, I have chosen Vale S.A. to begin my Motley Fool Real Money Portfolio. Value, diversification, income generation, financial strength, and personal opinion about market dynamics have all led me to this point. In hopes of beating the S&P 500, along with a friendly competition among fellow Real Money Portfolio managers, I believe this pick will prove more than worthwhile over the long term.
Fool on!
The article Positives Continue to Outweigh Negatives With This Value Play originally appeared on Fool.com.
Taylor Muckerman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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