VALE vs. BHP: A Strategic Long-Short Play on Iron Ore & Valuation Gaps

Hi everyone,

Today we are focusing on Vale S.A. (VALE) and BHP Group Ltd. (BHP).
We are initiating a long position in Vale S.A. (NYSE: VALE) and a short position in BHP Group Ltd. (NYSE: BHP), capitalizing on relative valuation inefficiencies, structural tailwinds for Vale, and potential headwinds for BHP.

This long VALE short BHP trade provides a risk-adjusted opportunity to generate alpha in the global mining sector. Vale’s attractive valuation, high-quality iron ore, and improved governance position it as a superior investment, while BHP’s stretched valuation, cost pressures, and weaker commodity mix present downside risk.

Vale (VALE)

Vale S.A. (VALE) is a Brazilian multinational mining company and one of the world’s largest producers of iron ore and nickel. It benefits from high-grade iron ore that commands a price premium, making it a key supplier to the global steel industry, especially in China.

Undervalued Relative to Peers

Vale currently trades at a compelling valuation compared to its global mining peers, with a P/E of 5.15x, that is less than half of BHP’s 11.45x, signaling deep undervaluation relative to earnings.
 VALE’s lower Revenue/EV ratio (1.47x vs. 2.65x) implies greater potential upside if iron ore prices rise, as incremental revenue disproportionately boosts equity value.
 The 14% dividend yield (vs. BHP’s 5%) suggests aggressive capital returns, though sustainability depends on iron ore prices and cash flow stability.

Stronger Iron Ore Exposure & High-Quality Product

Vale’s iron ore portfolio is among the highest quality globally, with its premium-grade 65% Fe fines commanding a price premium over BHP’s lower-grade 62% Fe iron ore. Demand for higher-grade iron ore continues to grow due to steelmakers seeking to reduce emissions and optimize blast furnace efficiency.

Currency Tailwinds

A weaker Brazilian real (BRL) reduces VALE’s USD-denominated production costs, enhancing profitability. Conversely, a stronger Australian dollar (AUD) pressures BHP’s margins.

VALE obtains 81.6% of revenue from iron ore, with China accounting for 51.6% of sales. As China prioritizes infrastructure spending to counter economic headwinds, steel demand (and iron ore) is poised to rebound sharply.

BHP Group (BHP)

BHP Group Ltd. (BHP) is an Australian multinational mining company with a diversified portfolio including iron ore, copper, nickel, and metallurgical coal. While diversification can be advantageous, BHP faces challenges such as declining ore grades, cost inflation, and regulatory risks.

Overvaluation & Peak Earnings Risk

BHP trades at a premium valuation relative to Vale and other diversified miners, despite facing earnings headwinds. With iron ore prices stabilizing and potential margin compression in its copper and nickel businesses, BHP’s earnings power may be peaking.

Weaker Commodity Mix & Declining Ore Grades

BHP has a more diversified commodity mix, including significant exposure to lowerquality iron ore and metallurgical coal. While diversification can be a strength, it can also weaken BHP’s ability to capitalize on high-margin iron ore sales

Cost Pressures & Capex Concerns

BHP is facing rising cost pressures across its mining operations, particularly in Australia, where labor shortages and inflationary pressures are pushing up operational expenses.

BHP is more diversified, with iron ore representing 50.2% of revenue, copper 33.4%, and coal with 13.8%. While copper benefits from green energy transitions, nearterm Chinese recovery is steel-intensive, favoring iron ore-centric players like VALE.

China’s Recovery: Iron Ore Demand Surge

China's economic performance significantly influences both companies, given its substantial demand for commodities.

VALE: As a major iron ore producer, VALE is poised to benefit from any uptick in China's steel production resulting from economic stimulus measures. The recent increase in iron ore futures, driven by strong steel consumption data from China, suggests a favorable environment for VALE.

BHP: Recently reported a 23% decline in profits, primarily due to reduced iron ore prices amid China's slowing economy and property market downturn. However, BHP's CEO, Mike Henry, has noted early signs of recovery in China, particularly in the real estate sector, which could positively impact demand for steel and copper.

The graph illustrates China's M1 money supply (in CNY billions) from 2016 to 2025, reflecting the total liquid money in the economy, including physical currency and demand deposits (e.g., checking accounts). The economic impacts are the Boosted Spending & Investment with higher M1 increases liquidity, encouraging consumer spending and business investment, driving GDP growth. Lower Borrowing Costs with increased money supply can reduce short-term interest rates, making loans cheaper for households and firms.

https://www.reuters.com/markets/commodities/iron-ore-gains-strong-chinasteel-consumption-short-covering-2025-02-20/?utm_source=chatgpt.com

Risks to the Long-Short

• China’s Recovery Delays: Weak household spending or delayed stimulus could suppress steel demand.
• Commodity Price Volatility: A downturn in iron ore prices (e.g., due to global recession) would hurt VALE disproportionately.
• BHP’s Copper Hedge: Rising copper prices (from green energy demand) could offset BHP’s iron ore underperformance.

Conclusion

VALE’s leverage to iron ore, coupled with China’s infrastructure-led recovery and attractive valuation, positions it to outperform BHP. Shorting BHP hedges against broader commodity volatility while capitalizing on its relative overexposure to noniron ore sectors. This pairs trade offers asymmetric upside, with iron ore prices as the primary catalyst.

Unusual Options Activity

Both VALE and BHP are exhibiting unusual options activity, with a notable skew toward bearish sentiment driven by increased put option volume. In VALE, significant spikes in unusual options activity occurred in November and December, while BHP saw a major surge in January. This heightened put volume suggests that market participants may be anticipating a decline in stock prices, engaging in institutional hedging to mitigate downside risk, or speculating on potential negative catalysts such as earnings reports, geopolitical uncertainties, or broader industry challenges. This bearish flow in both stocks is hedged as part of our longshort strategy.

Long/Short Position

The current deviation of this long/short strategy stands at -15.04%. As of this writing, VALE is trading at $9.63, while BHP is at $49.36. The position sizing follows a customized 10:10 ratio, given the similar implied volatility (IV). However, due to recent earnings, VALE's IV is slightly elevated. The strategy allocates a long position of 95.42 shares in VALE ($948.47) and a short position of 25.20 shares in BHP ($1,274.36).