DBRS Comments on Labrador Iron Ore Royalty Income Fund 2008 Results and Expansion Cutbacks at IOC

DBRS notes that on February 27, 2009, Labrador Iron Ore Royalty Income Fund (Labrador or the Fund) released its 2008 results from operations and announced that Iron Ore Company of Canada (IOC) intends to suspend a number of expansion projects due to the sharp drop in world demand for iron ore. In addition, the Fund indicated that during the fourth quarter of 2008, IOC experienced sharply reduced demand for iron ore and that IOC has cut back production to avoid building excessive inventories. DBRS expects that with reduced iron ore sales by IOC and lower iron ore prices, the Fund’s income will drop in 2009 compared with the very high levels achieved in 2008. Reduced revenue to the Fund is expected to lead to the Fund retaining its regular distributions in 2009 but significantly reducing its special payouts, which will be consistent with the Fund’s STA-3 (low) rating.

The Fund had a record year in 2008 with distributions totalling $4.85 per unit, comprised of $1.85 per unit in regular distributions and $3.00 in special distributions. The regular quarterly distribution level was raised to $0.50 per unit in the second quarter. Although IOC has increased production capacity during the year, its concentrate and pellet sales during 2008 were only equal to 15.1 million tonnes due largely to weaker-than-expected fourth quarter sales (3.3 million tonnes). A drop in shipments to regular customers in the fourth quarter also led to the pursuit of spot sales in addition to contract tonnages.

DBRS expects that IOC’s first quarter 2009 sales will also be weak as international iron ore prices for the 2009-2010 contract year beginning April 1, 2009, have not been settled as yet. With reduced sales in at least in the first half of 2009 and reduced average prices for iron ore for the calendar year, DBRS expects the Fund’s cash available for distributions will be well below the record levels achieved in 2008. We do note that the Fund has retained some distributable cash from prior periods (approximately $0.60 per unit), and has no net debt obligations, so it has some ability to manage distribution levels going forward. A reduction of quarterly distributions to below the current $0.50 rate may lead to a re-examination of the current stability rating.

The Fund has also been advised by IOC that previously announced programs totaling $800 million to expand concentrate production capacity to 22.8 million tonnes per year from 18.4 million tonnes have been suspended in response to adverse market conditions. IOC has also decided to not proceed with the refurbishment of its Sept-Îles pellet plant due to the project no longer being viable with current weak market conditions. The suspension of these projects will reduce IOC’s potential sales over the medium term, which will limit the growth of the Fund’s income on the basis of increased sales tonnage at IOC. With current weak market conditions, the delay in growth in production capacity at IOC is not considered a significant issue for the Fund.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Mining, which can be found on our website under Methodologies.

This is a Corporate rating.