Labrador Iron Ore Royalty Corporation (TSX: LIF) is a Canadian corporation. The company generates all of its revenue from its equity investment in Iron Ore Company of Canada, (IOC) and its IOC royalty and commission interests. IOC operates a major iron mine near Labrador City, Newfoundland, and Labrador on lands leased from LIORC. Directly and through its wholly-owned subsidiary, Hollinger-Hanna, LIORC owns an equity interest in IOC and receives gross overriding royalty on all iron ore products produced from the leased lands that are sold and shipped by IOC and commission on IOC's sales of iron ore. IOC is a Canadian producer of iron ore pellets and concentrate, serving customers worldwide.          

Investment Rationale

• An Income Play: The company has an excellent track record of dividend payment across economic cycles. LIF pays cash dividends to the maximum extent possible, subject to the maintenance of appropriate levels of working capital. For the first half of FY20, the company paid dividend amounting to CAD 0.80 per equity share versus an adjusted cash flow per share of CAD 0.82, which is encouraging from the income investor’s point of view. Meanwhile, cumulative standardized cash flow of the company since inception stood at CAD 31.73 per share, while cash distributions since the formation of the company stood at CAD 31.14 per share, reflecting a payout ratio of ~98%. At the last closing price, the stock was offering a dividend yield of ~4.131%, which is lucrative amid the low interest rate environment.                

                

Dividend Payment History from FY11 to FY20 (Source: Refinitiv, Thomson Reuters)

• Stable Royalty Income: The company derived its majority of revenue from royalty income, as LIORC’s Royalty structure allows continuous cashflows across economic cycles, which is a key positive. With IOC’s long mine life and LIF’s recent renewal of its mining leases for next thirty-years, the Management is optimistic of delivering positive cash flows for the future. LIF holds a 15.10% equity interest in Iron Ore Company of Canada (IOC), through its wholly owned subsidiary, Hollinger-Hanna. IOC has operated for more than 50 years without a shut amidst tepid market conditions and several economic cycles. 

• Strong Fundamentals: Revenue increased to CAD 178.3 million in FY19, from CAD 115.1 million in FY16, driven by production growth through proper implementing integrated operating model and prioritizing on proficient Asset Management. Net income per share stood higher at CAD 3.21 per share, improved drastically from CAD 1.22 per share in FY16.

Financial Highlights from FY16 to FY19 (Source: Company Presentation)

• Debt Free Balance Sheet: The company is virtually debt-free, which is a big advantage, looking at the price cyclicality of iron ore. The business does not have the burden of paying finance expense, which would support the company’s cash flows and profitability.

• Solid Margin Profile: The company maintained a strong margin profile over the years. The company maintained a gross margin above 80% over the last ten years. Furthermore, the group maintained an EBITDA Margin above 75% and Operating Margin above 70% at the same time.

Source: Refinitiv (Thomson Reuters), Kalkine Group

• Quarterly Result Outperformed the Industry: The company reported a decent quarterly result and outperformed the industry on various parameters which are reflected in the following chart.

Source: Refinitiv (Thomson Reuters), Kalkine Group

• Stable Cash Flow over the years: Irrespective to the industry cycles and price fluctuations in the iron ore prices, the company-maintained a superior cash flow level over the years (2011 to 2019), which is commendable. However, due to a plunge in recent iron ore prices, the group reported a lower cash flow from operations for Q2FY20 at CAD 37.6 million, as compared to CAD 47.8 million for Q2FY19. With the improved realized prices, higher operational efficiencies coupled with dividend income from IOC, we believe the company is well poised to deliver strong cash flow in the long term.                        

                         

Historical Cash-flow Trend (Source: Company Presentations)

• Improved Iron & Steel Outlook: The long-term outlook of the iron and steel remains bright, with strong demand from China, which is likely to support the future commodity prices as well. During the first half of the FY20, China imported 547 million tonnes of iron ore, 9.6% higher than the previous corresponding period (pcp). As per the guidance, IOC’s FY20 saleable production of CFS and pellets is likely to be in the range of 17.9 and 20.4 million tonnes, at par with 19 million tonnes in FY19, looks impressive amidst the current economic jolt. Furthermore, the steel prices are expected to improve due to a demand-supply mismatch on account of supply constraints from Brazil. In such an uncertain economic environment, IOC’s ability to enhance its production mix, in order to meet the changing market demands is a clear advantage for the business. 

• Risk Associated with Investment: The company’s revenue is correlated to the demand and prices of iron ore. Any event which may impact the demand or price of iron ore is likely to affect the group’s performance adversely.

Recent Highlights

The company reported Q3FY20 total saleable iron ore production of 3.99 million tonnes, including 2.22 million tonnes of pellets and 1.77 million tonnes of concentrate for sale (CFS).  IOC’s total iron ore sales during the same period stood at 4.65 million tonnes, comprised of 2.35 million tonnes of pellets and 2.31 million tonnes of CFS. 

Q2FY20 Operational Highlights:

• The company posted an impressive production of total concentrate of 4.8 million tonnes in Q2FY20, reflecting a growth of 7% on y-o-y basis and 3% increase from Q1FY20. Meanwhile, total saleable production (CFS plus pellets) stood at 4.7 million tonnes, up 9% over the pcp. During the period, IOC optimized its product mix to match market demand, by suspending two pellet machines from operation in order to increase the production of CFS.
• CFS production stood at 2.6 million tonnes, grew 28% on y-o-y basis and 65% from the previous quarter. Pellet production saw a 7% y-o-y decline at 2.1 million tonnes.
• LIF posted a revenue of CAD 46.712 million, lower than CAD 53.304 million recorded in Q2FY19, due to lower iron ore prices, which subsequently lead to a lower IOC royalty.
• Net income stood at CAD 48.858 million, as compared to CAD 61.100 million in Q2FY19.
• The corporation reported cash and short-term investments of CAD 36.526 million, while total assets were recorded at CAD 762.236 million.
• Cash flow from operations for the first half of FY20 stood significantly lower at CAD 48.3 million, as compared to CAD 72.8 million in pcp.                               

                              

Q2FY20 Financial Highlights (Source: Company Reports)

Top 10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 14.78% of the total shareholding. Mackenzie Financial Corporation and RBC Global Asset Management Inc. hold maximum interests in the company at 2.8% and 2.17%, respectively.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation:  The stock of LIF gained ~24% and ~12% in the last six-months and one-year, respectively, amid volatility in the equity market. The revenue of the group is directly co-related with the international prices of iron ore and the recent surge in commodity prices has resulted in positive investor’s sentiment on the stock. We expect the iron ore prices to remain elevated on account of an increase in demand from China, followed by supply constraints. LIORC’s Royalty structure allows it to continue to receive cash flows regardless of the economic environment as IOC has operated for over 50 years without a shut down due to market conditions. With IOC’s long mine life and LIORC’s recent renewal of its mining leases for another 30 years, shareholders can expect cash flows to continue well into the future. Further, the group has solid fundamentals and maintained a solid margin profile over the years. The stock is offering a lucrative dividend yield amid a low-interest-rate environment, which is encouraging from an income investor’s point of view. We have valued the stock using EV to EBITDA based relative valuation method and have arrived at a target upside of lower double-digit (in percentage terms). For the said purposes, we have considered Teck Resources Ltd, Champion Iron Ltd and Stelco Holdings , etc., as a peer group. Hence, we recommend a ‘Buy’ rating on the stock at the current market price of CAD 24.21 on October 29, 2020.

LIF Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

* Recommendation is valid at October 30, 2020 price as well.

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Disclaimer

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