Markets are sensitive to any news. Investors have a great opportunity to get into quality stocks through knee-jerk reactions.

Vale (VALE stock) seems to be the victim of overreaction from markets. VALE stock hit a high of $23.18 in June. VALE stock dropped 38% since then. (See Insiders’ Hot Stocks on TipRanks)

The fundamental elements that have been the catalysts for change are: There were concerns about a spillover of the Evergrande (EGRNF), crisis. China also announced a cut in steel production, which translated to a sharp correction of iron ore.

Despite these considerations, VALE stock appears undervalued. To put things into perspective, the stock trades at a price-to-earnings-ratio of 4.2. It is clear that the selling has been excessive. I am bullish on VALE stock for a reversal as the company’s fundamentals remain strong.

Healthy Cash is a Sustainer

In Q2 2021, Vale was able to benefit from the rise in iron ore price. Company reported record quarterly adjusted EBITDA at $11.2 billion and $6.5 billion in free cash flows.

The recent correction in iron ore prices will impact the company’s free cash flows.

According to Chris LaFemina, a Jefferies analyst (NYSE:), a metric iron price of $86.37 per ton would result in a P/E of 10 and a 10% free cash flow for the major iron ore producers.

Vale remains well-positioned to generate strong cash flow with iron ore trade at $118 per unit.

Vale also has negative net debt with an overall cash buffer of $14.6 million. Dividends are sustainable with an improving credit score.

Vale also has iron ore expansion plans. The company anticipates a capacity of 343 million tonnes per year (mtps) for the next year. The company anticipates that the capacity will increase to 400 mtpa by 2022. Even if iron ore costs remain stable, Vale has the potential to generate incremental cash flow in the next year.

Wall Street’s Take

According to TipRanks’ analyst rating consensus, VALE stock comes in as a Moderate Buy, with five Buys, four Holds, and one Sell assigned in the past three months.

Average VALE price target of $20.43 per Share, which translates into 42.5% upside potential compared to current levels.

Bottom line

Vale will also see increased growth from its base metals projects, which could lead to cash flow and additional revenue. Particularly, Vale is positive about nickel’s prospects.

While EV adoption is increasing worldwide, batteries with high nickel levels will help ensure that there’s a steady supply of nickel. The company’s Reid Brook and Eastern Deeps projects are likely to reach annual production rates of 40,000 tons of nickel concentrate by 2025.

Vale’s financial performance has been strong and there are growth investments in the future. It gives clear visibility to higher cash flows and ensures that shareholders continue to receive dividends and stock repurchases.

Disclosure: Faisal Humayun had no position at the publication of this article in any securities.

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