Desjardins
MARCH 22, 2012
Capital Markets
Research Iron ore Labrador Trough—Canada’s iron rush: Initiating coverage of five Canadian iron ore companies and transferring coverage of Alderon
We are initiating coverage of five Canadian iron ore companies with operations or assets located in the Labrador Trough and transferring coverage of Alderon We believe the iron ore market will remain tight in the near term as urbanization and infrastructure growth in developing economies continue to be strong; however, we see a risk of long-term oversupply as anticipated new iron ore supply could outpace demand growth Our Top Pick is Labrador Iron Mines Holdings Limited Highlights. We are initiating coverage of five Canadian pure-play iron ore equities: Adriana Resources Inc., Champion Minerals Inc., Labrador Iron Ore Royalty Corporation, Labrador Iron Mines Holdings Limited and New Millennium Iron Corp. We are also transferring coverage of Alderon Iron Ore Corp. Valuation. Our recommendations and target prices are primarily based on our net asset value (NAV) estimates. We believe that a NAV based on discounted cash flows is the best metric for assessing the relative value of companies, especially where a company’s value is largely associated with non-producing assets. We have applied target multiples to our NAV estimates on an asset-by-asset basis to reflect the relative risk associated with project start-up. Valuation multiples range from 0.3x for speculative, very early-stage assets such as Adriana Resources’ Lac Otelnuk and New Millennium’s KéMag and LabMag taconite deposits, to 0.8x for start-up producer Labrador Iron Mines’ DSO project. The exception to our NAV-based relative valuation approach is the hybrid valuation we apply to Labrador Iron Ore Royalty Corporation. We believe that a hybrid P/CF and P/NAV approach is appropriate as it places greater emphasis on the near-term distributions paid to unitholders. Recommendation. Our recommendations are based on the expected one-year return to shareholders, balanced by the risk to our target price (including risk of capital cost overruns, delays in permitting and construction, and a company’s ability to secure financing). We also consider the time period before positive cash flows are expected. Our Top Pick is Labrador Iron Mines with an C$8.50/share one-year target price, and we have a Buy–Speculative rating on Adriana Resources and Champion Minerals. Iron ore equities coverage universe Price Mar-16 (C$) Adriana Resources Inc. Alderon Iron Ore Corp. Champion Minerals Inc. Labrador Iron Ore Royalty Corporation Labrador Iron Mines Holdings Limited New Millennium Iron Corp. Average
1.06 3.09 1.68 36.00 5.00 2.44
Rating Buy–Speculative Hold–Speculative Buy–Speculative Hold–Average Risk Top Pick–Above-average Risk Hold–Speculative
1-yr target (C$)
Expected return (%)
Mkt cap (C$m)
P/NAV (x)
1.75 4.00 3.00 43.50 8.50 3.50
65 29 79 24 70 43 52
157 311 182 2,289 331 414
0.35 0.46 0.39 0.64 0.47 0.22 0.42
Source: Desjardins Capital Markets, Capital IQ
Jackie Przybylowski, P.Eng. (416) 607-3092 jackie.przybylowski@ vmd.desjardins.com
This report was prepared by an analyst(s) employed by Desjardins Capital Markets and who is (are) not registered as a research analyst(s) under FINRA rules. Please see disclosure section on pages 62–63 for company specific disclosures, analyst certification and legal disclaimers.
Desjardins Capital Markets
Iron ore
PAGE 2 MARCH 22, 2012
Table of contents
Jackie Przybylowski, P.Eng.
4
Executive summary
6
Focus on Canadian equities 8 Transportation challenges
11
Valuation
12
Sensitivity
14
Adriana Resources Inc.: Huge project, huge risk 15 Company overview 15 Anticipated catalysts 15 Lac Otelnuk—huge project, huge risk 18 No value attributed to non-core assets 18 December Lake 18 Brazore 18 Capital structure 19 Valuation 20 Recommendation 20 Risks 21 Key management and directors
22
Alderon Iron Ore Corp.: Closest to infrastructure and mature mines 23 Company overview 24 Anticipated catalysts 24 Kami—closest to infrastructure and mature mines 26 Capital structure 27 Valuation 27 Recommendation 28 Risks 28 Key management and directors
30
Champion Minerals Inc.: Portfolio of prospective assets in a mature region 31 Company overview 32 Anticipated catalysts 32 Portfolio of prospective assets in a mature region 34 Capital structure 34 Valuation 35 Recommendation 35 Risks 36 Key management and directors
37
Labrador Iron Ore Royalty Corporation: Unique opportunity for income while still exposed to iron ore prices 38 Company overview 38 Anticipated catalysts 39 Carol Lake 40 Capital structure 41 Valuation 42 Recommendation 42 Risks 43 Key management and directors
Desjardins Capital Markets
Iron ore
PAGE 3 MARCH 22, 2012
Jackie Przybylowski, P.Eng.
44
Labrador Iron Mines Holdings Limited: Keeping it simple 45 Company overview 45 Anticipated catalysts 46 Keep it simple—direct shipping ore 48 Logistics 49 Other assets—blue-sky potential 49 Capital structure 50 Valuation 50 Recommendation 51 Risks 51 Key management and directors
53
New Millennium Iron Corp.: World-class mine developer or just along for the ride? 54 Company overview 55 Anticipated catalysts 55 Direct shipping ore 57 Taconite projects 58 Exploration targets 58 Capital structure 59 Valuation 59 Recommendation 60 Risks 60 Key management and directors
Desjardins
Iron ore
Capital Markets
PAGE 4 MARCH 22, 2012
Executive summary
We are initiating coverage of five Canadian pure-play iron ore equities: Adriana Resources Inc. (ADI, TSX-V), Champion Minerals Inc. (CHM, TSX), Labrador Iron Ore Royalty Corporation (LIF.UN, TSX), Labrador Iron Mines Holdings Limited (LIM, TSX) and New Millennium Iron Corp. (NML, TSX). We are also transferring coverage of Alderon Iron Ore Corp. (ADV, TSX). Our Top Pick is Labrador Iron Mines based on its attractive potential return to our one-year target price of C$8.50/share, the company’s significant potential growth in the near term and comparatively low risk associated with its ability to execute its future expansion plans. Our recommendations and estimates are summarized in Exhibit 1. Exhibit 1: Iron ore equities coverage universe Price Mar-16 (C$)
1-yr target (C$)
Rating
Expected return (%)
Mkt cap (C$m)
P/NAV (x)
Adriana Resources Inc.
1.06
Buy–Speculative
1.75
65
157
0.35
Alderon Iron Ore Corp.
3.09
Hold–Speculative
4.00
29
311
0.46
Champion Minerals Inc.
1.68
Buy–Speculative
3.00
79
182
0.39
Labrador Iron Ore Royalty Corporation
36.00
43.50
24
2,289
0.64
Labrador Iron Mines Holdings Limited
5.00
Hold–Average Risk Top Pick–Above-average Risk
8.50
70
331
0.47
New Millennium Iron Corp.
2.44
Hold–Speculative
3.50
43
414
Average
52
0.22 0.42
Source: Desjardins Capital Markets, Capital IQ
We expect the iron ore market to be in balance in the near term. Demand for iron ore should continue to be strong as urbanization in developing economies drives steel consumption. Iron ore supplies are relatively fixed in the near term as mine operations are already running at or near capacity. However, in the longer term, we see a risk of oversupply as the number of expansions and new projects threatens to outpace demand growth. We expect iron ore benchmark fines prices to average US$137/t fob (63.5% Fe) through 2012 and US$95/t fob (63.5% Fe) in the long term. In the short term, we forecast that a supply-demand balance will continue, as strong consumption in China keeps the market tight. However, increasing supplies should cause prices to ease over the longer term. See Exhibit 2 for a summary of our commodity and currency assumptions. Exhibit 2: Desjardins commodity price assumptions (US$/t)
2009
2010
2011
2012E
2013E
Iron ore, fines (63.5% Fe), fob
69
134
168
137
129
95
Iron ore, lump (63.5% Fe), fob
85
154
192
158
151
116
Iron ore, pellet (63.5% Fe), fob US$/C$
Long-term
93
144
205
165
155
116
0.91
0.98
1.09
1.00
1.00
1.00
Source: Desjardins Capital Markets, AME Mineral Economics
Growth in emerging economies such as China and India, where infrastructure is generally in the earlier stages of development, has a significant impact on our steel consumption outlook. We believe the urbanization of developing economies, together with a gradual economic recovery in the western world, will enable raw steel demand—and hence iron ore demand—to continue to grow at a steady pace in the foreseeable future. In 2012, we forecast that global crude steel production should grow by 3.8% to 1.6Bt, down from growth of 5.9% in 2011. By 2016, we forecast that global crude steel production will have reached nearly 1.9Bt. Chinese steel production alone accounted for 65% of global steel production in 2011 and we expect the country’s rapid growth will continue to outpace growth in the developed world. We believe the Chinese government will follow its current five-year plan with regard to infrastructure growth, construction of affordable housing and the development of new industries.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Iron ore
PAGE 5 MARCH 22, 2012
Exhibit 3: Global crude steel production is expected to reach 1.9Mtpa by 2016
Source: AME Mineral Economics
Under China’s 12th Five-Year Plan (2011–15), Beijing aims to grow GDP by 7% per year. The government plans to construct 36m low-income dwellings, increase the country’s rail network to 120,000km and its highway network to 100,000km by 2020 (from 86,000km and 65,000km, respectively, in 2009), urbanize China’s western region and develop seven priority industries (new materials, high-end manufacturing, new IT, biotechnology, environmental protection, renewable power and clean energy vehicles). In the long term, we see a risk of oversupply in the iron ore market as the number of expansions and new projects threatens to outpace demand growth. At the same time, we expect the rate of iron ore demand growth to slow as developing economies mature. We highlight the risk of oversupply, given the large number of greenfield and expansion projects that are scheduled to start production within the next five years. According to estimates from market research group AME Mineral Economics, new projects and expansions in 2012 alone will add approximately 180Mt in global supply capacity. As illustrated in Exhibit 4, further new developments could grow iron ore supply beyond what can be supported by demand growth. Exhibit 4: Iron ore supply could outpace demand in the long term
Source: Desjardins Capital Markets, AME Mineral Economics
Although we do not expect all projects to be completed on schedule, we believe new supply should be sufficient to move the market into an oversupply situation, putting downward pressure on long-term iron ore prices. We expect many projects will be delayed or cancelled due to factors such as weakening iron ore commodity prices, infrastructure constraints and labour availability. However, we believe that many projects (in particular, world-class, low-cost projects controlled by major global diversified miners) will proceed to production despite these challenges. In our view, expansion is at least partly motivated by the race to take market share from higher cost operations. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Iron ore
PAGE 6 MARCH 22, 2012
Highest cost projects and those not supported by major miners are most likely to be impacted. In our view, iron ore prices will soften as the market moves into oversupply, and marginally profitable development projects are likely to be delayed or deferred. Chinese domestic iron ore production is generally the highest cost in the world, given the poor (and declining) iron content of China’s ores, and we would expect Chinese domestic iron ore production to be the most affected. We note that Canadian iron ore production is generally also relatively high cost, and some Canadian development projects could also be at risk of becoming uneconomic if markets are weaker than we anticipate.
Focus on Canadian equities
We are initiating coverage of five pure-play iron ore equities with operations or assets in Canada’s Labrador Trough: Adriana Resources, Champion Minerals, LIORC, Labrador Iron Mines and New Millennium. We are also transferring coverage of Alderon, which is based in the same region. The Labrador Trough, which spans the Québec–Labrador border, is the dominant iron ore–producing region in Canada. Ores in the trough may be present as direct shipping ore (DSO), taconite or meta-taconite. The ore type impacts the processing required and possible saleable end products. DSO is a naturally occurring high-grade material (generally 55% Fe or higher) and requires minimal processing. DSO can be sold as lump, which commands a premium price, as sinter fines material, the benchmark product, or as ultra fines, which are generally sold at a discount to the ‘fines’ benchmark price. Although taconite deposits have never been mined in Canada, similar deposits in the Mesabi Iron Range in Minnesota have been mined in significant quantities since the mid-1950s. Taconite deposits can be as large as 1Gt and show great lateral continuity. Taconite contains about 25–30% iron, which is present as fine magnetite (Fe3O4) and hematite (Fe2O3) alternated with silica-rich bands. Taconite must be ground to a fine powder (45 micrometres or 0.045mm particle size) to liberate the finely dispersed saleable iron ore from the waste rock. Due to its fine particle size, the resulting concentrate is not suitable for sinter feed and is generally agglomerated into pellets. Taconite bands that have gone through metamorphosis and folding over time are known as meta-taconites. The transformation would have concentrated the taconite ore and created a coarser texture. In comparison with taconite ores, meta-taconites require grinding to only approximately 420 micrometres (0.42mm) particle size to liberate the ore. While concentrate may be pelletized, it is also often suitable as sinter feed and may be sold in concentrate form to steel producers who will sinter the iron ore onsite.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Iron ore
PAGE 7 MARCH 22, 2012
Exhibit 5: Key iron ore properties in the Labrador Trough
Source: Desjardins Capital Markets, company reports, Google Maps
Most known iron ore deposits are centred around two historic mining districts—the Schefferville area and the Labrador City/Wabush camp. The Schefferville region was mined by the Iron Ore Company of Canada (IOC) during the 1950s–1980s and is currently home to early-stage producer Labrador Iron Mines and near-producer New Millennium, as well as developers including Adriana Resources. The region holds both DSO and taconite deposits. All mature iron ore operations in Canada are centred in the Labrador City/Wabush region. IOC, Cliffs Natural Resources and ArcelorMittal Mines Canada currently have combined production capacity of approximately 47Mtpa, with plans for further expansion. Development-stage assets owned by Champion Minerals and Alderon are also located in close proximity to these existing mines. The iron ore found in this region is meta-taconite. The assets and operations of all of the companies in our coverage universe are located in the Labrador Trough. However, the nature of the deposits and the scale of planned operations vary significantly depending on the type of deposit. Largescale projects with massive infrastructure requirements have been planned for the taconite deposits owned by Adriana Resources and New Millennium, while much smaller scale projects with minimal capex spending is planned for the DSO deposits owned by Labrador Iron Mines and New Millennium. Jackie Przybylowski, P.Eng.
Desjardins
Iron ore
Capital Markets
PAGE 8 MARCH 22, 2012
Exhibit 6: Comparison of iron ore deposits in our coverage universe 16,000 14,000
ADI
Total resouce size (m tonnes)
12,000 10,000 8,000
NML taconite
6,000 4,000
IOC
CHM
2,000
NML DSO LIM
ADV
0 -2,000 -4,000 20%
25%
30%
35%
40%
Taconite
45%
50%
Average grade (% Fe) Meta-taconite
55%
60%
65%
DSO
Note: Size of bubble reflects annual long-term production (100% basis), Desjardins Capital Markets estimates Source: Desjardins Capital Markets, company reports
Planned projects will add significantly to Canada’s iron ore production. As noted earlier, a large number of greenfield developments and expansion projects are scheduled to start production worldwide in the next five years. Within Canada alone, many projects in various stages of development currently are also being planned. Over the next 5–10 years, we forecast that the production volume attributable to iron ore equities in our coverage universe alone will increase to over 45t in 2020 from approximately 3Mt in 2011. Exhibit 7: We expect a significant jump in iron ore production from our coverage universe
Concentrate (or DSO) production (Mt, attributable)
50 45 40 35 30 25 20 15 10 5 0 2011
2012E
2013E
2014E LIF
2015E LIM
NML
2016E CHM
ADV
2017E
2018E
2019E
2020E
ADI
Note: Calendar year Source: Desjardins Capital Markets, company reports
Transportation challenges
Jackie Przybylowski, P.Eng.
Among Canadian iron ore producers, as with producers in other parts of the world, access to rail, port and power is key. The availability of existing infrastructure can materially impact the economic viability of a project. Given announced government funding of a new multi-user port at Pointe-Noire under the Plan Nord, port capacity in Canada is not expected to be a constraint for new producers. However, rail capacity remains a limitation. Developers who are able to make use of the existing rail network (we expect this will include Champion Minerals, Labrador Iron Mines and Alderon) are more likely to move into production.
Desjardins Capital Markets
Iron ore
PAGE 9 MARCH 22, 2012
IOC owns the Québec North Shore & Labrador Railway (QNS&L), a 418km rail line that connects the ports at Sept-Îles to the iron ore mines in the Labrador City/Wabush region. Because the QNS&L is considered a ‘common carrier’ line, Canadian law stipulates that IOC must provide service to any party, including its competitors, at a fair market price as long as the line has sufficient capacity. The current capacity of the QNS&L is believed to be about 75–80Mtpa based on our discussions with IOC representatives. Currently, approximately 37Mtpa is shipped on the railway: up to 22Mt from IOC’s Carol Lake operations, approximately 6Mt from Cliffs’ Scully mine (Wabush operations) and up to 8Mt from its Bloom Lake operations, and approximately 1Mt from Labrador Iron Mines’ Silver Yards plant. Room for more, but not all. In our view, expansions at Carol Lake, Bloom Lake and Silver Yards will increase the production capacity of the existing producers to approximately 53Mtpa within the next few years. Beyond this, the QNS&L will have sufficient capacity to handle some of the new production planned in the Labrador Trough. We expect ore from Alderon’s Kami project, Champion Minerals’ Fire Lake North project and New Millennium’s DSO project will be transported on the QNS&L. However, we do not expect the rail line to have sufficient capacity to handle Adriana Resources’ Lac Otelnuk project, New Millennium’s KéMag or LabMag projects, or many of the other projects that are in the early stages of development, which must therefore include alternative transportation options in their development plans. A second rail line would provide much needed rail capacity. On March 20, Québec’s government announced a partnership with CN Rail and the Caisse de dépôt et placement du Québec. According to a government release, the new rail line will extend 800km from Sept-Îles to the north of Schefferville, although the exact route of the proposed rail line has not been identified. According to the Caisse de dépôt, the estimated cost of C$5b will be financed half with debt and half with equity, with CN Rail contributing two-thirds of the equity portion and the Caisse de dépôt one-third. We view the March 20 announcement as a positive, as it demonstrates government support for a rail project. However, we note that this project will require stakeholder support, including from mining companies and First Nations groups, before construction can begin. We anticipate that stakeholder feedback could influence the final design of the rail line and the financing, ownership and operating structure. A rail line connects Schefferville to the QNS&L rail line (and ultimately to the ports at Sept-Îles). Tshiuetin Rail Transportation (TSH Rail) is owned by a consortium of three local First Nations groups which took possession of the former IOC rail line between Labrador City and Schefferville in 2005. The estimated iron ore haulage capacity of the rail line is approximately 10Mtpa; we expect this will be evenly divided between Schefferville-area DSO producers Labrador Iron Mines and New Millennium. However, we believe capacity could be increased with investment in the infrastructure. The Port of Sept-Îles is one of North America’s largest port facilities. Each year, nearly 23Mt of merchandise is handled, comprised mainly of iron ore, alumina, aluminium and petroleum products. The iron ore docks include IOC’s Sept-Îles facility and Cliffs’ ports at Pointe-Noire (including the former Consolidated Thompson port). The port at Sept-Îles is capable of loading vessels as large as 225,000 tonnes (Capesize), while Pointe-Noire can load Panamax vessels (approximately 60,000–80,000 tonnes). Government port solution a boon to the region. The federal government announced in February 2012 that it has committed C$55m to the construction of a new multi-user deepwater port at Sept-Îles. The first phase of the project is expected to cost a total of approximately C$220m and will include a 50Mtpa port with two ship loaders and two conveyor lines. The Port Authority of Sept-Îles has also committed a further C$55m toward construction. We anticipate that the remaining cost to develop the port will be directly paid by users or indirectly borne by users through user fees. The port will accommodate vessels as large as Chinamax (up to approximately 388,000 tonnes). Construction of the port is expected to be completed by the end of March 2014.
Jackie Przybylowski, P.Eng.
Desjardins
Iron ore
Capital Markets
PAGE 10 MARCH 22, 2012
Exhibit 8: Conceptual illustration of future multi-user port at Pointe-Noire
Source: Port Authority of Sept-Îles
Existing alternative is not likely to be made available to new participants. ArcelorMittal Mines Canada also operates a parallel rail (Cartier Railway) and port (Port Cartier) network but the facilities are private and not accessible to third parties. As the 420km Cartier Railway does not cross provincial borders, it is not considered a ‘common carrier’ and ArcelorMittal Mines Canada is not obligated to provide rail service to any third party. The company also operates Port Cartier, located about 60km west of Sept-Îles. The port facility includes a pellet plant, storage and docks that can handle vessels as large as 188,000 tonnes. Infrastructure requirement and project size are key factors in expected capital cost of building projects. The amount of capital required to develop the planned projects within our coverage universe depends on the size of each project, the end product and the location of the deposit relative to rail, power and other infrastructure. As expected, based on the above metrics, Adriana Resources’ Lac Otelnuk project is the most capital-intensive within our coverage universe, while Labrador Iron Mines’ and New Millennium’s relatively simple DSO projects are expected to be the least expensive to build. Exhibit 9: Development costs are related to project size and deposit type
Total development capital, 100% project level (US$b)
12
10
8
6
4
2
0 ADI
NML taconite
Source: Desjardins Capital Markets, company reports
Jackie Przybylowski, P.Eng.
CHM
ADV
LIF (IOC expansion)
LIM
NML DSO
Desjardins
Iron ore
Capital Markets
PAGE 11 MARCH 22, 2012
End product and deposit geology are key factors in long-term operating costs. Our estimate for the unit cash cost of each mining operation in our coverage universe depends on the nature of the mining and processing (for instance, pelletizing costs are higher than the cost of producing concentrate-for-sale, while DSO mining and processing costs should be lower than either pellet or concentrate costs, all else equal). Other factors that influence cost include the size and shape of the deposit (assets with a higher strip ratio generally have higher overall operating costs) and agreements with third-party rail and port operators. As illustrated in Exhibit 10, the Kami project is expected to have the lowest longterm operating cost due to its low strip ratio and its plan to sell ore as concentrate-for-sale rather than to further process this into pellets. New Millennium’s KéMag and LabMag taconite projects are also expected to be low-cost due to the company’s plan to transmit concentrate via pipeline, which is expected to be materially cheaper than rail transportation. Exhibit 10: Long-term operating costs in our coverage universe 70
Long-term unit cash cost (US$/t)
60
Carol Lake
50
KéMag/LabMag
40
Kami
LIM DSO
Lac Otelnuk
Fire Lake North NML/Tata DSO
30 20 10 0 0
10
20
30
40
50
60
70
80
90
100
110
120
130
Cumulative production, 100% basis (Mt)
Source: Desjardins Capital Markets, company reports
Valuation We believe that a net asset value (NAV) based on discounted cash flows is the best metric for assessing relative value for companies where the asset value is associated with non-producing assets. Our primary valuation method for the five development-stage or near-producing companies in our coverage universe is P/NAV; our NAV is based on a discounted cash flow analysis, all at a consistent 8% discount rate. We have applied target multiples to our NAV estimates on an asset-by-asset basis to reflect the relative risk associated with project start-up. Iron ore projects may be susceptible to capital cost overruns and delays in permitting, construction and financing. Our target multiples also reflect the anticipated time period before cash flows are received. Exhibit 11: Methodology for applying target multiples within our coverage universe P/NAV range (x)
Relative risks
0.0–0.3
Speculative—very little information currently available about the project; permitting and construction uncertain
0.4–0.5
Reasonable probability of construction; growing confidence on construction timeline
0.6–0.7
Likely—financed, near production or in the commissioning phase
0.8–1.0
Producing; stable cash flow stream
Source: Desjardins Capital Markets
A unique approach for a unique company. We use a hybrid P/CF and P/NAV approach to value LIORC. We believe this approach is appropriate as it places greater emphasis on the near-term distributions paid to unitholders. With a high payout ratio (average of 80% over the past three years), LIORC’s relatively high yield is attractive to many investors and is an important factor in determining the company’s unit price. Jackie Przybylowski, P.Eng.
Desjardins
Iron ore
Capital Markets
PAGE 12 MARCH 22, 2012
Exhibit 12: Summary of target multiples applied in our coverage universe Company
Valuation method based on 8% discount rate
Adriana Resources Inc.
0.3x NAV
Alderon Iron Ore Corp.
0.5x NAV
Champion Minerals Inc.
0.5x NAV
Labrador Iron Ore Royalty Corporation
12x NTM cash flow (50%) & 1x NAV (50%)
Labrador Iron Mines Holdings Limited
0.8x NAV
New Millennium Iron Corp.
0.6x NAV DSO project & 0.3x NAV taconite and other assets
Source: Desjardins Capital Markets
Sensitivity The financial performance of the equities in our coverage universe will be largely driven by the iron ore price. Also, as revenues are received in US dollars and operating costs paid in Canadian dollars, the US$/C$ exchange rate can have a material impact on performance. Labrador Iron Mines is the best way to take advantage of current historically strong iron ore prices. Companies with the strongest growth offer significantly higher leverage to the iron ore commodity price, and high leverage is preferred in the current environment of historically high prices. Companies with the largest long-term projects as well as relatively high-cost producers have a higher sensitivity to iron ore commodity prices, as illustrated in Exhibit 13. Although we expect historically high prices will be sustained in the short term by strong demand, we see a risk of lower iron ore commodity prices in the long term as new mines increase the risk of market oversupply. LIORC offers an excellent hedge against falling iron ore commodity prices due to its low NAV leverage to changes in the iron ore price and its relatively stable revenue base. LIORC also offers lower sensitivity to iron ore prices because its royalty and commission-based revenue streams are not affected by costs such as operating expenses and capital expenditures. On the other hand, its 15.1% equity stake in IOC provides some upside to rising markets as well as to organic growth and expansion opportunities. Exhibit 13: Labrador Iron Mines has the highest sensitivity within our coverage universe to iron ore commodity prices LIM NML ADI CHM ADV LIF 0
200
400
600
800
1,000
1,200
NAV sensitivity to 10% chg in iron ore price per C$1,000 invested (C$)
Source: Desjardins Capital Markets
Companies with meaningful near-term capital spending or high future expected capex are the most sensitive to changes in the US$/C$ exchange rate, given we have assumed that capital costs are tied to the US dollar (as most equipment will be purchased overseas). Lower margin operations will also have high sensitivity to the exchange rate on an ongoing basis.
Jackie Przybylowski, P.Eng.
Desjardins
Iron ore
Capital Markets
PAGE 13 MARCH 22, 2012
Exhibit 14: Labrador Iron Mines has the highest sensitivity within our coverage universe to changes in the US$/C$ exchange rate LIM NML ADI CHM ADV LIF -1,000
-900
-800
-700
-600
-500
-400
-300
-200
-100
NAV sensitivity to 10% chg in US$/C$ exchange rate per C$1,000 invested (C$)
Source: Desjardins Capital Markets
Jackie Przybylowski, P.Eng.
0
Desjardins
Adriana Resources Inc.
Capital Markets
PAGE 14 MARCH 22, 2012
Adriana Resources Inc. (ADI C$1.06, TSX-V)
Huge project, huge risk; initiating coverage with a Buy rating and C$1.75 target price Adriana Resources Inc. Rating Target Valuation
Buy–Speculative C$1.75 0.3x NAV (8%)
Symbol Exchange Sector
ADI TSX-V Bulk Commodities
President & CEO Allen Palmiere Website www.adrianaresources.com Share price C$1.06 Potential return 65% 52-week range C$0.71–1.82 3m volume traded 180,000 1m volume traded 103,000 Shares O/S* 149m Dividend yield Reported cash* Cash/sh* Reported total debt* Reported book value/sh* Current market cap Current EV
0% C$18m C$0.12 C$6m C$0.46 C$157m C$156m
Resources (100% basis at asset level) M&I 4,890Mt at 27.3% Fe Inferred 1,560Mt at 27.1% Fe Historical 6,318Mt at 33.0% Fe
Adriana Resources is working with joint venture partner WISCO, a Chinese state-owned steel producer. WISCO owns a 60% stake in the Lac Otelnuk project and holds a 19.9% equity stake in Adriana Resources; it also has an offtake agreement and equity stake in Cliffs Natural Resources’ Bloom Lake mine We are initiating coverage with a Buy–Speculative rating and C$1.75 target price Highlights. Adriana Resources is working with joint venture partner Wuhan Iron and Steel Group Corporation (WISCO) to develop the Lac Otelnuk project. Lac Otelnuk is Canada’s largest iron ore deposit, and with further definition drilling, the deposit is potentially among the largest in the world. Production is expected to begin in 2017 and should ultimately grow to 50Mtpa pellets (100% basis), approximately double the expected capacity at the Iron Ore Company of Canada, currently the largest producer in the region. The anticipated capital cost of the Lac Otelnuk project is substantial—we estimate that the development capex will total approximately US$12b (on a 100% project basis), including construction of a new 815km rail line linking the mine site to Sept-Îles. Valuation. Our valuation is based on a 0.3x multiple applied to our Lac Otelnuk net asset value and a 1.0x multiple to current net working capital. While we foresee potential for significant large and long-lived cash flows from the Lac Otelnuk project, we note that development based on the anticipated timeline remains a significant risk at this stage in the company’s growth. Adriana Resources and WISCO have outlined an extremely ambitious project that is expected to have the largest scale construction and highest capital cost in our coverage universe. We also see some risk to WISCO’s honouring its commitment to developing the project in a timely manner. In our view, WISCO could elect to delay the Lac Otelnuk development in favour of its agreement with Century Iron Ore Corporation to jointly develop Century’s projects, or if it identifies lower cost alternative supplies elsewhere. Recommendation. We are initiating coverage of Adriana Resources Inc. with a Buy–Speculative rating and C$1.75/share one-year target price, which implies an expected return of 65% to the current share price. Adriana Resources fully financed NAV estimate
2.00 Price (C$)
* As at October 31, 2011 Source: Desjardins Capital Markets, Capital IQ, company reports
Lac Otelnuk, Adriana Resources’ flagship project, is the largest iron ore deposit in Canada. The company is working to build what would be the largest pellet producer in Canada
Asset (C$m) 1.50
Volume (m)
1.00 0.50 2 1 0 Mar-11
Source: Bloomberg
Jackie Przybylowski, P.Eng.
Jun-11
Sep-11
Dec-11
Feb-12
Lac Otelnuk Other assets NPV multiple (x) Current working capital Current long-term debt Corporate adjustments Proceeds from options and warrants Anticipated financing Reported basic shares O/S (m) Shares O/S post financing (m) NAV NAV/share (C$) Source: Desjardins Capital Markets
NPV (8%)
NPV (10%)
2,061 0 0.30 4 0 -126 6 4,791 149 1,117 3,381 3.03
1,067 0 0.30 4 0 -115 6 4,791 149 1,117 2,397 2.15
Desjardins Capital Markets
Adriana Resources Inc.
PAGE 15 MARCH 22, 2012
Company overview
Adriana Resources is a development-stage iron ore–focused company with deposits in the Labrador Trough and an ownership stake in an iron ore port project in Brazil. The company’s flagship asset is the Lac Otelnuk project in northern Québec. Adriana Resources is working with its joint venture partner Wuhan Iron and Steel Group Corporation (WISCO) to advance Lac Otelnuk toward feasibility and into production. The company currently envisions construction of mine, concentrator, pelletizing facilities and rail line to support a 50Mtpa pellet operation. Exhibit 1: Lac Otelnuk location
Source: Company reports
Anticipated catalysts Feasibility study expected in 4Q13 Construction of Lac Otelnuk from 2013–17 Production expected to start in 2017
Lac Otelnuk—huge project, huge risk Adriana Resources’ flagship project is Lac Otelnuk, a large taconite deposit located in the Labrador Trough approximately 155km northwest of Schefferville. The site is very remote, with no access by road or rail; several lakes adjacent to the property are accessible via float plane. Adriana Resources and WISCO have formed a joint venture to oversee development at Lac Otelnuk. WISCO holds a 60% ownership interest in the project and controls three seats on the JV board, while Adriana Resources controls two seats and will act as operator of the project.
Jackie Przybylowski, P.Eng.
Desjardins
Adriana Resources Inc.
Capital Markets
PAGE 16 MARCH 22, 2012
Exhibit 2: Lac Otelnuk camp (July 2011)
Source: Desjardins Capital Markets
Iron ore resources. Lac Otelnuk is already Canada’s largest known iron ore deposit and, with further definition drilling, Adriana Resources believes it could potentially be one of the largest in the world. The property’s South Zone contains approximately 6.45Bt measured, indicated and inferred resources, and the North Zone contains approximately 6.3Bt historical resources (not NI 43-101–compliant) with potential for further resource delineation that could bring the total resource to 15Bt or more, according to company estimates. Current NI 43-101–compliant resources imply a minelife of approximately 30 years; however, additional drilling, including upgrading historical resources to NI 43-101–compliant resources, could increase the minelife to at least 75 years. Exhibit 3: Total estimated iron ore resources at Lac Otelnuk as at April 2011 Measured & indicated
Inferred
Historical (not NI 43-101–compliant)
Tonnes (m)
% Fe
Tonnes (m)
% Fe
Tonnes (m)
% Fe
North Zone
-
-
-
-
6,318
33.0
South Zone
4,890
27.3
1,560
27.1
-
-
Total
4,890
27.3
1,560
27.1
6,318
33.0
Source: Company reports
Massive open pit mining operations are planned at Lac Otelnuk, with an average of approximately 300Mt material (waste and ore) mined each year. Approximately 175Mtpa run-of-mine ore will be processed at an onsite concentrator to produce approximately 50Mtpa concentrate at 68.5% Fe. The concentrate will then be converted to approximately 49Mtpa high-grade (67–69% Fe) pellets at an onsite pellet plant. Given the deposit is a taconite-type ore, concentrate is not suitable for sale as sinter feed and must be agglomerated (eg formed into pellets) before it can be charged into a blast furnace. Logistics, while always an important consideration, are especially critical for Lac Otelnuk. Our US$12b (100% basis) development capital cost estimate, shown in Exhibit 4, includes an estimated US$4.75b for rail, port and power infrastructure. Lac Otelnuk’s expected large production and sales volumes will exceed anticipated capacity available on the Québec North Shore & Labrador Railway and existing capacity on the Tshiuetin Rail Transportation line. The project partners must therefore construct a new rail line between the Lac Otelnuk site and Sept-Îles (approximately 815km).
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Adriana Resources Inc.
PAGE 17 MARCH 22, 2012
Exhibit 4: Expected capital cost at Lac Otelnuk (US$m) Mine Crusher and concentrator
800 2,500
Pellet plant
3,500
Rail
3,500
Port
650
Power
600
Other
450
Total
12,000
Source: Desjardins Capital Markets
Rail infrastructure is one of the biggest hurdles to project completion, in our view. Rail construction represents an upfront fixed cost that is largely independent of the final size of the project. While the mine fleet, concentrator and pelletizing facilities may be scaled down to reflect any potential change to the market outlook or to WISCO’s requirements (note that the concentrator and pelletizing facilities will each be constructed as three standalone modules), rail capacity cannot be easily adjusted once construction is underway. We believe Adriana Resources could see significant cost creep in rail construction costs beyond the approximately US$2.7b (100% basis) allotted to the development of the railway transport system in the project PEA. Our estimates include about US$3.5b (100% basis) for rail construction, which is in line with industry estimates of C$3–5m per kilometre of rail constructed. A government-supported rail construction will impact Adriana Resources’ capital costs. The proposed 800km rail line by the government of Québec and partners CN Rail and the Caisse de dépôt et placement du Québec that was announced on March 20 is planned to extend from Sept-Îles to north of Schefferville. We expect a third-party rail solution would reduce Adriana Resources’ capital costs but increase the company’s operating costs. For conservatism, we assume that Adriana and its joint venture partner WISCO will be fully responsible for funding the capital cost of a rail line. A third potential solution balances capital costs and operating expenses. A partnership agreement with other Labrador Trough iron ore producers or developers could mitigate the high risk and cost of the rail line. Potential members of a rail partnership include Cliffs Natural Resources, Champion Minerals and Alderon which could utilize the portion of the rail line between Sept-Îles and Labrador City/Wabush, as well as Labrador Iron Mines, New Millennium and Century which could use the portion of the rail line between Sept-Îles and Schefferville. If all of the potential participants joined the rail partnership, we estimate Lac Otelnuk’s proportionate share of construction costs would drop to approximately US$2b. However, for conservatism, we have not included the cost-sharing scenario in our estimates. Establishment of a partnership could be a lengthy process and is not likely to include all of the potential participants identified above. Port construction will be completed through Plan Nord. Based on discussions with government officials, Adriana Resources expects that the second or third phase of the anticipated multi-user port in Pointe-Noire will have 50Mtpa of port capacity available for sales from Lac Otelnuk. We have allocated US$650m to Adriana Resources’ share of port development, which will include stockpile facilities and dedicated stacker/reclaimer equipment. Actual costs to Adriana Resources could be less, depending on government contributions to the expansion. Lower operating costs offset high capex. The economies of scale associated with the relatively large 50Mtpa planned operation at Lac Otelnuk, combined with the company’s plan to own its independent rail network, result in operating costs that are below levels expected for smaller facilities operating in similar remote conditions. Our long-term operating cost estimates are shown in Exhibit 5.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Adriana Resources Inc.
PAGE 18 MARCH 22, 2012
Exhibit 5: Expected long-run cash operating costs at Lac Otelnuk (US$/t pellets) Mining Crusher and concentrator
8.50 10.00
Pelletizing
16.00
Transport/loading
18.00
G&A
2.00
Total
54.50
Source: Desjardins Capital Markets
No value attributed to non-core assets In addition to the flagship Lac Otelnuk property, Adriana Resources has other assets, including December Lake and Brazore. We view these assets to be non-core and do not expect Adriana Resources to spend significant capital on the development of these properties.
December Lake December Lake is comprised of 159 mineral claims totalling approximately 74km2 65km from the Lac Otelnuk property and 230km north of Schefferville in the Nunavik region of northern Québec. In addition to the Lac Otelnuk property, Adriana Resources transferred its 100% ownership stake in December Lake to the joint venture partnership with WISCO. A very long-term project. Although Adriana Resources has identified over 20km of untested magnetic anomalies on this property, we believe development of December Lake is a very long-term prospect as the joint venture is currently focused on the development of Lac Otelnuk. We do not expect Adriana Resources to develop December Lake in the near term.
Brazore Adriana Resources currently holds an effective 56.1% direct interest in Brazore Ltda., which is developing a deepwater iron ore port facility approximately 70km west of Rio de Janeiro in Brazil. The proposed port would facilitate access to the seaborne market for Worldlink (Canada) Resources Ltd. (which has the right of first refusal to access the full capacity of the facility on reasonable commercial terms) and/or for various independent iron ore miners in the region. The current facility design incorporates a capacity of 45Mtpa and would include railcar dumpers, stockpile, stacker/reclaimers, a conveyor tunnel under a strait and island, and a deepwater load-out facility that can accommodate Capesize vessels. Waiting for an opportunity to sell. In our view, the Brazore port project is a non-core asset for Adriana Resources. We anticipate that Adriana Resources will divest of the port project within the next few years in order to focus management attention on the Lac Otelnuk project and to provide funds for development of the Lac Otelnuk site. As at October 31, 2011, Brazore Ltda. had spent approximately US$32m on port development, which would imply an US$18m ADI stake. However, we anticipate that the value of the port project would increase on receipt of environmental permits.
Capital structure
Adriana Resources Inc. is listed on the TSX Venture Exchange under the symbol ‘ADI’. As at October 31, 2011, Adriana Resources had approximately 149.3m shares issued and outstanding, and an additional 9.8m options and warrants outstanding. WISCO is Adriana Resources’ largest single shareholder, with a 19.9% equity stake; individuals and insiders hold a further 3.9% of the shares outstanding.
Jackie Przybylowski, P.Eng.
The company most recently raised funds on January 12, 2012 upon closing of its joint venture agreement with WISCO. Under the terms of the agreement, Adriana Resources has transferred ownership of the Lac Otelnuk and December Lake assets to a joint venture company (WISCO 60%, Adriana Resources 40%). In exchange, WISCO provided approximately C$91.6m, of which C$51.6m was paid directly to Adriana Resources and C$40.0m to the joint venture company (ADI stake C$16.0m). WISCO has also agreed to use commercial best efforts to obtain project financing for 70% of the
Desjardins Capital Markets
Adriana Resources Inc.
PAGE 19 MARCH 22, 2012
development and construction costs of the Lac Otelnuk project, and has agreed to buy its 60% proportionate share of all iron ore production from Lac Otelnuk at market prices. We believe it is likely that WISCO will purchase all ore from Lac Otelnuk, which should simplify sales and marketing. About WISCO. Wuhan Iron and Steel Group Corporation (WISCO) is a Chinese state-owned integrated iron and steel company. From its inception in 1955, WISCO has become a global giant with annual steelmaking capacity of 40Mt and ranks fourth in the world. The group will strive to reach an annual capacity of 60Mt in support of China’s 12th Five-Year Plan (2011–15). WISCO has a record of investing in the Labrador Trough. The group previously participated in Consolidated Thompson’s Bloom Lake project, acquiring a 19.9% equity interest in Consolidated Thompson, a 25% stake in Bloom Lake (which it has retained following the acquisition of Consolidated Thompson by Cliffs) and a 4Mtpa offtake agreement for the life of Bloom Lake (which it also retained following the acquisition). More recently, WISCO acquired a 25% equity interest in development-stage Century Iron Mines Corporation, and holds a 40% stake in Century’s ownership interest in several development projects, including Sunny Lake, Duncan Lake and Attikamagen; WISCO has agreed to take its 40% share of production plus an additional 20% offtake at market prices from these deposits. Potential to consolidate and simplify WISCO’s investments. Given WISCO’s involvement in both Adriana Resources and Century, and the relatively close proximity of the Lac Otelnuk deposit to Century’s Sunny Lake and Attikamagen deposits, it is possible that WISCO could co-ordinate the combination of the two companies. This would reduce redundancies in management and in some assets and infrastructure through the sharing of rail and potentially concentrator, pellet plant and maintenance/support facilities. In our view, Adriana Resources is the most likely acquirer due to its advanced stage of development and management expertise in mining operations.
Valuation
Our primary valuation approach for Adriana Resources is P/NAV; our NAV is based on a discounted cash flow analysis (at an 8% discount rate) using the US$/C$ exchange rate and iron ore price assumptions summarized in Exhibit 2 on page 4. Our estimated net asset value is C$3.03/share (see Exhibit 6) after an assumed C$4.8b financing to raise Adriana Resources’ share of development costs for Lac Otelnuk. Adriana Resources’ NAV is based exclusively on the Lac Otelnuk iron ore deposit; we attribute no value to its December Lake property or to its Brazore assets. We note that the sale of the Brazore project would represent upside to our estimates. We have applied a 0.3x target multiple to the Lac Otelnuk assets and a 1.0x multiple to current working capital to derive our target price of C$1.75/share. We believe that a 0.3x multiple is appropriate based on our perception of relative risk for the assets (given factors such as the high expected capital cost and long period to production). Exhibit 6: Adriana Resources net asset value details NPV (8%) (C$m) Lac Otelnuk—NPV estimate of future cash flows
4
Expected proceeds from options and warrants
6
Total capital expenditure requirement (attributable to ADI)
4,791
Portion of capex to be financed by debt
3,354
Portion of capex to be financed by equity
1,437
NAV
3,381
Current number of basic shares outstanding (m)
149.3
Number of shares to be issued at an assumed C$1.50/share (m)
958.0
Options with exercise price of C$0.59/share (m)
7.4
Warrants with exercise price of C$0.50/share (m)
2.4
Pro forma fully diluted shares outstanding (m) NPV/share (C$) Source: Desjardins Capital Markets
Jackie Przybylowski, P.Eng.
1,935
Current working capital
1,117.1 3.03
Desjardins Capital Markets
Adriana Resources Inc.
PAGE 20 MARCH 22, 2012
Recommendation
We are initiating coverage of Adriana Resources Inc. with a Buy–Speculative rating and C$1.75/share one-year target price, which implies an expected return of 65% to the current share price. Adriana Resources holds a 40% interest in Lac Otelnuk, Canada’s largest iron ore deposit. The company has partnered with WISCO, a large Chinese state-owned steel producer, which will provide or arrange a significant component of total development costs for the Lac Otelnuk project. However, we view the Lac Otelnuk project as very high risk. Its capital cost is the highest among peers because of its extremely ambitious scale and the new rail infrastructure required. In addition, we see some risk to WISCO’s honouring its commitment to developing the project in a timely manner. In our view, WISCO could elect to delay the development of Lac Otelnuk in favour of its Century commitment or if it identifies lower cost alternative supplies elsewhere.
Risks We have a ‘Speculative’ risk qualifier for Adriana Resources. Start-up and operating risk. There is a significant risk that the exploration, development and completion of the Lac Otelnuk project could be delayed due to circumstances beyond Adriana Resources’ control. Setbacks could include delays in securing financing or in construction or commissioning. Liquidity and financing. The development of the Lac Otelnuk project will require significant capital, and there is no assurance that Adriana Resources will be able to obtain sufficient financing at favourable rates. Adriana Resources may be unable to invest capital for its development and exploration programs, take advantage of business opportunities or respond to competitive pressures. Iron ore prices. The company’s future profitability is directly related to the volume of iron ore products sold and the price of these products. Iron ore prices have historically been volatile and are primarily affected by the demand for, and price of, steel. Iron ore prices are also affected by numerous other factors beyond the company’s control, including global and regional demand, political and economic conditions, and global production volumes and operating costs. Foreign exchange. Once in production, Adriana Resources will be subject to foreign exchange risks because revenues will be received in US dollars while operating costs will be in Canadian dollars. Fluctuations in exchange rates, principally the US$/C$ exchange rate, can significantly impact earnings and cash flows. Licences and permits. The exploration and development activities at Lac Otelnuk require permits and approvals from various government authorities and are subject to federal, provincial and local laws. The company will be required to obtain additional licences and permits to continue and expand its development activities, and there can be no guarantee that these licences will be obtained or maintained. There is also a risk that future legislation and regulations could result in additional expenses at Lac Otelnuk’s operations and in reclamation obligations, the extent of which cannot be predicted. First Nations land claims. The Lac Otelnuk property falls within an area subject to First Nations land claims. In January 2008, Adriana Resources signed a letter of intent with Makivik Corporation, the development corporation mandated to manage the heritage funds of the Inuit of Nunavik. However, Adriana Resources has not yet signed firm impact benefit agreements with affected First Nations groups. Even with agreements in place, ongoing or new aboriginal claims to lands may have an impact on the company’s ability to develop the property.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Adriana Resources Inc.
PAGE 21 MARCH 22, 2012
Key management and directors
Donald K Charter, Chairman. Mr Charter is currently the President and CEO of Corsa Coal Ltd. He was previously a partner at a national law firm where he practised as a securities lawyer specializing in mergers and acquisitions, as well as President and CEO of Dundee Securities Corporation. Mr Charter holds or held director positions at a number of public and private companies, including IAMGOLD Corporation, Dundee Real Estate Investment Trust, Lundin Mining Corporation, Great Plains Exploration Inc. and Baffinland Iron Mines Corporation. Allen J Palmiere, President, CEO and director. Mr Palmiere has more than 35 years of extensive experience in senior executive and leadership roles in the mining industry. His former positions include Chairman, President and CEO of HudBay Minerals Inc., President and CEO of Silk Road Resources Ltd., CEO and CFO of Breakwater Resources Ltd., CFO of Zemex Corporation and Executive Chairman of Barplats Investments Limited. Daniel Im, CFO. Mr Im, a Chartered Accountant and lawyer, was appointed CFO in July 2011. Prior to joining Adriana Resources, Mr Im worked as a securities lawyer at a major Toronto law firm after obtaining his law degree from Osgoode Hall Law School. Prior to law school, Mr Im had obtained his CA designation in 2003 while working at Deloitte & Touche LLP. He earned his Master of Accounting and Honours Bachelor of Arts in Accounting from the University of Waterloo. Frank Condon, P.Eng., Director of Québec Operations. Mr Condon has 35 years of experience in various positions with Noranda (1964–99) including General Manager, and Hopewell Phosphate Corp. (1976–86) where he was responsible for the acquisition, evaluation and development of the Hopewell phosphate mine.
Jackie Przybylowski, P.Eng.
Desjardins
Alderon Iron Ore Corp.
Capital Markets
PAGE 22 MARCH 22, 2012
Alderon Iron Ore Corp. (ADV C$3.09, TSX)
Closest to infrastructure and mature mines; initiating coverage with a Hold rating and C$4 target price Alderon Iron Ore Corp. Rating Target Valuation
Hold–Speculative C$4.00 0.5x NAV (8%)
Symbol Exchange Sector
ADV TSX Bulk Commodities
President & CEO Tayfun Eldem Website www.alderonmining.com Share price C$3.09 Potential return 29% 52-week range C$2.09–4.00 3m volume traded 178,000 1m volume traded 158,000 Shares O/S* 83m Dividend yield Reported cash* Cash/sh* Reported total debt* Reported book value/sh* Current market cap Current EV
0% C$13m C$0.16 C$0m C$1.22 C$311m C$298m
Resources (100% basis at asset level) M&I 490Mt at 30.0% Fe Inferred 598Mt at 30.3% Fe * As at September 30, 2011 Source: Desjardins Capital Markets, Capital IQ, company reports
Alderon’s flagship Kami property is located in the Labrador City/Wabush region, close to mature mines owned by Cliffs Natural Resources and the Iron Ore Company of Canada. There is rail, road and power infrastructure nearby, and an existing skilled labour pool as well as maintenance and support services can be sourced from local towns A joint venture or offtake agreement is anticipated over the next few months. We expect an agreement would be an important milestone as it would represent guaranteed long-term sales for a significant portion of Kami’s anticipated future production We are initiating coverage with a C$4 target price and Hold–Speculative rating as we believe Alderon’s shares are fairly valued Highlights. Alderon is working to develop its Kamistiatusset (Kami) project into production by 2015. We believe it is highly likely that Kami will be developed into a near-term producer, given its relatively low anticipated development cost and low operating costs. Because Kami is located close to mature producing mines in the Labrador City/Wabush area, infrastructure requirements are minimal compared with other, more remote sites in the Labrador Trough. Additionally, the Kami deposit is expected to have relatively low operating costs due to its low stripping ratios and the relatively minimal processing required to prepare concentrate-for-sale (as compared with pellet production). Valuation. Our valuation is based on a 0.5x multiple applied to our Kami net asset value and a 1.0x multiple to current net working capital. We believe that the Alderon team is highly capable and experienced in mine development and operations, and we expect the company will maximize value for shareholders from its Kami property as the asset is developed over the next few years. Recommendation. We are initiating coverage of Alderon Iron Ore Corp. with a Hold–Speculative rating and C$4/share one-year target price. We have applied a Hold rating as we believe Alderon’s share price already reflects the company’s strong management team, the relatively advanced stage of development at Kami and the relatively low anticipated capex and operating costs. Our C$4/share target price implies an expected return of 29% to the current share price vs the average expected return of 52% for our coverage universe. Alderon fully financed NAV estimate
Volume (m)
Price (C$)
4
Asset (C$m) 3
2 3 2 1 0 Mar-11
Source: Bloomberg
Jackie Przybylowski, P.Eng.
Jun-11
Sep-11
Dec-11
Feb-12
Kami Other assets NPV multiple (x) Current working capital Current long-term debt Corporate adjustments Proceeds from options and warrants Anticipated financing Reported basic shares O/S (m) Shares O/S post financing (m) NAV NAV/share (C$) Source: Desjardins Capital Markets
NPV (8%)
NPV (10%)
1,312 0 0.50 -15 0 -100 19 1,200 83 253 1,698 6.70
957 0 0.50 -15 0 -89 19 1,200 83 253 1,354 5.35
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 23 MARCH 22, 2012
Company overview
Alderon is a development-stage iron ore–focused company with a single asset in the Labrador Trough. The company’s 100%-owned Kamistiatusset (Kami) iron ore project is located entirely in Labrador, right on the Québec–Labrador border, in a relatively busy area of the trough, near the town of Labrador City (with a local population of about 15,000) and in close proximity to mature producers. Kami is close to Cliffs Natural Resources’ Bloom Lake mine (formerly owned by Consolidated Thompson) and 5.0km southwest of Cliffs’ Scully mine. There is a paved highway 2.5km from the property and power lines approximately 15.5km away; the existing common carrier rail network (Québec North Shore & Labrador Railway or QNS&L) may be accessed with the construction of a 15km rail spur line. Exhibit 1: Location of Kami property
Source: Company reports
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 24 MARCH 22, 2012
Anticipated catalysts
Resource update at Rose North expected by June 2012 First offtake agreement, likely with an Asian steelmaker, expected to be signed mid-year 2012 Feasibility study expected to be published in 4Q12 Ordering of long-lead-time equipment could begin before the end of 2012 All permits, including environmental assessment, expected in 3Q13 Mine construction expected to begin in 3Q13 on receipt of permits Production expected to start in 2015
Kami—closest to infrastructure and mature mines Exhibit 2: Kami site plan
Source: Company reports
Jackie Przybylowski, P.Eng.
The Kami project is comprised of three ore zones—Rose Lake, North Rose and Mills Lake (see Exhibit 2). Exploration results to date include nearly 500Mt indicated resources and nearly 600Mt inferred resources at approximately 30% Fe, as shown in Exhibit 3. Exploration drilling continues to define the orebody; Alderon’s current exploration drill program should be completed in April 2012. The focus of the current program is to upgrade the existing North Rose inferred resource to the indicated category. The company expects to report the results in an updated resource estimate by June 2012.
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 25 MARCH 22, 2012
Exhibit 3: Total estimated iron ore resources at Kami Indicated resources
Inferred resources
Tonnes (m)
% Fe
376 -
Mills Lake Total
Rose Central Rose North
Tonnes (m)
% Fe
29.8
46
29.8
-
480
30.3
114
30.5
72
30.7
490
30.0
598
30.3
Source: Company reports
We continue to envision an operation with 8Mtpa concentrate production at the Kami site. The Rose Central and Rose North deposits will be mined first as one large super pit, followed by mining of the Mills Lake deposit after 5–10 years of operation. Construction of the mine and concentrator is expected to commence after environmental permits are received, which is anticipated in 3Q13. According to the company’s project development timeline, mining is expected to begin in 2015 and commercial production achieved by late 2015. We have taken a slightly more conservative approach and assume that production will begin in 3Q15. We expect the capital costs to develop Kami into an 8Mtpa concentrator will total about US$1.3b, slightly above the company’s estimate of US$1.0b. Our detailed capital cost assumptions are shown in Exhibit 4. Exhibit 4: Expected capital cost at Kami (US$m) Mine
120
Concentrator and site infrastructure
500
Rail
60
Port
200
Power
50
Other
400
Total
1,330
Source: Desjardins Capital Markets
Further upside not reflected in our estimates. Following successful ramp-up to 8Mtpa, Alderon is planning for further expansion to 16Mtpa. This is similar to the expansion planned by Consolidated Thompson management for the Bloom Lake mine (prior to the acquisition of Consolidated Thompson by Cliffs). According to Alderon’s estimates, Phase 2 expansion would follow four years after the start-up of Phase 1. We have not yet included the second phase in our estimates, as the expansion is conceptual at this time. A relatively simple rail and port solution. Unlike many of the other projects in our coverage universe, transportation issues at Kami are relatively straightforward. The deposit’s close proximity to existing mature mines and infrastructure means that only a short 15km spur line is required to connect to the existing rail network. We expect that QNS&L will continue to have adequate capacity when production begins at Kami. We also expect Alderon will participate in the new multi-user port at Pointe-Noire, which is expected to be completed well before first sales at Kami. We have allocated US$200m in our capital cost estimates to Alderon’s share of port costs, including stockpile facilities and dedicated stacker/reclaimer equipment. Very competitive operating costs. As illustrated in Exhibit 10 on page 11, the Kami project is expected to have the lowest per-unit cash operating costs in our coverage universe. This is attributable to several factors: (1) We expect Alderon will sell Kami material as concentrate for sinter feed, and the additional expense of pelletizing operations are not included in our estimates; (2) Kami enjoys cost advantages due to its central location and relative proximity to power, rail, port and an established labour pool; and (3) Its relatively low expected stripping ratio reduces mining costs relative to operations such as Champion Minerals’ Fire Lake North project, where a significantly higher volume of waste must be moved to produce the same concentrate volume. Our long-term operating cost estimates are outlined in Exhibit 5. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 26 MARCH 22, 2012
Exhibit 5: Expected long-run cash operating costs at Kami (US$/t concentrate) Mining Crusher and concentrator Transport/loading
15.00 7.50 18.00
G&A
2.00
Total
42.50
Source: Desjardins Capital Markets
Not included in the above operating cost estimate is a 3% gross sales royalty payable to Altius Minerals Corporation. Alderon acquired a 100% interest in the Kami property from Altius on December 6, 2010 in exchange for 32.3m ADV shares (a 37% stake in the company at the time) and the 3% royalty payment. Ore quality is most suited to Asian buyers. The concentrate from Kami is expected to have low levels of most gangue elements; however, the sulphur and manganese content could be marginally higher than the generally accepted limit in Europe. According to the 2011 preliminary economic assessment report, the sulphur level at Rose Central is 0.053%, slightly above the acceptable limit of 0.050%. Manganese levels at Rose Central are expected to average 0.75%, which was considered by the authors of the study to be in excess of levels acceptable to most blast furnace operations. However, we expect that the manganese content at Rose North will be significantly lower. With careful pit design and blending, we believe the final ore product could have a manganese level of about 0.3–0.5%, within acceptable limits for Asian buyers. Still fully independent but we expect a deal to be done. At the present time, Alderon has not signed any joint venture or offtake agreements with third parties. However, we expect the company is in talks with potential partners, most likely Asian steel producers. Executive Chairman Mark Morabito had indicated to reporters in late 2011, “You have to be patient…I could do a deal today, I’ll tell you that right now, but we don’t want to. We want to get the best possible terms we can, and that requires patience as you create competitive tensions amongst the potential offtake parties. It’s a longterm game. We started the file early, and we’re giving ourselves till the middle of next year to get the best possible deal”. We expect an offtake deal to be announced by mid-2012, in line with Mr Morabito’s comments. The signing of an offtake agreement for concentrate production in the range of 3–5Mtpa would be an important milestone, as it would represent guaranteed long-term sales for a significant portion of Kami’s future production and commercial acceptance of Alderon’s ore.
Capital structure Alderon Iron Ore Corp. is listed on the Toronto Stock Exchange under the symbol ‘ADV’. As at September 30, 2011, Alderon had approximately 82.7m shares issued and outstanding, and 7.6m options and warrants outstanding. Altius Minerals Corporation remains Alderon’s largest shareholder, with a ~32.4% ownership stake. Liberty Metals & Mining Holdings, LLC is also a significant shareholder with a 15.0% stake. Individuals and insiders hold approximately 4.8% of the shares outstanding, including Executive Chairman Mark Morabito’s 3.0% stake. Altius has been a shareholder since the December 2010 transaction whereby Alderon acquired 100% of the property rights for the Kami project from Altius in exchange for 32.3m ADV shares (a 37% stake in the company at the time) and a 3% gross sales royalty on any future sales from Kami. Altius is a natural resources-project-generating and royalty business based in Newfoundland and Labrador. The company’s business model is centred around early-stage exploration and discovery of iron ore, base metals, gold, uranium and rare earth elements in eastern Canada. Altius prefers to create partnerships or corporate structures in connection with the opportunities it generates, with the company carrying minority and non-operating project or equity interests and/or royalty interests. Liberty Metals & Mining, a wholly owned subsidiary of Boston-based insurance giant Liberty Mutual Group, acquired approximately 15m shares (approximately 15.0% stake in the company) for C$40m on January 16, 2012. Alderon intends to use the net proceeds of the placement primarily to fund the drilling program and feasibility study for the Kami project, to secure long-lead-time equipment and for general and administrative expenses. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 27 MARCH 22, 2012
Potentially a long-term supporter. We expect Liberty Metals & Mining will be a long-term investor and will continue to support Alderon through the construction stage at Kami. Under the terms of the January 2012 subscription agreement, Liberty Metals & Mining has a pre-emptive right to participate in future equity financings by Alderon, and we believe it will do so.
Valuation
Our primary asset valuation approach for Alderon is P/NAV; our NAV is based on a discounted cash flow analysis (at an 8% discount rate) using the US$/C$ exchange rate and iron ore price assumptions summarized in Exhibit 2 on page 4. Our estimated net asset value is C$6.70/share (see Exhibit 6) after an assumed C$1.2b financing to fund development and construction of the Kami project. We apply a 0.5x target multiple to our primary asset NAV and a 1.0x multiple to current working capital to derive our one-year target price of C$4/share. We believe a 0.5x target multiple is appropriate, given the relative risk of successful start-up. In our view, the risk associated with the long-term development of a mineral deposit is offset in Alderon’s case by its experienced and well-connected management team and by the Kami project’s proximity to mature mines, which reduces permitting and infrastructure risk. Exhibit 6: Alderon net asset value details NPV (8%) (C$m) Kami—NPV estimate of future cash flows Current working capital Expected proceeds from options and warrants Total capital expenditure requirement (attributable to ADV) Portion of capex to be financed by debt Portion of capex to be financed by equity NAV Current number of basic shares outstanding (m) Number of shares to be issued at an assumed C$3.25/share (m)
1,213 -15 19 1,200 720 481 1,698 97.7 148.0
Options with exercise price of C$2.09/share (m)
2.8
Warrants with exercise price of C$2.76/share (m)
4.9
Pro forma fully diluted shares outstanding (m) NPV/share (C$)
253.3 6.70
Source: Desjardins Capital Markets
Recommendation We are initiating coverage of Alderon Iron Ore Corp. with a Hold–Speculative rating and C$4/share one-year target price, which implies an expected return of 29% to the current share price. We believe the Alderon team is highly experienced in mine development and operations, and we expect the company will maximize the value from its Kami property over the next few years. The property is in close proximity to existing and mature infrastructure and benefits from low expected operating costs (due to low stripping ratios and minimal processing required to prepare the ore for sale as sinter feed). However, we believe that the company’s share price already reflects its strong management team, the relatively advanced stage of development at Kami and the relatively low anticipated capex and operating costs. Relative to our coverage universe, Alderon shares are fairly valued and offer limited upside at this time. Please see Exhibit 1 on page 4 for a comparative analysis of iron ore–focused equities in our coverage universe.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 28 MARCH 22, 2012
Risks
We have a ‘Speculative’ risk qualifier for Alderon. Start-up and operating risk. There is a significant risk that the exploration, development and completion of the Kami iron ore project could be delayed due to circumstances beyond Alderon’s control. Setbacks could include delays in finding a strategic partner, securing financing or in construction or commissioning. Ability to secure financing. The development of the Kami project will require significant capital, and there is no assurance that Alderon will be able to obtain financing at favourable rates. Alderon may be unable to invest capital for its development and exploration programs, take advantage of business opportunities or respond to competitive pressures. Iron ore prices. The company’s future profitability is directly related to the volume of iron ore products sold and the price of these products. Iron ore prices have historically been volatile and are primarily affected by the demand for, and price of, steel. Iron ore prices are also affected by numerous other factors beyond the company’s control, including global and regional demand, political and economic conditions, and global production volumes and operating costs. Foreign exchange. Once in production, Alderon will be subject to foreign exchange risk because revenues will be received in US dollars while operating costs will be in Canadian dollars. Fluctuations in exchange rates, principally the US$/C$ exchange rate, can significantly impact earnings and cash flows. Licences and permits. The exploration and development activities at Kami require permits and approvals from various government authorities and are subject to federal, provincial and local laws. The company will be required to obtain additional licences and permits to continue and expand its development activities, and there can be no guarantee that these licences will be obtained or maintained. There is also a risk that future legislation and regulations could result in additional expenses in Kami’s operations and in reclamation obligations, the extent of which cannot be predicted. Aboriginal land rights. The Kami property falls within an area where five different aboriginal parties from three different aboriginal groups assert their rights and title. Aboriginal assertions to traditional rights and title on the property between the aboriginal groups may have an impact on the company’s ability to develop the Kami property. Alderon is engaged in meaningful discussions with the five aboriginal groups that have asserted rights and title or that have traditional territories in proximity to the Kami property: Innu Nation—a memorandum of understanding (MOU) was signed in August 2010 Matimekush-Lac John—consultation with the company is ongoing Naskapi Nation of Kawawachikamach—consultation with the company is ongoing NunatuKavut Community Council (NCC)—consultation with the company is ongoing Uashat mak Mani-Utenam—consultation with the company is ongoing
Key management and directors Mark Morabito, Executive Chairman. Mr Morabito has a background in corporate finance and securities law; he has over 15 years of experience in public markets, with a strong focus on junior mining and small business venture capital, as well as extensive experience in capital-raising and corporate development. Mr Morabito obtained a BA from Simon Fraser University and completed his JD at the University of Western Ontario. Stan Bharti, Vice-Chairman. Mr Bharti brings over 25 years of business, management and financing experience to Alderon. In the last 10 years, he has been involved in acquiring, restructuring and financing public companies, and has raised over C$2b in public markets in the last five years. His experience in public markets includes acquisitions of companies in Europe, Australia and North America. Mr Bharti has held several positions (including CEO) with Consolidated Thompson Iron Mines Ltd. (2005–09). He holds a Master’s degree in engineering from Moscow, Russia, and the University of London, England. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Alderon Iron Ore Corp.
PAGE 29 MARCH 22, 2012
Tayfun Eldem, President, CEO and director. Mr Eldem worked for the Iron Ore Company of Canada for more than 20 years. During this period, he held many senior roles including Vice-President, Expansion Projects & Engineering and Vice-President, Operations & Engineering. Mr Eldem holds a Bachelor of Engineering degree from Dalhousie University, along with Operations & Strategic Management Certificates from the Richard Ivey School of Business and London Business School. Keith Santorelli, CFO. Mr Santorelli has over 16 years of experience, including three years with a publicly traded biopharmaceutical company as Vice-President, Finance. He has wide-ranging expertise in various areas of complex US GAAP and IFRS accounting in both publicly traded and private companies in the US, Canada and internationally. Mr Santorelli holds a Bachelor’s degree in Accountancy from the University of Massachusetts and an MA from McGill University. Bernard Potvin, Executive Vice-President, Project Execution. Mr Potvin has over 37 years of experience in mining and processing operations. He has held senior roles at Québec Cartier Mining Company, Canadian Reynolds Metals, Alcoa Primary Metals Group, Alcoa Primary Growth Group and the Iron Ore Company of Canada. During his tenure at IOC, Mr Potvin was General Manager of Expansion Projects, and successfully managed greenfield and brownfield expansion projects in Labrador City and Sept-Îles. Mr Potvin holds a Mechanical Engineering degree from Laval University. Danny Williams, Special Advisor to the Chairman. Mr Williams served as Premier of Newfoundland and Labrador from October 2003 until his retirement in November 2010. In addition to his distinguished public service career, Mr Williams has been deeply involved in private sector business development in the province, including in his position as President of offshore oil & gas supply and services company OIS Fisher (later Spectrol). Mr Williams studied political science and economics at Memorial University of Newfoundland. Awarded the Rhodes scholarship in 1969, he received a degree in Arts in Law from Oxford University in England, and returned to Canada to earn a Bachelor of Law degree from Dalhousie University in Halifax. He practised law in Newfoundland and Labrador beginning in 1972 and was appointed Queen’s Counsel in 1984.
Jackie Przybylowski, P.Eng.
Desjardins
Champion Minerals Inc.
Capital Markets
PAGE 30 MARCH 22, 2012
Champion Minerals Inc. (CHM C$1.68, TSX)
Portfolio of prospective assets in a mature region; initiating coverage with a Buy rating and C$3 target price
Rating Target Valuation
Buy–Speculative C$3.00 0.5x NAV (8%)
Symbol Exchange Sector
CHM TSX Bulk Commodities
President & CEO Tom Larsen Website www.championminerals.com Share price C$1.68 Potential return 79% 52-week range C$0.77–2.46 3m volume traded 775,000 1m volume traded 635,000 Shares O/S* 88m Dividend yield Reported cash* Cash/sh* Reported total debt* Reported book value/sh* Current market cap Current EV
0% C$16m C$0.18 C$1m C$0.77 C$182m C$173m
Resources (100% basis at asset level) Measured 8Mt at 35.0% Fe Indicated 392Mt at 30.5% Fe Inferred 1,823Mt at 25.5% Fe
There is potential for significant upside as the properties are developed or sold, as we assign only a nominal value to most of Champion Minerals’ assets at this time We are initiating coverage with a Buy–Speculative rating and C$3/share target price Highlights. Champion Minerals has the most prospective collection of land claims in the Fermont, Québec, region, with a portfolio of 17 iron ore properties separated into three clusters. The company is currently working to develop its Fire Lake North property. We expect that the company will concurrently develop the nearby Oil Can deposit to advance nearterm production of the valuable coarse-grained hematite ores found at both sites and to optimize development and operating costs for the overall operation. Valuation. Our valuation is based on a 0.5x multiple applied to our Fire Lake North net asset value and a 1.0x multiple to current net working capital. In our view, several of Champion Minerals’ other properties could be sold to raise funds for the development of Fire Lake North. We currently assign a value of only C$50m for the present exploration value of Champion Minerals’ other assets. However, we note that there is potential for considerable upside to our estimates if one or more of these assets is monetized. The strategic location of Champion Minerals’ properties within the Fermont region could offer valuable synergies with nearby mining operations, processing facilities and infrastructure. In our view, ArcelorMittal Mines Canada and Cliffs Natural Resources are best positioned to realize these synergies, based on the nearby locations of their existing operations. Recommendation. We are initiating coverage of Champion Minerals Inc. with a Buy–Speculative rating and C$3/share one-year target price, which implies an expected return of 79% to the current share price.
Asset (C$m) 2 1 0 6 4 2 0 Mar-11
Source: Bloomberg
Jackie Przybylowski, P.Eng.
Champion Minerals fully financed NAV estimate
3
Volume (m)
* As at December 31, 2011 Source: Desjardins Capital Markets, Capital IQ, company reports
Champion Minerals has substantial land holdings, with a portfolio of 17 iron ore properties located in close proximity to ArcelorMittal Mines Canada’s and Cliffs Natural Resources’ assets in the Fermont, Québec, region
Price (C$)
Champion Minerals Inc.
Jun-11
Sep-11
Dec-11
Feb-12
Fire Lake North Other assets NPV multiple (x) Current working capital Current long-term debt Corporate adjustments Proceeds from options and warrants Anticipated financing Reported basic shares O/S (m) Shares O/S post financing (m) NAV NAV/share (C$) Source: Desjardins Capital Markets
NPV (8%)
NPV (10%)
1,199 50 0.50 50 0 -33 24 1,600 88 445 1,930 4.34
893 50 0.50 50 0 -31 24 1,600 88 445 1,626 3.66
Desjardins Capital Markets
Champion Minerals Inc.
PAGE 31 MARCH 22, 2012
Company overview
Champion Minerals is one of the largest landholders in the Fermont, Québec, region, with a portfolio of 17 iron ore properties separated into three clusters. The town of Fermont is home to ArcelorMittal Mines Canada’s mature Mont Wright mine and has ready access to power, roads and the Québec North Shore & Labrador Railway (QNS&L) common carrier rail network. Champion Minerals is currently focused on the development of its Fire Lake North property but has also explored other projects nearby in Clusters 1 and 2. Exhibit 1: Detailed map of Champion Minerals’ Fermont properties
Source: Company reports
Jackie Przybylowski, P.Eng.
Desjardins
Champion Minerals Inc.
Capital Markets
PAGE 32 MARCH 22, 2012
Anticipated catalysts
Mineral resource estimate at Oil Can expected in 1Q12 Mineral resource estimate at Moire Lake expected in 1Q12 after Oil Can Feasibility on Fire Lake North expected in 3Q12 PEA on Oil Can expected to be completed during 1H12 Construction of Fire Lake North mine and concentrator expected to start in late 2013 Production at Fire Lake North expected to start in early 2016
Portfolio of prospective assets in a mature region
Champion Minerals owns a portfolio of 17 iron ore properties in the Fermont region. The properties are separated into three clusters, based on geographic proximity to infrastructure and existing mining operations. Please see Exhibit 2 for a summary of the currently available reserve and resource estimates for Champion Minerals’ properties. Cluster 1 includes the Moire Lake (Lac Moire) property, which is adjacent to ArcelorMittal Mines Canada’s Mont Wright mine and close to Cliffs Natural Resources’ Bloom Lake mine. Cluster 2 contains Champion Minerals’ most advanced assets, including Fire Lake North, Oil Can, Bellechasse and Harvey-Tuttle. The assets are adjacent to Cliffs’ Lamêlée and Peppler deposits and ArcelorMittal Mines Canada’s Fire Lake mine, which operates seasonally. Cluster 3 is furthest from development. The properties surround ArcelorMittal Mines Canada’s Mont Reed deposit. Exhibit 2: Total estimated iron ore resources Measured resources Tonnes (m)
Indicated resources % Fe
Tonnes (m)
Inferred resources % Fe
Tonnes (m)
% Fe
Bellechasse
-
-
-
-
215
28.7
Fire Lake North
8
35.0
392
30.5
661
27.7
Harvey-Tuttle
-
-
-
-
947
23.2
Total
8
35.0
392
30.5
1,823
25.5
Source: Company reports
Potential for a number of consecutive operations. Champion Minerals is presently focused on the development of its flagship Fire Lake North project (Champion Minerals holds an 82.5% stake, with Fancamp Exploration Ltd. holding the remaining 17.5% interest) and on the exploration of other deposits in Cluster 2. Further drilling and exploration on Champion Minerals’ extensive land package could justify the development of mines to feed ore through the Fire Lake North concentrator (such as the nearby Oil Can deposit), or the development of additional standalone operations. Our current estimates reflect only the development of Fire Lake North. All other deposits combined are assigned a nominal value of only C$50m for exploration potential. As Champion Minerals moves to develop these assets, they could represent additional upside to our current estimates. Drill results at Fire Lake North have delineated regions of coarse-grained ore. The deposit contains a blend of high-grade coarse specular hematite and meta-taconite mineralization, which is typical of the region. The specular hematite is a desirable product because it produces a high-quality sinter feed, which could command a premium price. Due to its coarse grain size, the material does not have to be finely ground to liberate the ore; grind size of 0.6–0.7mm is expected to be sufficient (vs about 0.42mm for typical meta-taconite or 0.045mm for taconite). Hematite also does not require magnetic separation to produce a high-grade concentrate, which should reduce both development capital costs and ongoing operating costs in the near term.
Jackie Przybylowski, P.Eng.
Plans to produce a concentrate product. Champion Minerals intends to produce concentrate-for-sale from the Fire Lake North property. Due to the coarse grain size of the ore, Fire Lake North and Oil Can ores are expected to be highly
Desjardins Capital Markets
Champion Minerals Inc.
PAGE 33 MARCH 22, 2012
desirable sinter feed products. The company envisions a concentrator that will produce approximately 10Mtpa concentrate in the first five years of minelife and an average 8.7Mtpa concentrate in the first 25 years of minelife. Construction of the mine and concentrator is expected to start in late 2013 after all permits are received. We expect the company will begin mining in early 2016. Capex. We estimate that the total capital costs to develop Fire Lake North will be about US$1,650m, above the company’s estimate of C$1,368m (US$1,368m assuming US$/C$ parity). Our detailed capital cost assumptions are shown in Exhibit 3. Exhibit 3: Expected capital cost at Fire Lake North (US$m) Mine
125
Crusher and concentrator
550
Rail
250
Port
200
Power
75
Other
450
Total
1,650
Source: Desjardins Capital Markets
Rail costs could be reduced with Plan Nord support. We currently assume that Champion Minerals will build a 62km rail spur to connect its properties to the QNS&L. Our US$250m cost estimate equates to approximately US$4m per kilometre of rail to be constructed, which is in line with industry estimates of US$3–5m per kilometre of rail constructed. However, any potential rail construction subsidized by the government’s Plan Nord program could reduce the cost to Champion Minerals. Rail partnership is another option, but this is not likely to result in capital cost savings. As noted in the Adriana Resources Inc. section, it is possible that existing producers and developers such as Champion Minerals could join together to build and operate a new rail line in the Labrador Trough region. Although this could result in operating cost savings for Champion Minerals, we do not anticipate that development capex would be significantly different, as Champion Minerals would be expected to contribute a comparable amount to the partnership. Port construction will be completed through Plan Nord. We expect that Champion Minerals will participate in the new multi-user port at Pointe-Noire, completion of which is planned for 2014, well before first sales at Fire Lake North. We have allocated US$200m in our capital cost estimate to Champion Minerals’ share of port costs, which include the cost of stockpile facilities and dedicated stacker/reclaimer equipment. High strip ratio is the biggest contributor to costs. We anticipate that operating costs at Fire Lake North will be relatively high compared with the other operations in our coverage universe. Although we assume similar per-unit mining costs for Fire Lake North and Kami, the cost per tonne of concentrate produced at Fire Lake North is high due to the large volumes of waste that must be moved. For example, the November 2011 preliminary economic assessment (PEA) study estimates the life-of-mine strip ratio at Fire Lake North at 3.6:1 vs the life-of-mine strip ratio of 2.16:1 at Alderon’s Rose Central property (this is expected to decrease with further pit optimization) and 1.07:1 at its Mills Lake deposit, and approximately 1:1 at Cliffs’ Bloom Lake mine. See Exhibit 4 for our operating cost assumptions for Fire Lake North. Exhibit 4: Expected long-run cash operating costs at Fire Lake North (US$/t concentrate) Mining Crusher and concentrator Transport/loading
Jackie Przybylowski, P.Eng.
27.00 7.00 18.00
G&A
2.00
Total
54.00
Source: Desjardins Capital Markets
Desjardins Capital Markets
Champion Minerals Inc.
PAGE 34 MARCH 22, 2012
Not included in our estimate of operating cost is a 3% net smelter return (NSR) royalty payable to Fancamp and Sheridan Platinum Group Ltd. The royalty may be reduced to 2% in exchange for a C$3m payment. Champion Minerals completed the acquisition of its majority stake in Fire Lake North from Fancamp and Sheridan in July 2010. Opportunity to refine the operating plan. Champion Minerals’ current economic assessment is based on plans to mine from Fire Lake North and to process at a concentrator onsite. However, we expect this plan will be further refined to maximize the economic benefit once additional exploration results are available. Specifically, Champion Minerals could coordinate the concurrent development and mining of Fire Lake North and nearby Oil Can, where early drill results indicate further zones of coarse-grained hematite similar to the coarse specular hematite at Fire Lake North. Focusing on the hematite deposits first would accelerate any premiums paid to Champion Minerals for the high-quality ore and also ensure lower capital costs in the early years as magnetic separation would likely be unnecessary on start-up.
Capital structure Champion Minerals Inc. is listed on the Toronto Stock Exchange under the symbol ‘CHM’. As at December 31, 2011, Champion Minerals had approximately 88.0m shares and 19.4m options and warrants outstanding. The company does not have a strategic partner or investor. Individuals and insiders hold approximately 5.6% of the shares outstanding, including CEO Tom Larsen’s 2.6% stake. Recent C$30m financing will fund near-term activities. Champion Minerals recently announced a bought deal financing of 15m shares for C$30m. An over-allotment option gives the underwriters the option to acquire an additional 2.25m shares, which would increase the total size of the offering to C$34.5m. Proceeds will be used for exploration and development and for general working capital purposes. The offering closed on March 12, 2012. Following the financing (including the over-allotment option), we expect Champion Minerals will have a cash balance of C$57m, sufficient to fund exploration activities in 2012. Not expecting a strategic partner right now. We believe Champion Minerals will continue exploration and development activities at its development projects, including Fire Lake North, without seeking a strategic investor. We believe Champion Minerals is looking to divest of a portion of its sizeable land package. Champion Minerals could sell one or more of its non-core assets in order to fund construction of its flagship Fire Lake North project. The strategic location of the company’s 17 properties within the Fermont region could offer valuable synergies with nearby mining operations, processing facilities and infrastructure. In our view, ArcelorMittal Mines Canada and Cliffs are best positioned to realize synergies based on the location of their existing operations. Sale of the entire company or Fire Lake North is a second (although much less likely) possibility. Although Champion Minerals is currently focused on moving Fire Lake North into production, we believe the property is a natural fit with ArcelorMittal Mines Canada’s Fire Lake mine or Cliffs’ Lamêlée and Peppler deposits. Development of Fire Lake North in combination with either of these neighbouring properties could reduce duplication of processing facilities and/or infrastructure, and would maximize the value of all deposits in the Fermont area.
Valuation Our primary asset valuation approach for Champion Minerals is P/NAV; our NAV is based on a discounted cash flow analysis (at an 8% discount rate) using the US$/C$ exchange rate and iron ore price assumptions summarized in Exhibit 2 on page 4. Our estimated net asset value is C$4.34/share (see Exhibit 5) after an assumed C$1.6b financing to fund development and construction of the Fire Lake North project. We apply a 0.5x target multiple to our primary asset NAV and a 1.0x multiple to current working capital to derive our one-year target price of C$3/share. We believe that a 0.5x target multiple is appropriate, given the relative risk of successful financing, construction and start-up.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Champion Minerals Inc.
PAGE 35 MARCH 22, 2012
Exhibit 5: Champion Minerals net asset value details NPV (8%) (C$m) Fire Lake North—NPV estimate of future cash flows Exploration properties Current working capital Expected proceeds from options and warrants Total capital expenditure requirement Portion of capex to be financed by debt Portion of capex to be financed by equity NAV
1,168 50 50 24 1,600 960 640 1,930
Current number of basic shares outstanding (m) Number of shares to be issued at an assumed C$2.00/share (m) Options with exercise price of C$1.04/share (m) Warrants with exercise price of C$1.55/share (m) Pro forma fully diluted shares outstanding (m) NPV/share (C$)
105.3 320.0 12.5 6.9 444.7 4.34
Source: Desjardins Capital Markets
Recommendation We are initiating coverage of Champion Minerals Inc. with a Buy–Speculative rating and C$3/share one-year target price, which implies an expected return of 79% to the current share price. Potential for significant upside as properties are developed or sold. At this time, we attribute value only to Champion Minerals’ Fire Lake North project. A further C$50m is added for the current value of exploration properties in our net asset value estimate. However, as properties continue to be drilled and explored, or as non-core properties are monetized, the value attributed to these other assets could increase materially.
Risks We have a ‘Speculative’ risk qualifier for Champion Minerals. Start-up and operating risk. There is a significant risk that the exploration, development and completion of the Fire Lake North project and other projects owned by Champion Minerals could be delayed due to circumstances beyond the company’s control. Setbacks could include delays in finding a strategic or offtake partner, securing financing or in construction or commissioning. Ability to secure financing. The development of Fire Lake North or other Champion Minerals projects will require significant financing, and there is no assurance that Champion Minerals will be able to obtain financing at favourable rates. The company may be unable to invest capital for its development and exploration programs, take advantage of business opportunities or respond to competitive pressures. Iron ore prices. The company’s future profitability is directly related to the volume of iron ore products sold and the price of these products. Iron ore prices have historically been volatile and are primarily affected by the demand for, and price of, steel. Iron ore prices are also affected by numerous other factors beyond the company’s control, including global and regional demand, political and economic conditions, and global production volumes and operating costs. Foreign exchange. Once in production, Champion Minerals will be subject to foreign exchange risk as revenues will be received in US dollars while operating costs will be in Canadian dollars. Fluctuations in exchange rates, principally the US$/C$ exchange rate, can significantly impact earnings and cash flows.
Jackie Przybylowski, P.Eng.
Licences and permits. The exploration and development activities at Fire Lake North and Champion Minerals’ other properties require permits and approvals from various government authorities and are subject to federal, provincial and local laws. The company will be required to obtain additional licences and permits to continue and expand its development activities, and there can be no guarantee that these licences will be obtained or maintained. There is also a risk that future legislation and regulations will result in additional expenses in Champion Minerals’ operations and in reclamation obligations, the extent of which cannot be predicted.
Desjardins Capital Markets
Champion Minerals Inc.
PAGE 36 MARCH 22, 2012
First Nations land claims. Champion Minerals has recognized the claims of Innu Takuaikan Uashat mak Mani-Utenam on its lands, including the Fire Lake North deposit and proposed rail spur line corridor. Champion Minerals has reported that advanced discussions with the group are ongoing.
Key management and directors Tom Larsen, Chairman, President and CEO. Mr Larsen has held the role of President and CEO of the company since 2006. He has over 30 years of experience in the investment industry, specializing in corporate finance and management of junior mining companies. Prior to joining Champion Minerals, Mr Larsen held senior executive positions at a number of junior resource companies where he was also involved in corporate finance and management activities. He is a director of Eloro Resources Ltd., Northfield Metals Inc. and Bear Lake Gold Ltd. Mr Larsen is a member of the company’s Environmental, Health and Safety Committee. Alexander Horvath, Executive Vice-President, Exploration and director. Mr Horvath joined Champion Minerals as a director in September 2007 and was appointed Executive Vice-President, Exploration in March 2008; he brings over 28 years of experience in mineral exploration and mining. Since 2006, Mr Horvath has been President of A.S. Horvath Engineering Inc., an Ottawa-based exploration/mining geological services firm. He also spent over 20 years with Asarco Inc. and its associated international subsidiaries in Canada, Portugal and French Guyana in progressively senior operational roles, where he was involved in managing base and precious metals exploration, mineral resource estimates, feasibility studies, reserves audits and acquisition due diligence reviews. Mr Horvath is currently a director of Bear Lake Gold Ltd. and Eloro Resources Ltd. He is a member of the company’s Compensation and Nominating Committee and Environmental, Health and Safety Committee. Martin Bourgoin, Executive Vice-President, Operations. Mr Bourgoin joined Champion Minerals as Executive VicePresident in December 2007, bringing with him over 25 years of experience in both mining and exploration program management. Since 1999, Mr Bourgoin has been President of MRB & Associates, a Val D’Or, Québec–based geological consulting firm. Prior to founding MRB & Associates, Mr Bourgoin worked as Chief Geologist at Sigma Mines, a worldclass gold mine located in Val D’Or; he has held similar positions with Placer Dome Inc. and Agnico-Eagle Mines Ltd. Mr Bourgoin holds a Bachelor of Science degree in geology from the University of New Brunswick and is a member of Ordre des géologues du Québec. Jeff Hussey, Executive Vice-President, Development. Mr Hussey was appointed to the position of Executive VicePresident, Development in March 2011; he joined Champion Minerals as Vice-President, Exploration in February 2008, bringing with him over 25 years of international exploration and mining experience, including 19 years with Noranda Inc. and Falconbridge Ltd. (now part of Xstrata Plc). Mr Hussey also worked at Brunswick Mines, Mines Gaspe and the Antamina mine start-up in Peru. He has also worked as a senior scientist with the mining group at the Noranda Technology Centre and as general foreman, open pits and surface projects, at Raglan Mines, where he led Six Sigma optimization projects for the concentrator and surface projects departments. Mr Hussey holds a Bachelor of Science degree in geology from the University of New Brunswick. Richard Quesnel, Senior Technical Advisor and Head of Advisory Board. Mr Quesnel was named as the company’s senior technical advisor in September 2011. He brings over 30 years of senior mine management and engineering experience to Champion Minerals. Most recently, Mr Quesnel served for more than five years as President and CEO of Consolidated Thompson Iron Mines Inc. During his tenure at Consolidated Thompson, Mr Quesnel was responsible for the successful construction and production ramp-up of the Bloom Lake iron ore mine as well as the construction of a rail spur line and ore-handling facilities near the port of Pointe-Noire. Under Mr Quesnel’s guidance, Bloom Lake entered into commercial production in early 2010, on schedule and just four years after completion of its feasibility study. Mr Quesnel and the Consolidated Thompson team raised over C$850m in financing, negotiated and concluded a C$240m strategic investment by Wuhan Iron and Steel Group Corporation (WISCO), and completed offtake agreements with WISCO, Worldlink Resources Ltd. of China and SK Networks Co. Ltd. Miles Nagamatsu, CFO. Mr Nagamatsu joined Champion Minerals as CFO in March 2006, bringing with him over 30 years of experience in accounting, management, lending, restructurings and turnarounds. Since 1993, Mr Nagamatsu has acted as CFO at public and private companies, primarily in the mineral exploration and investment management sectors. Mr Nagamatsu has served as volunteer Treasurer and director of Cystic Fibrosis Canada for over 25 years. He holds a Bachelor of Commerce degree from McMaster University and is a Chartered Accountant. Jackie Przybylowski, P.Eng.
Desjardins
Labrador Iron Ore Royalty Corporation
Capital Markets PAGE 37 MARCH 22, 2012
Labrador Iron Ore Royalty Corporation (LIF.UN C$36.00, TSX)
Unique opportunity for income while still exposed to iron ore prices; initiating coverage with a Hold rating and C$43.50 target price
Rating Hold–Average Risk Target C$43.50 Valuation 12x NTM cash flow (50%) & 1x NAV (8%) (50%) Symbol Exchange Sector
LIF.UN TSX Bulk Commodities
President & CEO Bruce Bone Website www.labradorironore.com Unit price C$36.00 Potential return 21% 52-week range C$28.60–39.57 3m volume traded 125,000 1m volume traded 184,000 Units O/S* 64m Dividend yield 2.8% Reported cash* C$41m Cash/un* C$0.65 Reported total debt* C$248m Reported book value/un* C$4.28 Current market cap Current EV
C$2,289m C$2,495m
Resources (100% basis at asset level) Measured 227Mt at 39% Fe Indicated 864Mt at 38% Fe Inferred 1,372Mt at 38% Fe
Its equity stake in IOC offers leverage to iron ore prices and participation in IOC’s planned and future capacity expansion projects LIORC’s royalty revenue stream limits downside risk as the royalties are not influenced by operating costs, capital spending requirements, tax rates or financing costs We are initiating coverage with a Hold–Average Risk rating and C$43.50/unit target price Highlights. Labrador Iron Ore Royalty Corporation (LIORC) is not a mine operator or developer. Rather, its revenues are directly tied to the sales and earnings performance of the Iron Ore Company of Canada (IOC) through royalty and commission payments and its 15.10% equity stake in IOC. As the company itself has minimal overhead and operating costs, LIORC offers its unitholders a very high payout ratio (average 80% over the past three years). Valuation. Because LIORC’s units are valued both for near-term income as well as for the long-term value of the company’s equity stake in IOC and its other revenue streams, we have applied a hybrid 12.0x P/CF (NTM) (50%) and 1.0x P/NAV (8%) (50%) multiple to our estimates to derive our target price. Recommendation. We are initiating coverage of Labrador Iron Ore Royalty Corporation with a Hold–Average Risk rating and C$43.50/unit one-year target price, which implies an expected total return of 24% to the current unit price. Although we expect historically high prices will be sustained in the short term by strong demand, we see a risk of lower iron ore commodity prices in the long term as new mines increase the risk of market oversupply. We view LIORC as a safe alternative in weak markets, and believe it is the best choice among the iron ore–focused equities in our coverage universe in an environment of falling prices. Royalty and commission revenues, which constitute a material proportion of the corporation’s revenue base, are relatively unaffected by changes in iron ore commodity prices as they are not influenced by operating costs, capital spending requirements, tax rates or financing costs.
Asset (C$m) 35 30 25 1.5 1.0 0.5 0.0 Mar-11
Source: Bloomberg
Jackie Przybylowski, P.Eng.
LIORC NAV estimate
40
Volume (m)
* As at December 31, 2011 Source: Desjardins Capital Markets, Capital IQ, company reports
LIORC represents a unique opportunity for income in the bulk commodities sector as it offers a high dividend yield relative to most mining companies
Price (C$)
Labrador Iron Ore Royalty Corporation
Jun-11
Sep-11
Dec-11
Feb-12
IOC royalties IOC commissions IOC dividends NPV multiple (x) Current working capital Current long-term debt Corporate adjustments Reported basic units O/S (m) NAV NAV/share (C$) Source: Desjardins Capital Markets
NPV (8%)
NPV (10%)
2,318 26 1,220 1.00 69 0 -10 64 3,623 56.62
2,037 23 1,074 1.00 69 0 -9 64 3,193 49.89
Desjardins Capital Markets
Labrador Iron Ore Royalty Corporation
PAGE 38 MARCH 22, 2012
Company overview
Labrador Iron Ore Royalty Corporation (LIORC) is not a mine operator or developer. Rather, its revenues are directly tied to the sales and earnings performance of the Iron Ore Company of Canada (IOC) through royalty and commission payments and its equity stake in IOC. Royalty. LIORC holds 12 long-term leases and six licences from the government of Newfoundland and Labrador. Under a long-term agreement, LIORC has granted IOC the rights to mine 100% of the ore on those lands in exchange for a 7% gross overriding royalty on all iron ore products at Carol Lake sold by IOC. Commissions. LIORC also receives a commission fee of C$0.10/t on all iron ore products sold by IOC. We note that commissions are not currently a material revenue stream relative to the royalty and dividends. Equity. LIORC owns a total equity interest of 15.10% in IOC and controls two seats on the IOC board of directors. The other equity partners are majority shareholder and operator Rio Tinto (58.72%) and Mitsubishi Corporation (26.18%). The IOC board typically declares dividends to its shareholders on a semi-annual basis, depending on its earnings and capital requirements. LIORC is entitled to its proportionate 15.10% share of the declared dividends. Participation in iron ore commodity prices and IOC growth expansion through equity interest. LIORC unitholders should benefit from the current expansion at IOC’s Carol Lake mine (IOC’s only producing mine operation), as we expect IOC to expand concentrate production capacity from 18.4Mtpa to 26Mtpa by 2016. Plans by majority shareholder and operator Rio Tinto to expand further to 50Mtpa are not reflected in our forecasts and would represent upside to our estimates. Exhibit 1: Carol Lake pits
Source: Company reports
Anticipated catalysts Commissioning Phase 1 expansion expected in early 2012 IOC board approval of Phase 3 expansion expected in 1H12 Completion of Phase 2 expansion expected in late 2012 and commissioning in early 2013 Commissioning of Phase 3 expansion expected in early 2016
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Labrador Iron Ore Royalty Corporation
PAGE 39 MARCH 22, 2012
Carol Lake
Carol Lake has approximately 1.4Bt of ore reserves, which implies a minelife of over 30 years from the existing reserve base at current production rates, and an additional 2.5Bt of resources (Exhibit 2). Exhibit 2: Total estimated iron ore reserves and resources (IOC 100%) at Carol Lake as at December 31, 2011 Tonnes (m)
% Fe
Proven reserves
844
38
Probable reserves
530
38
1,374
38
Measured resources
227
39
Indicated resources
864
38
Total reserves
Inferred resources
1,372
38
Total resources
2,463
38
Source: Company reports
Facilities at Carol Lake include two active mining pits (Humphrey Main and Luce), a concentrator and pellet plant. IOC’s concentrate production capacity has historically been approximately 18.4Mtpa although this is somewhat dependent on product mix. The capacity of the pellet plant is approximately 13.0Mtpa and ore that is not pelletized is typically sold as concentrate-for-sale for sinter feed. Mining costs at the mature producer are expected to fall slightly in the long term as the expansion increases total iron production and sales volumes. As illustrated in Exhibit 3, we estimate that the long-term average cash operating costs at Carol Lake will be approximately US$62/t concentrate. Exhibit 3: Expected long-run cash operating costs at Carol Lake (US$/t) Concentrate unit costs
US$/t concentrate
Pellet unit costs
US$/t pellet
50 20
Average cash operating costs
US$/t concentrate
62
Source: Desjardins Capital Markets
Three-phased expansion underway. IOC has outlined a plan to expand the concentrate production capacity at the Carol Lake operation from 18.4Mtpa to 26Mtpa in three phases. At this time, the company does not plan to increase pelletizing capacity. Please see Exhibit 4 for a summary of our development capital cost assumptions for the expansion project. Phase 1 increased concentrate production capacity to 22.0Mtpa from 18.4Mtpa and cost US$486m. Pellet capacity was unchanged at approximately 13.0Mtpa. Construction has been completed and the project is currently being commissioned. Phase 2 is expected to increase concentrate capacity to 23.3Mtpa at a cost of approximately US$300m. IOC started construction of Phase 2 in early 2011 and has spent approximately US$100m on the project to date. We expect first production from this phase of the expansion by late 2012, with commissioning completed in early 2013. Phase 3 could increase concentrate capacity further to 26Mtpa. We anticipate that the IOC board of directors will approve the third phase shortly. While the company has not announced a cost estimate or project timeline for the Phase 3 expansion, we are assuming that the project will cost approximately US$600m and that it will be commissioned by early 2016. Potential for further expansion in the long term. Rio Tinto has indicated (see Exhibit 5) that capacity at Carol Lake could expand further to 50Mtpa in the long term; however, we have not included any further expansion in our estimates. We do not believe the current concentrator and pellet plant site have space for such an aggressive Jackie Przybylowski, P.Eng.
Desjardins
Labrador Iron Ore Royalty Corporation
Capital Markets PAGE 40 MARCH 22, 2012
expansion; we speculate that additional expansion could be achieved through the development of a third mine and the construction of a second concentrator facility. Exhibit 4: Remaining capital costs for Phase 2 and Phase 3 expansion (IOC 100%) (US$m) Phase 2 expansion
200
Phase 3 expansion
600
Total
800
Source: Desjardins Capital Markets
Exhibit 5: IOC concentrate capacity could grow beyond 26Mtpa 80
(Mtpa)
60
50
40 26 20
18
0 Current
Concentrate expansion project (CEP)
New mine studies
Further options
Source: Rio Tinto plc company reports
Capital structure
Labrador Iron Ore Royalty Corporation units are listed on the Toronto Stock Exchange under the symbol ‘LIF.UN’. As at December 31, 2011, LIORC had 64m stapled units outstanding. Insider holdings are modest at 0.08%. LIORC was originally incorporated in 1995 as Labrador Iron Ore Royalty Income Fund and was structured as an income trust. LIORC converted to a corporation in July 2010 in anticipation of changes to Canada’s Income Tax Act, which became effective in 2011. Under the conversion, unitholders exchanged their units in the fund for shares in LIORC. LIORC also distributed C$248m in 12.08% subordinated notes to unitholders that trade alongside the shares as stapled units on the TSX. Each stapled unit consists of one common share and C$3.875 face amount of subordinated notes of LIORC that are entitled to interest payments of C$0.468/year. At the time of Labrador Iron Ore Royalty Income Fund’s conversion to a corporation, the stapled units represented the most tax-efficient arrangement for unitholders. An announcement by the Canadian government in July 2011 will increase taxes payable by stapled unit structures (expected to take effect in July 2012). Under the new proposals, interest paid on the debt portion of a stapled security is not deductible in computing the corporation’s income for tax purposes. Dividend policy. LIF.UN units are unique in our coverage universe because of their relatively high dividend yield. We assume that LIORC will maintain its regular distribution (dividend and interest on subordinated notes) of C$0.25/unit/quarter going forward. In addition, we expect LIORC will declare special dividends corresponding to the dividends paid to LIORC by IOC. As illustrated in Exhibit 6, special dividends paid to LIORC unitholders are generally highly correlated with the dividends that the corporation receives from IOC.
Jackie Przybylowski, P.Eng.
Desjardins
Labrador Iron Ore Royalty Corporation
Capital Markets PAGE 41 MARCH 22, 2012
Exhibit 6: Dividends paid to unitholders are generally highly correlated with dividends received from IOC 1.60 1.40
(C$/LIORC unit)
1.20 1.00 0.80 0.60 0.40 0.20
4Q12E
3Q12E
2Q12E
3Q11
2Q11
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
IOC dividend received by LIORC (per LIF unit)
1Q12E
Special dividend
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
Dividend
4Q11E
Interest payment
4Q07
3Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
0.00
Source: Desjardins Capital Markets, company reports
Valuation
Unique high-yield equity deserves a unique approach to valuation. LIORC pays a high dividend yield relative to most mining companies and is the only dividend-paying name in our coverage universe. We believe the company should be attractive to investors seeking steady income in addition to exposure to iron ore markets. We believe that a hybrid P/CF and P/NAV approach is appropriate in valuing LIORC as it places greater emphasis on the near-term distributions paid to unitholders. Our target price is weighted 50% to the value derived from P/CF (NTM) and 50% to the value derived from P/NAV (8%). Our 12.0x P/CF (NTM) target multiple considers the company’s expected near-term cash flows. LIORC’s relatively high yield is attractive to many investors and is an important factor in determining the unit price. Consensus operating cash flow per share is an effective proxy for distributions to unitholders, given LIORC’s high payout ratio (average 80% over the past three years). In our view, the average consensus P/CF (NTM) multiple for LIORC over the past five years (January 2007–December 2011) best reflects the appropriate target multiple. As illustrated in Exhibit 7, LIF.UN units have traded at an average of 12x consensus NTM CFPS over the past five years; we expect the units to continue to trade within this range. Exhibit 7: LIF.UN units trade at an average of 12x NTM cash flow 24
48
20
40
Average consensus P/CF (NTM) multiple Jan-07–Dec-11: 12x
32
12
24
8
16
4
8
Consensus P/CF (NTM) (LHS)
Jackie Przybylowski, P.Eng.
Source: Desjardins Capital Markets, Capital IQ
LIF unit price (RHS)
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
Jan-10
Oct-09
Jul-09
Apr-09
Jan-09
Oct-08
Jul-08
Apr-08
Jan-08
Oct-07
Jul-07
Apr-07
Jan-07
(x)
(C$)
16
Desjardins Capital Markets
Labrador Iron Ore Royalty Corporation
PAGE 42 MARCH 22, 2012
Our estimated net asset value is C$56.62/unit (see Exhibit 8). We apply a 1.0x multiple to our NAV; this is based on a discounted cash flow analysis (at an 8% discount rate) using the iron ore price forecast and US$/C$ exchange rate assumptions summarized in Exhibit 2 on page 4. We believe a 1.0x multiple is appropriate, given the relatively low risk associated with LIORC’s royalty and commission revenue streams and the corporation’s equity interest in IOC, a low-risk, long-lived, mature producer. Exhibit 8: Net asset value details NPV (8%) (C$m) IOC royalties IOC commissions
2,318 26
IOC dividends
1,220
Total primary assets
3,564
Current working capital Corporate adjustments NAV Number of units outstanding (m) NPV/unit (C$)
69 -10 3,623 64.0 56.62
Source: Desjardins Capital Markets
Recommendation
We are initiating coverage of Labrador Iron Ore Royalty Corporation with a Hold–Average Risk rating and C$43.50/unit one-year target price, which implies an expected total return of 24% to the current unit price. Unique opportunity for income in the bulk commodities sector. LIORC pays a high dividend yield relative to other miners, and we believe LIF.UN units are valued by investors seeking steady income in addition to exposure to the iron ore markets. In order to emphasize the near-term distributions to unitholders, we have applied a hybrid 12.0x P/CF (NTM) (50%) and 1.0x P/NAV (8%) (50%) multiple to derive our one-year target price. Some leverage to iron ore prices...Through LIORC’s equity stake in IOC, LIORC unitholders can participate in the strong iron ore commodity markets and benefit from planned and future capacity expansion projects. While we have reflected the current three-phase expansion program at Carol Lake in our forecasts, potential future expansion would represent upside to our estimates. …but royalty ‘hedge’ limits downside risk. LIORC’s royalty and commission-based revenues are relatively unaffected by changes in iron ore commodity prices, as the royalties and commissions are not influenced by operating costs, capital spending requirements, tax rates or financing costs.
Risks
We have an ‘Average’ risk qualifier for LIORC. Iron ore prices. Royalty payments to LIORC as well as IOC’s earnings are directly related to the volume of iron ore products sold and the price of these products. Iron ore prices have historically been volatile and are primarily affected by the demand for, and price of, steel. Iron ore prices are also affected by numerous other factors beyond the company’s control, including global and regional demand, political and economic conditions, and global production volumes and operating costs. Foreign exchange. A majority of IOC’s revenues are received in US dollars while operating costs are in Canadian dollars. Fluctuations in exchange rates, principally the US$/C$ exchange rate, can significantly impact earnings and cash flows. Additionally, the royalty payments received by LIORC are denominated in US dollars and hence its revenue in Canadian dollars is impacted by the US$/C$ exchange rate. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Labrador Iron Ore Royalty Corporation
PAGE 43 MARCH 22, 2012
Dependence on IOC. Royalty revenue is earned only when IOC mines and sells iron ore from the Carol Lake mine. A decision by IOC to cease operations or to mine iron ore elsewhere would eliminate revenue from the royalty. Dividend income from LIORC’s equity stake in IOC is also dependent upon IOC’s earnings and dividend policy. Licences and permits. IOC’s activities are subject to federal, provincial and local laws. Permits from a variety of regulatory authorities are required for many aspects of mining operations. There is also a risk that future legislation and regulations could result in additional expenses in IOC’s operations and in reclamation obligations, the extent of which cannot be predicted.
Key management and directors William J Corcoran, Chairman. Mr Corcoran has been a director of LIORC since 1995 and was elected Chairman in 2010. He is Vice-Chairman and an independent director at Jarislowsky Fraser Limited. Mr Corcoran has worked in the corporate finance area at ScotiaMcLeod. He is also a director at E-L Financial Corporation Limited. James C McCartney, Vice-Chairman and Executive Vice-President. Mr McCartney has been a director of LIORC since 1995 and was named Vice-Chairman of LIORC in May 2007. He is a retired partner and former Chairman of McCarthy Tétrault LLP and acts as counsel in the firm’s Corporate Finance and Mergers & Acquisitions Group. Bruce C Bone, President, CEO and director. Mr Bone serves as President and CEO of LIORC and has been a director since 1995. He also serves as a director of IOC. Mr Bone was previously Vice-President and Treasurer of Noranda Inc. Alan R Thomas, CFO and director. Mr Thomas, a Chartered Accountant, has been an LIORC director since 2004 and was appointed CFO in May 2007. Mr Thomas previously served as CFO of ShawCor Ltd. and Noranda Inc., and as a partner with Clarkson Gordon (now Ernst & Young). Mr Thomas is also a director of Teranga Gold Corporation. Duncan NR Jackman, director. Mr Jackman has been a director of LIORC since 2010. He also currently serves as the Chairman, CEO and President of E-L Financial Corporation Limited and Chairman of Algoma Central Corp., and as a director on a number of other boards, including The Empire Life Insurance Company, The Dominion of Canada General Insurance Company and First National Financial Corporation. Paul H Palmer, director. Mr Palmer has been a director of LIORC since 1995. He previously served as Vice-President of Finance at Global Atomic Fuels Corporation (formerly Global Uranium Corporation), Manager at Deloitte & Touche and in various roles including CFO at Sierra Health Services, Inc. Donald J Worth, director. Mr Worth has been a director of LIORC since 1995. He served as Vice-President of the Global Mining Group at the Canadian Imperial Bank of Commerce (CIBC) from July 1984 through August 1997. Prior to that, Mr Worth was the mining specialist at Canadian Imperial Bank of Commerce (Canada) in Toronto from 1964–84. Mr Worth is well known in the Canadian exploration and mining community and currently serves on the boards of Royal Gold Inc. and Sentry Select Capital Inc., in addition to LIORC.
Jackie Przybylowski, P.Eng.
Desjardins
Labrador Iron Mines Holdings Limited
Capital Markets PAGE 44 MARCH 22, 2012
Labrador Iron Mines Holdings Limited (LIM C$5.00, TSX)
Keeping it simple; initiating coverage with a Top Pick rating and C$8.50 target price Labrador Iron Mines Holdings Limited
There is significantly reduced risk of capex creep and construction delays, as the company is already in the early stages of production
Rating Top Pick–Above-average Risk Target C$8.50 Valuation 0.8x NAV (8%)
The company’s modular expansion is flexible—stages can be built as cash flows permit and as market demand dictates
Symbol Exchange Sector
LIM TSX Bulk Commodities
President & CEO John Kearney Website www.labradorironmines.ca Share price C$5.00 Potential return 70% 52-week range C$4.67–14.82 3m volume traded 613,000 1m volume traded 531,000 Shares O/S* 54m Dividend yield Reported cash* Cash/sh* Reported total debt* Reported book value/sh* Current market cap Current EV
0% C$22m C$0.40 C$2m C$4.94 C$331m C$311m
Resources (100% basis at asset level) M&I 36.9Mt at 57.4% Fe Inferred 1.6Mt at 55.1% Fe Historical 124.9Mt, grade NA * As at December 31, 2011 Source: Desjardins Capital Markets, Capital IQ, company reports
We view Labrador Iron Mines as a potential acquisition target; a takeout could provide upside to our target price We are initiating coverage with a Top Pick–Above-average Risk rating and C$8.50/share target price Highlights. Labrador Iron Mines is in the early stages of production at its direct shipping ore (DSO) project in the Schefferville region. The company’s 20 DSO deposits are individually short-lived but together contain over 150Mt of total reserves of high-grade iron ore that require minimal processing to prepare for market. The deposits will be developed in several stages, beginning with the near-producing James mine and Silver Yards beneficiation plant. Valuation. Our valuation is based on a 0.8x multiple applied to our DSO deposit net asset value and a 1.0x multiple to current net working capital. This is the highest target multiple applied to any development-stage mine in our coverage universe, given the relatively low risk of capex creep and construction delays at the James mine/Silver Yards beneficiation plant. Recommendation. We are initiating coverage of Labrador Iron Mines Holdings Limited with a Top Pick–Above-average Risk rating and C$8.50/share one-year target price, which implies an expected return of 70% to the current share price. Labrador Iron Mines is our Top Pick owing to its high return relative to the average expected return of 52% for our coverage universe. In our view, Labrador Iron Mines is the most attractive investment within our coverage universe, given the low risk to shareholders relative to other development-stage equities. We believe Labrador Iron Mines is a potential acquisition target, given the company’s position as a pure-play iron ore producer with no strategic partner or offtake agreement. In our view, the Iron Ore Company of Canada (IOC) is the most logical acquirer, given majority owner and operator Rio Tinto’s aggressive plans to expand capacity at IOC, as well as IOC’s previous operating experience in the Schefferville region and its existing shipping and sales agreement with Labrador Iron Mines. A takeout could provide additional upside to our target price and is not considered in our estimates. Labrador Iron Mines fully financed NAV estimate
Volume (m)
Price (C$)
16
Asset (C$m) 12
Direct shipping ore Other assets
NPV (10%)
697
551
0
0
NPV multiple (x)
0.80
0.80
4 10
Current working capital
103
103
Current long-term debt
-1
-1
5
Corporate adjustments
-55
-51
0 Mar-11
Proceeds from options and warrants
8
Jun-11
Sep-11
Dec-11
Feb-12
Reported basic shares O/S (m) Shares O/S post financing (m) NAV NAV/share (C$)
Source: Bloomberg
Jackie Przybylowski, P.Eng.
NPV (8%)
Source: Desjardins Capital Markets
8
8
54
54
71
71
752
610
10.60
8.60
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 45 MARCH 22, 2012
Company overview
Labrador Iron Mines is in the early stages of production at its direct shipping ore (DSO) project in the Schefferville region. While some of the company’s 20 DSO deposits are individually short-lived (such as James and Redmond), together they contain over 150Mt of total reserves of high-grade ore (see Exhibit 2) that require minimal processing to prepare for market. These properties were previously owned by the Iron Ore Company of Canada (IOC) but were never mined or prepared for mining by IOC. Labrador Iron Mines is also investigating the value of other assets located on its property, including high-grade stockpiles left from IOC’s mining operations in 1954–82, potential taconite deposits and a historical magnetite resource located on the deposit. Exhibit 1: Labrador Iron Mines’ DSO project in Québec and Labrador
Source: Company reports
Anticipated catalysts James mine and Silver Yards seasonal start-up—open pit mining resumes in March 2012, rail operations in April and Silver Yards processing and sales in May Revised resource estimates at James, Knob Lake, Houston and Malcolm expected in 1Q12 Commercial production expected to be declared at James mine and Silver Yards beneficiation plant in 2Q12 Commissioning of Silver Yards expansion to 3.0Mtpa capacity expected in late 2Q12 or early 3Q12 Development of Stage 2 Houston deposit expected in 2Q12–4Q12 Production from Houston deposit expected in 2013
Jackie Przybylowski, P.Eng.
Desjardins
Labrador Iron Mines Holdings Limited
Capital Markets PAGE 46 MARCH 22, 2012
Keep it simple—direct shipping ore
Labrador Iron Mines plans to develop its 20 DSO deposits in four stages. Its DSO deposits are each relatively dispersed; to overcome the challenges of long haul distances and high transportation charges, Labrador Iron Mines has devised a unique approach to ore processing; as illustrated in Exhibit 3, the company plans to orchestrate mine ramp-up and closures in order to maintain a steady production run rate of 5.0Mtpa (its share of Tshiuetin Rail Transportation (TSH Rail) capacity). We believe the company’s staged approach is a competitive advantage given the flexibility in staged expansion. Modules can be built as company cash flows permit and Labrador Iron Mines is free to expand production or maintain current output levels as market demand dictates. Exhibit 2: Total estimated iron ore resources Measured & indicated
Inferred
Historical (not NI 43-101–compliant)
Tonnes (m)
% Fe
Tonnes (m)
% Fe
Tonnes (m)
% Fe
Stage 1A—James
8.1
57.7
0.1
53.6
-
-
Stage 1A—Redmond
2.9
56.4
0.1
53.7
-
-
Stage 1A—Denault
6.4
54.8
0.4
53.9
-
NA
Stages 1B and 1C
-
-
-
-
17.1
Stage 2—Houston
19.5
58.3
1.0
55.8
-
-
Stage 2—Malcolm
-
-
-
-
2.9
NA
Stage 3
-
-
-
-
34.5
NA
Stage 4
-
-
-
-
19.8
NA
Stage 5
-
-
-
-
50.7
NA
36.9
57.4
1.6
55.1
124.9
NA
Total Source: Company reports
Exhibit 3: Labrador Iron Mines production profile
2.5
1.0
2.0
5.0
5.0
5.0
2.5
2.5
2.5
2.5
2.5
2.5
2.5
2.5
2.5
2.5
2.5 2.5
2.5
2.5
2.5
2.5
2.5
2.0
1.5
2019E
2018E
2017E
2016E
2015E
2014E
2013E
0.6 2011
5.0
2.5
1.0 2020E
0.6
5.0
1.5
2.5
2.0
2
5.0
2025E
2.5
5.0
2024E
2.0
5.0 0.5
1.0
3
0
5.0
2023E
3.5
2012E
(Mtpa)
4
1
5.0
4.5
2022E
5.0
5
2021E
6
Plant 3—Howse North Central Zone Plant 2—Houston/Redmond South Central Zone & South Zone Plant 1—Silver Yards Central Zone
Source: Company reports
Direct shipping ore requires minimal processing to prepare it for sale. Due to its high grade, most of Labrador Iron Mines’ ore will require only crushing, washing and screening at a beneficiation plant. Further, some ore occurs naturally at sufficiently high grades such that beneficiation is not even necessary; this ore, which Labrador Iron Mines refers to as ‘direct railing ore’, is loaded onto rail cars for sale directly from the James mine. Presently, direct railing ore makes up approximately 25% of Labrador Iron Mines’ production, although we conservatively expect all ore to be processed in the longer term. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 47 MARCH 22, 2012
A simple approach to development means lower capex, shorter construction time and lower risk. Results from the James mine and Silver Yards beneficiation plant confirm that Labrador Iron Mines can achieve quick start-up and relatively low capital costs. The approach has allowed the company to begin mining operations at the James mine with a small beneficiation plant that was relatively inexpensive to build; the first phase was essentially built and commissioned in one season. We anticipate that the company will continue to expand operations toward its long-term run rate of 5.0Mtpa. During the 2012 summer season, we expect the company will install a dry in-pit crusher at the Houston deposit in anticipation of production in 2013. We also expect that a second beneficiation plant will be built at Houston/Redmond in 2013 (for production in 2014). Development costs for the expansion to Stage 2 are expected to be relatively low based on the low cost of Stage 1 construction and start-up. However, development costs for Stages 3 and 4, which we expect the company will begin to incur in 2015, are expected to be significantly higher due to the longer distance to existing rail and road networks, and the resulting additional infrastructure that will be required. See Exhibit 4 for a summary of our development capital cost assumptions. Exhibit 4: Expected capital costs at Labrador Iron Mines’ DSO project (US$m) Stage 1 (remaining) Stage 2
45 175
Stages 3 and 4
350
Total
570
Source: Desjardins Capital Markets
Labrador Iron Mines started production at the James mine and Silver Yards beneficiation plant in June 2011. A total of 564,000 tonnes iron ore was hauled to the Port of Sept-Îles in 2011 and three shipments to China totalling 386,000 tonnes were completed. In addition, approximately 265,000 tonnes of iron ore are held in inventory at Silver Yards and a stockpile of approximately 178,000 tonnes of direct rail ore remains at the port. Exhibit 5: James mine (July 2011)
Source: Company reports
Current operating costs are not known but are believed to be high. Because Labrador Iron Mines did not declare commercial production in 2011, its cash operating costs have not been disclosed. In our assessment, the prevailing view among investors is that operating costs, including the shipping rates and selling fees charged by IOC and Rio Tinto in particular, were high, which would have significantly impacted Labrador Iron Mines’ margins in 2011. However, we believe the cost for sales and marketing services is competitive and should continue to improve in the long term (see Exhibit 6). Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 48 MARCH 22, 2012
Exhibit 6: Expected near-term and long-run cash operating costs (US$/t ore)
2012E
Long-term
Mining
12.50
11.75
Crusher and concentrator
18.00
7.00
Transport/loading
45.00
30.00
7.00
2.00
G&A Sales and agency Total
25.00
5.00
107.50
55.75
Source: Desjardins Capital Markets
In the long term, we expect Labrador Iron Mines’ relatively low capital costs to be offset by high cash operating costs (relative to other DSO producers). In our view, two factors contribute to the higher costs: (1) the seasonal operation of its beneficiation plants and shipping functions, and (2) the company’s reliance on contract labour for mining, operation of the wash plant and maintenance. Optimization of Silver Yards is in progress. The Silver Yards facility was started in June 2011 with an initial capacity of 1.0Mtpa. A hydrosizer and filter were installed in 2011 to recover ‘ultra fines’ from the waste, improving iron recovery and increasing the plant capacity to approximately 2.0Mtpa. Further expansion to approximately 3.0Mtpa is underway and is expected to be completed by June 2012. Exhibit 7: Silver Yards beneficiation plant (August 2011)
Source: Desjardins Capital Markets
Logistics Rail access to the Silver Yards site is settled. A 6.0km spur line connects the Silver Yards plant to the TSH Rail line, which links to the Québec North Shore & Labrador Railway (QNS&L) to access the ports at Sept-Îles. Labrador Iron Mines has reached rail agreements with both TSH Rail and QNS&L for access to these key rail lines. Up to five locomotives will be operated by Genesee & Wyoming, and rail cars have been purchased and refurbished to suit the company’s requirements. Shipping and sales agreement renewed for 2012. Labrador Iron Mines recently announced it had renewed its agreement with IOC, where all of Labrador Iron Mines’ 2012 production and the remaining 2011 stockpile will be shipped through IOC’s port, which is capable of loading cost-effective Capesize vessels. The ore will also be sold by IOC’s marketing organization on the spot market for delivery to Asian markets. Although the terms of the agreement are confidential, we believe the cost for sales and marketing services is competitive relative to market rates charged by other third-party sales agents. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 49 MARCH 22, 2012
Other assets—blue-sky potential
Labrador Iron Mines is also investigating the value of other assets known to be located on its property. While we do not attribute any value to these assets in our net asset value, the ‘blue-sky’ potential represents possible upside to our estimates. Waste stockpiles left from IOC’s 1954–82 mining operations will be studied and sampled in the summer 2012 season to determine if the waste ore can be economically processed at Silver Yards. The waste stockpiles contain an estimated 50% Fe, are pre-crushed rock and easily accessible by existing roads or rail bed (on which a road may be built). If the bulk sampling is successful, stockpiles could represent potentially five years’ worth of relatively high-margin feed. The company is planning to ramp up its efforts to explore for taconite deposits on its Schefferville properties over the summer 2012 season. Labrador Iron Mines has identified approximately 2.5Bt of taconite targets in four areas on its Schefferville property. The company will conduct exploration drilling in 2012 with the aim of defining an inferred resource. We do not attribute any value to the taconite potential at this time. However, discovery of an economic taconite deposit could create significant value for the company. A historical manganese deposit is also located on Labrador Iron Mines’ property. Typically, manganese ore is beneficiated in a process similar to that at the Silver Yards plant. In the summer 2012 season, Labrador Iron Mines will sample the manganese ore to determine its suitability for treatment at Silver Yards. If this is successful, the company could mine and sell occasional manganese shipments to supplement its revenue from iron ore sales.
Capital structure Labrador Iron Mines Holdings Limited is listed on the TSX under the symbol ‘LIM’. As at December 31, 2011, Labrador Iron Mines had approximately 54.1m common shares issued and outstanding, and an additional 1.9m options outstanding. Following the February 2012 financing, including the over-allotment, we expect the company will have approximately 69.0m shares outstanding. Anglesey Mining plc is the largest shareholder with 26% of the common shares outstanding following the recent equity issue. Individual insiders hold a modest 1.6% of the shares outstanding. About Anglesey Mining. UK-based Anglesey Mining’s primary assets are its equity interest in Labrador Iron Mines and its wholly owned Parys Mountain zinc-copper-lead deposit in north Wales. In our view, the objectives of Anglesey Mining are likely to be aligned with those of Labrador Iron Mines’ board and management. Labrador Iron Mines Chairman and CEO John Kearney also acts as Chairman of Anglesey Mining; in addition, former LIM Vice-Chairman (and retired COO) Bill Hooley serves as an Anglesey director and Chief Executive. Recent C$80m financing will fund 2012 development and expansion. On February 28, 2012, Labrador Iron Mines announced an equity financing of 11.5m common shares and 1.75m flow-through shares for gross proceeds of approximately C$72m. We assume the over-allotment option to purchase an additional 1.725m shares at C$5.30/share will also be exercised, bringing total gross proceeds to approximately C$80m. Labrador Iron Mines will use the proceeds to fund Phase 3 expansion at Silver Yards, contribute its share of capital to railway improvement and upgrades, for development of its Houston project, exploration of mineral properties (including the Houston and Malcolm DSO deposits as well as the manganese deposit and IOC stockpiles), and for general corporate and working capital purposes. Working capital and growth will be funded going forward. We do not anticipate that the company will be required to raise capital in the near term, as it has C$29.3m in cash on hand (as at December 31, 2011) and an additional C$19.2m in accounts receivable, mostly related to the third shipment sold (but not completed) in 2011, as well as the expected C$80.8m recently raised (including over-allotment). We believe that the cash on hand, along with internally generated cash flows anticipated in 2012, should be sufficient to finance working capital, expansion activities at Silver Yards and future exploration and development. However, we note that if cash flows are below expectations (due to weak or delayed sales, low commodity prices or high operating costs), the company may have to delay expansion plans or raise additional capital.
Jackie Przybylowski, P.Eng.
Among the most likely in our coverage universe to be an acquisition target. We believe Labrador Iron Mines is a potential acquisition target, given the company’s position as a pure-play iron ore producer with no strategic partner or offtake agreement. In our view, the most likely acquirer is Rio Tinto through its subsidiary IOC. Labrador Iron Mines could contribute to IOC’s aggressive long-term growth objective to target future capacity expansion to 50Mtpa or higher
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 50 MARCH 22, 2012
at IOC (from 26Mtpa following the current expansion). Although Labrador Iron Mines is a relatively small producer, it has potential for growth to 5.0Mtpa in the near term as well as potential for further expansion with additional capex to increase TSH Rail capacity. In addition, IOC is familiar with Labrador Iron Mines’ assets, given it was the original operator in the Schefferville region (1954–82) and through its 2011 and 2012 shipping and selling agreements with Labrador Iron Mines.
Valuation Our primary valuation approach for Labrador Iron Mines is P/NAV; our NAV is based on a discounted cash flow analysis (at an 8% discount rate) using the US$/C$ exchange rate and iron ore price assumptions summarized in Exhibit 2 on page 4. Our estimated net asset value is C$10.60/share (see Exhibit 8). We apply a 0.8x target multiple to our primary asset NAV and a 1.0x multiple to current working capital and long-term debt to derive our one-year target price of C$8.50/share. We believe a 0.8x multiple is appropriate in view of the company’s relative low start-up and financing risk, given it has already demonstrated construction, production and sales. Exhibit 8: Labrador Iron Mines net asset value details NPV (8%) (C$m) DSO project—NPV estimate of future cash flows
642
Current working capital
103
Long-term debt
-1
Expected proceeds from options and warrants
8
NAV
752
Current number of basic shares outstanding (m)
69.0
Options with weighted average exercise price of C$4.37/share (m) Pro forma fully diluted shares outstanding (m) NPV/share (C$)
1.9 70.9 10.60
Source: Desjardins Capital Markets
Recommendation
We are initiating coverage of Labrador Iron Mines Holdings Limited with a C$8.50/share one-year target price, which implies an expected return of 70% to the current share price. Labrador Iron Mines is our Top Pick within our coverage universe. Already generating cash flow. Labrador Iron Mines is the only junior in the Labrador Trough that has sold material shipments of iron ore and that is generating cash flow. The company’s relatively quick construction period and proven production and sales reduce the construction and start-up risk. Near-term growth is fully financed, long-term growth is flexible. We do not anticipate that the company will need to raise significant capital in the near term, as it had C$29.3m in cash on hand (as at December 31, 2011); along with the recent C$80m financing and internally generated cash flows anticipated in 2012, this should be sufficient to finance working capital and expansion activities at Silver Yards. In the long term, we believe the company’s staged approach is a competitive advantage as expansion stages can be built as company cash flows permit and Labrador Iron Mines is free to expand production or maintain current output levels as market demand dictates. Takeout potential. We believe Labrador Iron Mines is a potential acquisition target, given the company’s position as a pure-play iron ore producer with no strategic partner or offtake agreement. In our view, Rio Tinto is the most logical acquirer given its aggressive plans to expand capacity at IOC, as well as IOC’s previous operating experience in the Schefferville region and its existing shipping and sales arrangement with Labrador Iron Mines. A takeout could provide additional upside to our target price and is not considered in our estimates. Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 51 MARCH 22, 2012
Risks
We have an ‘Above-average’ risk qualifier for Labrador Iron Mines. Start-up and operating risk. There is a significant risk that the exploration, development and completion of the DSO project could be delayed due to circumstances beyond Labrador Iron Mines’ control. Setbacks could include delays in securing financing or in construction or commissioning. Liquidity and financing. The development of subsequent stages of the DSO project will require additional capital, and there is no assurance that Labrador Iron Mines will be able to finance development from internally generated cash flows. The company may be unable to invest capital for its development and exploration programs, take advantage of business opportunities or respond to competitive pressures. Iron ore prices. The company’s future profitability is directly related to the volume of iron ore products sold and the price of these products. Iron ore prices have historically been volatile and are primarily affected by numerous other factors beyond the company’s control, including global and regional demand, political and economic conditions, and global production volumes and operating costs. Foreign exchange. Labrador Iron Mines is subject to foreign exchange risk because revenues will be received in US dollars while operating costs are in Canadian dollars. Fluctuations in exchange rates, principally the US$/C$ exchange rate, can significantly impact earnings and cash flows. Licences and permits. The company’s exploration and development activities require permits and approvals from various government authorities and are subject to federal, provincial and local laws. The company will be required to obtain additional licences and permits to continue and expand its development activities and there can be no guarantee that these licences will be obtained or maintained. There is also a risk that future legislation and regulations could result in additional expenses in Labrador Iron Mines’ operations and in reclamation obligations, the extent of which cannot be predicted. First Nations land claims. Labrador Iron Mines’ operations fall within an area subject to conflicting First Nations land claims. Although the company has signed impact benefit agreements with all recognized groups, aboriginal claims to lands and the conflicting claims to traditional rights between aboriginal groups may have an impact on the company’s ability to develop its deposits. Labrador Iron Mines has recognized the claims of four First Nations groups. The Labrador Metis Nation has also asserted a land claim in parts of Labrador, which may include the Schefferville area. However, this claim has not been accepted for negotiation by the government of Canada or Newfoundland and Labrador. Completed agreements are as follows: Labrador Innu—impact benefit agreement signed in July 2008 Naskapi Nation of Kawawachikamach—impact benefit agreement signed in September 2010 Innu Matimekush-Lac John—impact benefit agreement signed in June 2011 Innu Takuaikan Uashat mak Mani-Utenam—impact benefit agreement signed in February 2012 Labrador Iron Mines also reached an agreement with the NunatuKavut Community Council, which represents the Southern Inuit of Labrador, in February 2012. The agreement addresses such matters as environmental and cultural protection, jobs, training and aboriginal contracting.
Key management and directors
Jackie Przybylowski, P.Eng.
John F Kearney, Chairman and CEO. Mr Kearney holds degrees in law and economics from University College Dublin and an MBA from the University of Dublin (Trinity College). Mr Kearney has over 37 years of experience in the mining industry and is active on numerous boards and management teams, including active roles in the following: Chairman and CEO, Labrador Iron Mines; Chairman of Labrador Iron Mines’ parent company, Anglesey Mining plc; Executive Chairman, Minco plc, a subsidiary of Anglesey Mining plc; Chairman and President, Canadian Zinc Corporation; Chairman, Xtierra Inc.; Chairman, Conquest Resources Limited; Director, Vatukoula Gold Mines plc; Director, Avnel Gold Mining Limited; and Director, Mining Association of Canada.
Desjardins Capital Markets
Labrador Iron Mines Holdings Limited
PAGE 52 MARCH 22, 2012
Bill Hooley, Vice-Chairman. Mr Hooley is currently Chief Executive of Anglesey Mining plc. He is a professionally qualified mining engineer and has over 40 years of experience in the mining industry. Previously, Mr Hooley served as COO of Labrador Iron Mines until his retirement in 2011. He holds a degree in mining engineering from the Royal School of Mines, Imperial College, London. Terence McKillen, Executive Vice-President and director. Mr McKillen is a professional geologist and has over 40 years of experience in the mining industry. He is currently President, CEO and director of Xtierra Inc. and Conquest Resources Limited, and Chief Executive of Minco plc. He holds degrees in geology from the University of Dublin (Trinity College) and a Master’s degree in mining geology and mineral exploration from the University of Leicester. Rod Cooper, President and COO. Mr Cooper is a mining engineer with over 30 years of experience in the resource industry. Prior to joining Labrador Iron Mines, Mr Cooper was a senior analyst, base metals, at Dundee Securities. He was formerly COO of Baffinland Iron Mines Corporation, and Vice-President, Technical Services for Kinross Gold Corporation. Mr Cooper holds a degree in mining engineering (honours) from Queen’s University and a Master’s degree in business administration from the University of Toronto.
Jackie Przybylowski, P.Eng.
Desjardins
New Millennium Iron Corp.
Capital Markets
PAGE 53 MARCH 22, 2012
New Millennium Iron Corp. (NML C$2.44, TSX)
World-class mine developer or just along for the ride? Initiating coverage with a Hold rating and C$3.50 target price
Rating Hold–Speculative Target C$3.50 Valuation 0.6x NAV (8%) DSO project & 0.3x NAV (8%) taconite and other assets Symbol Exchange Sector
NML TSX Bulk Commodities
President & CEO Dean Journeaux Website www.nmliron.com Share price C$2.44 Potential return 43% 52-week range C$1.00–3.60 3m volume traded 474,000 1m volume traded 532,000 Shares O/S* 176m Dividend yield Reported cash* Cash/sh* Reported total debt* Reported book value/sh* Current market cap Current EV
0% C$17m C$0.10 C$0m C$0.84 C$414m C$327m
Resources (100% basis at asset level) DSO 76Mt at 58.5% Fe KéMag 3,462Mt at 31.2% Fe LabMag 5,741Mt at 29.5% Fe
The company’s long-term relationship with Tata Steel limits upside for New Millennium shareholders We are initiating coverage with a Hold–Speculative rating and C$3.50/share target price Highlights. New Millennium is working to advance its properties in the Schefferville region, including its direct shipping ore (DSO) project, the KéMag and LabMag taconite projects, and additional prospective exploration targets. New Millennium’s joint venture partner, Tata Steel, holds an 80% interest in the DSO project and an option to acquire a 64% stake in the KéMag and LabMag taconite projects, subject to positive feasibility study results. Tata Steel also holds a 26.8% equity interest in New Millennium. Valuation. Our valuation is based on a 0.6x target multiple applied to our NAV for the DSO asset and a 0.3x multiple to our NAV for the taconite and exploration assets. We believe these multiples are appropriate, given the relatively short time to production of the DSO project and the relatively high risk of construction delays and capital cost overruns for the taconite projects. Recommendation. We are initiating coverage of New Millennium Iron Corp. with a Hold–Speculative rating and C$3.50/share target price, which implies an expected return of 43% to the current share price. We have applied a Hold rating for two primary reasons. First, production and positive cash flows from New Millennium’s taconite projects, which make up approximately 87% of our NAV estimate, are several years away and are at high risk of construction delays or capital cost overruns. Second, the company’s close relationship with Tata Steel could limit upside to New Millennium shareholders as Tata Steel is expected to exercise its option to acquire a 64% ownership stake on positive feasibility study results. 4
New Millennium fully financed NAV estimate
3
Asset (C$m)
2 1
Volume (m)
* As at September 30, 2011 Source: Desjardins Capital Markets, Capital IQ, company reports
New Millennium owns low-cost, large-volume deposits with both near-term and long-term production potential
Price (C$)
New Millennium Iron Corp.
0 3 2 1 0 Mar-11
Source: Bloomberg
Jackie Przybylowski, P.Eng.
Jun-11
Sep-11
Dec-11
Feb-12
Direct shipping ore NPV multiple (x) Taconite projects Other assets NPV multiple (x) Current working capital Current long-term debt Corporate adjustments Proceeds from options and warrants Reported basic shares O/S (m) Shares O/S post financing (m) NAV NAV/share (C$) Source: Desjardins Capital Markets
NPV (8%)
NPV (10%)
163 0.60 1,965 10 0.30 79 0 -140 10 176 189 2,086 11.04
148 0.60 1,586 10 0.30 79 0 -129 10 176 189 1,703 9.02
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 54 MARCH 22, 2012
Company overview
Multiple projects in the pipeline. New Millennium’s asset portfolio includes high-grade direct shipping ore (DSO) deposits, the KéMag and LabMag taconite deposits, and several prospective regions that are believed to hold additional taconite resources (see Exhibit 2 for a summary of currently defined reserves and resources (100% basis)). We assume the US$500m (100% basis) DSO project will produce approximately 4Mtpa ore (100% basis), with production beginning in late 2012. The US$5.8b (100% basis) taconite projects will likely produce 22Mtpa (100% basis), with production beginning in 2017. Partnership with Tata Steel a long-term relationship. New Millennium has partnered with Tata Steel to develop its assets. Tata Steel has signed a joint venture agreement for the DSO project, and will contribute the first C$300m toward development of the project in exchange for an 80% ownership stake. Tata Steel also has an option to acquire a 64% stake in the taconite projects, which we expect it will exercise in 1H13. Tata Steel also has a 26.8% equity interest in New Millennium. Although New Millennium’s deposits have potential for significant future production volumes, we expect the company will ultimately hold a ‘small piece’ of the ‘big pie’ as ownership of its assets is transferred to Tata Steel in exchange for project financing. As the majority owner of the projects and likely sole offtaker, we expect Tata Steel will have control over the future of the developments. In our view, Tata Steel could defer development of the taconite deposits due to unfavourable feasibility study results, poor steel market conditions, the availability of lower cost alternative supplies or if Tata Steel cannot secure project financing. Exhibit 1: New Millennium asset locations
Source: Company reports
Jackie Przybylowski, P.Eng.
Desjardins
New Millennium Iron Corp.
Capital Markets
PAGE 55 MARCH 22, 2012
Exhibit 2: Total estimated iron ore reserves and resources (100% basis) Proven & probable reserves Tonnes (m) % Fe DSO
64
58.8
KéMag
2,141
LabMag
3,545
Total taconite
5,686
Measured & indicated resources Tonnes (m) % Fe
Inferred resources Tonnes (m)
% Fe
Historical (not NI 43-101–compliant) Tonnes (m) % Fe
5
58.9
7
55.9
40
NA
31.2
307
31.3
1,014
31.2
-
-
29.6
1,045
29.5
1,151
29.3
-
-
30.2
1,352
29.9
2,165
30.2
-
-
Source: Company reports
Anticipated catalysts Resource estimate on exploration targets Lac Ritchie and Perrault Lake expected in 2Q12 Completion of construction of the DSO project expected by 4Q12 Production from the DSO project expected to start in 1Q13 Completion of KéMag and LabMag feasibility study expected in 4Q12 Tata Steel expected to exercise its right to acquire a 64% stake in KéMag and LabMag in 2Q13–3Q13 Construction of the taconite projects expected to start in late 2013 Production at KéMag and LabMag expected to start in early 2017
Direct shipping ore Tata Steel is majority owner of the DSO project and New Millennium’s strategic partner. Tata Steel acquired an 80% interest in the DSO project in September 2010. In exchange, Tata Steel agreed to reimburse New Millennium for 80% of the cost of the feasibility study and to arrange debt and/or equity funding for up to C$300m of the capital cost of the project (similar to New Millennium’s estimated total cost to build the project but below our estimate of approximately C$500m). Tata Steel has also committed to purchasing 100% of DSO iron ore production at market prices for the life of the mining operation. Processing DSO is relatively simple. New Millennium’s facility will comprise crushing, washing, screening, and gravity and magnetic separation processes to upgrade the iron content of the ore. Due to the nature of DSO, the processing required to prepare it for sale is relatively simple in comparison with the processing required for meta-taconites and taconites found elsewhere in the Labrador Trough. For this reason, we expect operating costs will be among the lowest in our coverage universe, with long-term operating costs expected to total US$48/t (see Exhibit 3). Exhibit 3: Expected long-run cash operating costs at New Millennium’s DSO project (US$/t ore) Mining Crusher and concentrator Transport/loading
11.50 6.00 28.50
G&A
2.00
Total
48.00
Source: Desjardins Capital Markets
Jackie Przybylowski, P.Eng.
The first phase of construction includes development of the deposits in DSO Areas 2 and 3 (as illustrated in Exhibit 1), construction of the plant and installation of a 26km rail spur to connect the plant site to the main Tshiuetin Rail Transportation (TSH Rail) line. We expect that Phase 1 construction will be completed for production start-up in early 2013 (according to the construction timeline in Exhibit 5), and that the capital cost of Phase 1 will total approximately C$425m.
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 56 MARCH 22, 2012
Quick construction for start-up early next year. Camp construction began in July 2011 and long-lead-time equipment is on order. The concrete foundation and dome structure that will form the base of the beneficiation plant are being fabricated at manufacturers’ locations and will be delivered to site. Ramp-up to full production should be relatively quick (assuming construction is completed on time), given that the first orebodies to be mined are essentially prestripped. New Millennium noted on February 8, 2012 that construction was on track for production to begin in late 2012 as outlined in the JV partners’ project timeline shown in Exhibit 6. We are anticipating first sales from the project in 1Q13, essentially in line with the target schedule. Exhibit 4: DSO project camp construction (September 2011)
Source: Desjardins Capital Markets
Exhibit 5: Expected capital cost at New Millennium’s DSO project (US$m) Phase 1 Phase 2 Total
425 75 500
Source: Desjardins Capital Markets
Phase 2 greenfield development to follow. The second phase of development includes preparation of deposits in DSO Area 4 (as illustrated in Exhibit 1) and construction of a 38km haul road to connect the Area 4 deposits to the Phase 1 facilities. Phase 2 represents the most significant opportunity for DSO production as about 75% of the DSO reserves lie in Area 4 (according to New Millennium company estimates). We expect construction of Phase 2 to take one year and estimate the capital cost of Phase 2 at approximately C$75m. Exhibit 6: Joint venture partners’ proposed project timeline
Jackie Przybylowski, P.Eng.
Source: Company reports
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 57 MARCH 22, 2012
Rail and port. The company plans to ship ore to Sept-Îles via the TSH Rail and the Québec North Shore & Labrador Railway. At Sept-Îles, the ore will be carried by Cliffs Natural Resources’ Arnaud Railway to its shiploading facilities at the Pointe-Noire terminal. New Millennium has signed an agreement with the Port Authority of Sept-Îles for the shipment of DSO products at the authority’s dock at Pointe-Noire, which is currently used to ship ore from Cliffs’ Scully mine. Negotiations with Cliffs are ongoing with regard to the use of its stockpile facilities and stacker/reclaimer equipment; we expect an agreement to be completed before production begins at the DSO project.
Taconite projects New Millennium currently holds a 100% interest in the KéMag property in Québec and an 80% interest in the LabMag property in Labrador. The First Nations group, Naskapi Nation of Kawawachikamach (NNK), has a 20% free-carry interest on LabMag. We expect that Tata Steel will exercise its option to acquire a 64% ownership stake in the assets. Tata Steel is working with New Millennium on the feasibility study at KéMag and LabMag, and will contribute 64% of the total cost of the feasibility study (expected to be approximately C$50m). Under an agreement signed in March 2011, Tata Steel has an option to acquire a 64% ownership stake in the taconite deposits. In exchange, Tata Steel will arrange financing for up to C$4.85b toward development of the projects. New Millennium will have an option to acquire a 16% equity interest in addition to a 20% free-carry equity interest. New Millennium could also have future opportunity to increase its ownership stake to 40% (from 36%) as the company will have the right of first refusal to acquire up to 4% of paid equity. NNK will continue to hold a 20% free-carry interest in New Millennium’s equity stake in the LabMag deposit. A long-term project. We expect the feasibility study will be completed in late 2012; Tata Steel has four months from completion of the study to make its investment decision. Construction on the KéMag and LabMag project is expected to begin in late 2013 following a positive investment decision by Tata Steel. We believe Tata Steel could request extensions to the current deadline as it did during negotiations for the DSO project; we have therefore factored in a six-month delay in our estimated project timeline. We expect that production from the taconite projects will begin in early 2017. We envision that the KéMag and LabMag deposits will be built into a 22Mtpa pellet producer. We expect a concentrator will be built onsite and that concentrate produced at the site will be pumped through an ore transmission pipeline to a pellet plant that will be constructed near the future multi-user port at Pointe-Noire. Pipeline transmission is expected to be significantly more economical than rail haulage. We estimate that transportation (including pipeline and port loading costs) will total approximately US$8/t in the long term, compared with US$18/t to transport taconites from Adriana Resources’ Lac Otelnuk deposit. A combined taconite project is the most likely scenario. The most recently published KéMag (2009) and LabMag (2006) prefeasibility studies proposed separate and independent development of the two deposits, with standalone mining operations, concentrators, slurry pipelines and pellet plants. However, we speculate that the upcoming feasibility study will re-imagine the projects as a joint development. We believe that project economics would be significantly improved if KéMag and LabMag are combined into a single 22Mtpa operation as redundancies in the concentrator, pellet plant and 600–700km slurry pipeline could be reduced or eliminated. We have estimated the project size at 22Mtpa as we believe the project will be designed to meet Tata Steel’s European iron ore requirements to avoid selling ore on the open market. We expect that the planned 22Mtpa output will be entirely purchased by Tata Steel at market rates. Development of the taconite projects will require significant infrastructure, which we estimate will cost approximately C$5.8b (100% basis). We expect that a combined KéMag and LabMag operation would include a 22Mtpa concentrator at the minesite, a slurry pipeline to transport concentrate to processing facilities at Pointe-Noire, a 22Mtpa pellet plant and a shiploading facility at the new multi-user port at Pointe-Noire. Please see Exhibit 7 for a summary of our capital cost assumptions.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 58 MARCH 22, 2012
Exhibit 7: Expected capital cost at New Millennium’s taconite projects (US$m) Mine Crusher and concentrator
300 1,200
Pellet plant
1,700
Pipeline
1,450
Port
400
Power
300
Other
410
Total
5,760
Source: Desjardins Capital Markets
Competitive operating costs. Pipeline transmission of taconite concentrates is expected to result in meaningful cost savings relative to traditional rail transportation. As illustrated in Exhibit 8, we estimate that the taconite projects could operate at long-run unit costs of approximately US$46/t, which is expected to be competitive vs other pellet producers in Canada. Exhibit 8: Expected long-run cash operating costs at New Millennium’s taconite projects (US$/t pellets) Mining
10.30
Crusher and concentrator
10.00
Pelletizing
16.00
Transport/loading
8.00
G&A
2.00
Total
46.30
Source: Desjardins Capital Markets
Exploration targets The Millennium Iron Range, where the DSO and KéMag and LabMag taconite deposits were discovered, continues to be highly prospective. Only 10% of the 210km range has been fully explored to date. A 2010 airborne magnetometer survey identified several potential exploration targets. The company selected two properties, Lac Ritchie and Perrault Lake, for its initial drilling program in 2011. New Millennium also completed an exploration drill program at the Lac Ritchie property in 2011 and is currently working on a resource estimate, which is expected to be released in 2Q12. We currently ascribe a nominal value of C$10m for exploration assets in our net asset value estimate. Any future deposits discovered by New Millennium, including Lac Ritchie and Perrault Lake, will be 100% owned by New Millennium and are not included under its current agreements with Tata Steel. Should New Millennium choose to develop these potential future deposits, the company could form a joint venture or sell an offtake agreement to Tata Steel or another potential partner.
Capital structure
New Millennium Iron Corp. is listed on the Toronto Stock Exchange under the symbol ‘NML’. As at September 30, 2011, the company had approximately 176.2m shares issued and outstanding, and 12.7m options and warrants outstanding. Tata Steel is New Millennium’s largest shareholder with a 26.8% equity stake; individuals and insiders hold a further 3.3% of the shares outstanding.
Jackie Przybylowski, P.Eng.
Tata Steel is a close partner as well as New Millennium’s largest shareholder. Tata Steel also acts as joint venture partner with New Millennium on the DSO project. In exchange for an 80% stake in the project, Tata Steel agreed to
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 59 MARCH 22, 2012
arrange financing for up to C$300m toward development and construction costs. Tata Steel also reimbursed New Millennium for 80% of the cost of the feasibility study. Tata Steel is also working with New Millennium on a feasibility study at the KéMag and LabMag properties. We believe Tata Steel will exercise its option to acquire a 64% ownership interest in the assets, in which case it will arrange financing for its proportionate share of the capital costs, including New Millennium’s 20% free-carry interest. About Tata Steel. Established in 1907, Tata Steel is one of the world’s largest steel companies, with current crude steel capacity of 28Mtpa and plans to increase production to 40Mtpa by 2020. Tata Steel is one of the world’s most geographically diversified steel producers with operations in 26 countries, including a significant presence in Europe as a result of its acquisition of UK-based Corus Steel in 2007.
Valuation
Our primary valuation approach for New Millennium is P/NAV; our NAV is based on a discounted cash flow analysis (at an 8% discount rate) using the US$/C$ exchange rate and iron ore price assumptions summarized in Exhibit 2 on page 4. Our estimated net asset value is C$11.04/share (see Exhibit 9) after an assumed C$100m financing for the company’s share of development costs for the DSO and taconite projects. New Millennium’s NAV is based exclusively on the iron ore assets it holds in the region of Schefferville, Québec. We have applied a 0.6x target multiple to the DSO assets, a 0.3x multiple to the taconite and exploration assets, and a 1.0x multiple to current working capital to derive our target price of C$3.50/share. We believe these multiples are appropriate based on our perceived relative risk of the assets (given the expected capital cost, time to production and other factors). Exhibit 9: New Millennium net asset value details NPV (8%) (C$m) DSO project—NPV estimate of future cash flows attributable to NML Taconite project—NPV estimate of future cash flows attributable to NML Exploration properties—estimated current value to NML
163 1,824 10
Current working capital
79
Expected proceeds from options and warrants
10
Total capital expenditure requirement (attributable to NML)
100
Portion of capex to be financed by debt
100
Portion of capex to be financed by equity
0
NAV
2,086
Current number of basic shares outstanding (m)
176.2
Options with exercise price of C$0.77/share (m)
12.7
Pro forma fully diluted shares outstanding (m)
188.9
NPV/share (C$)
11.04
Source: Desjardins Capital Markets
Recommendation We are initiating coverage of New Millennium Iron Corp. with a Hold–Speculative rating and C$3.50/share one-year target price, which implies an expected return of 43% to the current share price. Once Tata Steel exercises its option to acquire the majority stake in the KéMag and LabMag projects, New Millennium will hold minority stakes in each of its known deposits. We caution that reliance on Tata Steel could be a risk. In our view, Tata Steel could defer development of the taconite deposits due to unfavourable feasibility study results, poor steel market conditions, the availability of lower cost alternative supplies or if Tata Steel cannot secure project financing. We estimate that the development cost of the taconite deposits will total C$5.8b, which implies a C$3.7b cost to Tata for a 64% stake in the projects.
Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 60 MARCH 22, 2012
Risks
We have a ‘Speculative’ risk qualifier for New Millennium. Start-up and operating risk. There is a significant risk that the exploration, development and completion of the DSO or taconite iron ore projects could be delayed due to circumstances beyond New Millennium’s control. Setbacks could include delays in securing financing or in construction or commissioning. Liquidity and financing. The development of the projects, particularly KéMag and LabMag, will require significant capital, and there is no assurance that New Millennium will be able to obtain sufficient financing at favourable rates. New Millennium may be unable to invest capital for its development and exploration programs, take advantage of business opportunities or respond to competitive pressures. Iron ore prices. The company’s future profitability is directly related to the volume of iron ore products sold and the price of these products. Iron ore prices have been volatile historically and are primarily affected by the demand for, and price of, steel. Iron ore prices are also affected by numerous other factors beyond the company’s control, including global and regional demand, political and economic conditions, and global production volumes and operating costs. Foreign exchange. Once in production, New Millennium will be subject to foreign exchange risk as revenues will be received in US dollars while operating costs will be in Canadian dollars. Fluctuations in exchange rates, principally the US$/C$ exchange rate, can significantly impact earnings and cash flows. Licences and permits. The company’s exploration and development activities require permits and approvals from various government authorities and are subject to federal, provincial and local laws. The company will be required to obtain additional licences and permits to continue and expand its development activities, and there can be no guarantee that these licences will be obtained or maintained. There is also a risk that future legislation and regulations will result in additional expenses in New Millennium’s operations and in reclamation obligations, the extent of which cannot be predicted. First Nations land claims. New Millennium’s DSO and taconite projects fall within an area subject to conflicting First Nations land claims. Aboriginal claims to lands and the conflicting claims to traditional rights between aboriginal groups could have an impact on the company’s ability to develop the properties. New Millennium and Tata Steel are engaged in discussions with four First Nations groups affected by the projects: Naskapi Nation of Kawawachikamach—impact benefit agreement for the DSO project signed in June 2010 Innu Matimekush-Lac John—impact benefit agreement for the DSO project signed in June 2011 Labrador Innu—impact benefit agreement for the DSO project signed in November 2011 Innu Takuaikan Uashat mak Mani-Utenam—impact benefit agreement for the DSO project signed in February 2012
Key management and directors Lee CG Nichols, Chairman. Mr Nichols has over 42 years of experience in the mining industry. Since 1963, Mr Nichols has worked for the Iron Ore Company of Canada, Syncrude Canada Ltd. and Luscar Ltd. in various engineering roles including Chief Mine Engineer. Since 1983, he has been the President of Terracon Geotechnique Ltd., a private consulting company. Mr Nichols received a Bachelor of Science and Engineering (Engineering Geology) from Queen’s University in 1966. He is a Registered Professional Engineer and Professional Geologist in the province of Alberta and British Columbia. Dean Journeaux, President, CEO and director. Mr Journeaux became President and CEO of New Millennium on July 1, 2011 and continues as a director. He was most recently COO, a post he had held since 2008; he has been involved with the company from its inception in 2003. Mr Journeaux has over four decades of experience in the mining industry and has held various engineering, operations and management positions with Québec Cartier Mining Company and Met-Chem Canada Inc., both of which were US Steel subsidiaries at the time. Mr Journeaux received a Bachelor of Engineering (Mining) from McGill University in 1960. He is a Member of the Ordre des ingénieurs du Québec (retired Jackie Przybylowski, P.Eng.
Desjardins Capital Markets
New Millennium Iron Corp.
PAGE 61 MARCH 22, 2012
category), a member of the Association of Iron and Steel Engineers and a Fellow of the Canadian Institute of Mining, Metallurgy and Petroleum. Mark Freedman, CFO. Mr Freedman, CA, was appointed CFO of New Millennium in 2011; he had been acting as interim CFO since 2008. Mr Freedman has been a partner of the Montréal-based accounting firm Roll Harris & Associés since 2001. Mr Freedman obtained his graduate diploma in Public Accountancy from McGill University in 1993 and has been a member of the Ordre des comptables agréés du Québec since 1994. Bish Chanda, Senior Vice-President, Marketing & Strategy. Mr Chanda has been with the company since its inception. He has over 40 years of experience, with over 35 years in iron ore. He worked for 25 years with the Iron Ore Company of Canada, where he held various technical and senior management positions in engineering, and process and quality improvements. In 1997, Mr Chanda became an independent consultant and was involved internationally in the iron ore development field. Mr Chanda received his Bachelor of Technology in Civil Engineering from the Indian Institute of Technology, Kharagpur, in 1962. He is a member of both the Ordre des ingénieurs du Québec and Professional Engineers Ontario. Moulaye Melainine, Senior Vice-President, Development. Mr Melainine has been with New Millennium since November 2005. He has over 31 years of experience in the iron ore sector in operations, planning and management. From 1979–87, he was the Head of the Mining Division and later Corporate Comptroller of Société Nationale Industrielle et Minière (SNIM), the Mauritanian state-owned iron ore producer. Mr Melainine then worked for 10 years on numerous international projects as a staff member of Met-Chem, the Montréal-based steel, iron ore, mining and minerals consulting company. Prior to joining New Millennium, Mr Melainine served as Regional Vice-President of Tecsult International Inc., an engineering consulting company based in Montréal, from 2000–05. Mr Melainine received his degree in Mining Engineering in 1977 from École Polytechnique and his Master’s in Mineral Industry Economics in 1979 from McGill University. Jean-Charles Bourassa, Vice-President, Mining. Mr Bourassa began his career at Québec Cartier Mining Company’s Mont Wright iron ore project in 1972. He was transferred to Met-Chem Canada Inc. in 1976 to be part of its mine development team for the Kudremukh Iron Ore Company Ltd.’s iron ore project in India, which focused on the development of mining, concentration, slurry pipeline and port facilities. As an employee of Met-Chem Canada Inc. he served as Assistant Project Manager (1980–82) and as Production Manager (1982–84) for the National Iron Ore Company, a producer of washed natural ores (similar to those at New Millennium’s DSO project) in Liberia. A 1972 graduate of École Polytechnique with a BSc in Mining Engineering (Honours), Mr Bourassa is also a member of the Ordre des ingénieurs du Québec and a CIM fellow. Ernest Dempsey, Vice-President, Investor Relations & Corporate Affairs. Mr Dempsey joined New Millennium in 2011 as Vice-President, Investor Relations & Corporate Affairs, bringing more than 35 years of international experience in all commercial aspects of the iron ore industry. He most recently served as Vice-President of Sales & Marketing for Mitsubishi Development Pty. Ltd.’s 50%-owned Crosslands Resources Ltd. iron ore joint venture in Perth, Western Australia. He held the same position at Iron Ore Company of Canada from 1997–2004, and subsequently represented Rio Tinto’s iron ore businesses in Europe. Earlier in his career, Mr Dempsey was with US-based mining companies Cleveland Cliffs Inc. (now Cliffs Natural Resources Inc.) and Pickands Mather & Co., where his roles included commercial responsibilities in Canadian iron ore. Mr Dempsey received a Bachelor of Arts in History and French (dual major) from the University of Virginia in 1973 and an MBA from John Carroll University in Cleveland, Ohio, in 1983.
Jackie Przybylowski, P.Eng.
Desjardins
Iron ore
Capital Markets
PAGE 62 MARCH 22, 2012
DISCLOSURES Distribution of ratings Rating category
Desjardins rating
Desjardins coverage universe (# of stocks)
% distribution
Desjardins Investment Banking (# of stocks)
% distribution
Buy Hold Sell Total
Top Pick/Buy Hold Sell
118 28 2 150
79 19 2 100
36 10 2 48
75 21 4 100
COMPANY SPECIFIC DISCLOSURES Legend 1. 2. 3. 4. 5.
Desjardins Capital Markets makes a market in the securities of the issuer. Desjardins Capital Markets has performed investment banking services for the issuer in the past 12 months. Desjardins Capital Markets has received compensation for investment banking services from the issuer within the past 12 months. Desjardins Capital Markets has managed or co-managed a public offering of securities for the issuer in the past 12 months. Desjardins Capital Markets beneficially owned 1% or more of the common equity (including derivatives exercisable or convertible within 60 days) as of the month end preceding this report. 6a. The Desjardins Capital Markets research analyst(s) and/or associate(s) who covers the issuer discussed has a long position in its common equity securities. 6b. A member of the household of the Desjardins Capital Markets research analyst(s) and/or associate(s) who covers the issuer has a long position in its common equity securities. 7a. The Desjardins Capital Markets research analyst(s) and/or associate(s) has viewed a material operation of the issuer, and the related travel expenses have not been paid for by the issuer. 7b. The Desjardins Capital Markets research analyst(s) and/or associate(s) has viewed a material operation of the issuer, and the related travel expenses have been paid for partially by the issuer. 7c. The Desjardins Capital Markets research analyst(s) and/or associate(s) has viewed a material operation of the issuer, and the related travel expenses have been paid for fully by the issuer. 8. Desjardins Capital Markets has received compensation for non-investment banking, non-securities-related services from the company in the past 12 months. 9. The issuer is a client for which a Desjardins Capital Markets company has performed non-investment banking, non-securities related services in the past 12 months. 10. The issuer is (or was) a client of Desjardins Capital Markets or an affiliate within the Desjardins Group within the past 12 months and received non-securities related services. 11. A partner, director or officer of Desjardins Capital Markets or any analyst(s) involved in the preparation of this publication has provided services (other than for investment advisory or trade execution purposes) to the issuer for remuneration within the past 12 months. 12. An officer or director of Desjardins Capital Markets, outside of the Equity Research Department, or a member of his/her household is an officer or director of the issuer or acts in an advisory capacity to the issuer. 13. The Desjardins Capital Markets research analyst(s) and/or associate(s) had communication with the issuer regarding the verification of factual material in this research publication. 14. The Desjardins Capital Markets research analyst(s) and/or associate(s) had communication with Investment Banking regarding the verification of material in this research publication. 15. A director or officer of the issuer (or any of its affiliates) serves on the board of the Desjardins Group. 16. The issue date for this research publication is within the restricted period for any recent IPO, secondary offering or lock-up agreement between the issuer and Desjardins Capital Markets. 17. The Desjardins Capital Markets supervisory analyst serves as an officer, director or employee of the issuer or acts in an advisory capacity to the issuer. Disclosures for issuers discussed in this publication Adriana Resources Inc.: 7b, 13
Labrador Iron Ore Royalty Corporation: 7b, 13
Alderon Iron Ore Corp.: 7b, 13
Labrador Iron Mines Holdings Limited: 7b, 13
Champion Minerals Inc.: 1, 7b, 13
New Millennium Iron Corp.: 1, 7b, 13
Price graphs: For full disclosure, please visit our website at https://www.desjardins-securities.ca Full disclosures for research of all companies covered by Desjardins Capital Markets can be viewed at http://www.desjardins-securities.ca/ Disclosures/English.aspx or http://www.desjardins-securities.ca/Disclosures/Francais.aspx
Desjardins
Iron ore
Capital Markets
PAGE 63 MARCH 22, 2012
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Risk represented by the stock is greater than that of its peer group* in terms of volatility, liquidity and earnings predictability
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High degree of risk represented by the stock, marked by an exceptionally low level of predictability
* Peer group refers to all of the companies that an analyst has under coverage and does not necessarily correspond to what would typically be considered an industry
group. Where an analyst’s coverage universe is such that ‘relative’ performance against a ‘peer group’ is not meaningful, the analyst will benchmark the rating against the most appropriate market index
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(514) 281-8653
(514) 281-4231
Jimmy Jean Hendrix Vachon
(514) 281-2336
[email protected]
Equity Capital Markets Sales
Paul Pint, CA, Head of Sales
(416) 867-7590
Robert Dennison
(604) 656-2665
Simon Dionne, Analyst
(514) 985-5064
[email protected] [email protected] [email protected]
Trading
Fabienne Evans
(416) 867-3580
Chung Kim
(416) 867-3581
Stephen Lloyd, CFA
(416) 867-3598
[email protected] [email protected] [email protected]
André Pagé
(514) 281-2291
Wolfgang Rosner
(514) 281-8632
Paul Sun, PEng, CFA
(416) 867-1404
[email protected] [email protected]
[email protected]
Felix Bélanger
(514) 985-5072
Meiwen Gouadec
(416) 867-3423
Michael Nicholishen
Eric Bouchard
(514) 985-1889
David Lailey
(416) 867-8612
Mel Peralta
Peter Byrne, Liability Trading
(416) 867-2260
François Laplante, Head of Liability Trading (514) 281-7707
Jose Estevez
(416) 867-2266
[email protected] [email protected] [email protected] [email protected]
Administration
[email protected]
[email protected]
[email protected]
Reid McGregor
[email protected]
(416) 867-1232
(416) 867-3436
[email protected] (416) 867-1710
[email protected] John Shingler, Associate (416) 867-3757
[email protected] Pierre-Olivier Tardif (514) 281-8771
[email protected]
Lindsay Booth (Sales)
(416) 867-3586
Jo-Ann Deguire
(514) 281-7251
Meni Stoikos
(416) 867-3586
Yasmina Borki (Trading)
(416) 867-2262
Angela Di Pede (Trading)
(416) 867-1465
Rick Sturch
(416) 867-3594
Marie-Eve Boulé
(514) 281-2894
Jay Peralta (Trading)
(416) 867-1888
Angelique Welsch
(514) 985-1844
David Paul
(416) 867-3772
Alex Somjen
(416) 867-3751
[email protected] [email protected] [email protected]
Preferred Shares
John Nagel, Vice-President
[email protected]
(416) 867-3535
[email protected] [email protected] [email protected]
[email protected]
[email protected] [email protected] [email protected]
[email protected]
