Bloomberg News

Vale Bonds Trail BHP, Rio as Higher Taxes Loom: Brazil Credit

September 13, 2011

Sept. 13 (Bloomberg) -- Vale SA’s borrowing costs rose to a record yesterday relative to BHP Billiton Ltd. as Brazil seeks to increase mining taxes amid surging metals prices.

The world’s largest iron-ore mining company’s dollar bonds due in 2019 yielded 4.22 percent, a record 152 basis points more than similar-maturity bonds from higher-rated BHP. The yield gap has swelled 61 basis points, or 0.61 percentage point, this year. The spread over Rio Tinto Group bonds reached 84 basis points yesterday after averaging 51 points in the first seven months of 2011.

Vale’s bonds have fallen on concern Brazil is seeking to tighten its grip over mining after boosting control of the oil industry last year. The Rio de Janeiro-based company, whose former Chief Executive Officer Roger Agnelli was replaced in May amid government criticism, faces a higher tax bill as President Dilma Rousseff prepares to send Congress new mining rules this month. Vale accounts for 12 percent of Brazil’s exports.

“Prices of all these commodities are through the roof, and governments want to make sure everyone benefits from that,” Edgardo Sternberg, an emerging-market debt strategist at Loomis Sayles & Co., said by telephone from Boston. “Investors never like taxes on their companies as they detract from profitability. Bond investors look at that and get concerned.”

Royalties

Brazil’s government aims to double mining royalties to 4 percent as part of new rules for the industry, Mines and Energy Minister Edison Lobao told reporters in Brasilia on Sept. 6.

“The project is already in the final phase of analysis at the Presidential Palace to send to Congress,” Lobao said.

Vale, the world’s second-largest mining company by market value after BHP, reported a record profit of $17.3 billion last year. Iron-ore prices have more than doubled in the past two years on growing demand from China, the world’s biggest consumer of the steel-making raw material.

In 2010, Brazil approved new oil industry regulations that raised the government’s stake in Petroleo Brasileiro SA and made the state-controlled oil producer the sole operator of deepwater fields in the so-called pre-salt region, home to the Americas’ largest oil discovery in more than three decades.

‘Headquarter Malaise’

“Vale’s bonds suffer from ‘headquarters malaise,’ as they trade wider than similar credits headquartered in other, developed market countries,” Robert Schmieder, an HSBC Holdings Plc analyst in New York, wrote in a note to clients yesterday. “The government has been pressuring Vale to make more investments in Brazil, investments that are not necessarily core for the company.”

Vale’s dollar bonds due in 2019 returned 1.3 percent since the company said July 28 it would pay the government $3.8 billion related to another tax dispute. Similar-maturity bonds of bigger rival BHP have gained 4.2 percent in the same period, while Rio Tinto debt advanced 2.9 percent. BHP’s notes yield 2.7 percent, while Rio’s securities yield 3.38 percent according to data compiled by Bloomberg.

Vale still has two continuing disputes with the government over 34.6 billion reais ($20.3 billion) in taxes and royalties, according to an April 28 filing with the U.S. Securities and Exchange Commission.

Murilo Ferreira replaced Agnelli as CEO after the Brazilian government criticized the company over the past two years for not spending more on domestic steel projects and for buying ships in China when the country was setting up its own yards.

Bond Rally

Vale’s strong earnings results may ease investor concerns and prompt a credit-rating upgrade from Moody’s Investors Service, which could trigger a bond rally, said Schmieder, who has an “overweight” recommendation on the bonds.

A Vale official who asked not to be identified citing corporate policy said the company had no comment. BHP spokesman Ruban Yogarajah and Rio Tinto press official Tony Shaffer, both of whom are based in London, declined to comment. The Mining Ministry’s press office also had no comment.

The cost of protecting Vale bonds against default for five years jumped 45 basis points this year to 176, CMA prices show. Vale had net debt of $11.2 billion on June 30. The spread above BHP default-swap contracts widened to the most in more than a year on Aug. 30.

Vale Rating

Vale is rated BBB+ by Standard & Poor’s, the third-lowest investment grade. London-based Rio Tinto’s A- and Melbourne- based BHP’s A+ ratings are one and three steps higher, respectively.

The cost of protecting Brazilian bonds against default climbed five basis points yesterday to 173, according to CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell seven basis points to 228 at 11:56 a.m. New York time, according to JPMorgan Chase & Co.

The yield on the overnight interest-rate futures contract due in January 2012 fell one basis point to 11.33 percent.

The real weakened 0.7 percent to 1.7144 per dollar.

The drop in Vale’s bonds compared with its peers creates an opportunity for investors that are looking for returns, said Rodrigo Covian, head of fixed-income trading at Bulltick Capital Markets.

“The company’s fundamentals didn’t change and I expect investors to come back as the fall in yields of U.S. Treasuries has made spreads for Vale’s bonds much more compelling,” he said in a telephone interview from Miami. “The recent volatility in Brazilian securities has affected the confidence of some investors, particularly those based in the U.S.”

--With assistance from Gabrielle Coppola in Sao Paulo. Editors: Jessica Brice, Glenn J. Kalinoski

To contact the reporter on this story: Juan Pablo Spinetto in London at jspinetto@bloomberg.net; Boris Korby in New York at bkorby1@bloomberg.net.

To contact the editors responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net; Dale Crofts at dcrofts@bloomberg.net


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