DBRS Assigns Rtg Labrador Iron Ore Royalty IF at STA-3 (low)

Dominion Bond Rating Service (“DBRS”) has assigned a Stability Rating of STA-3 (low) to the Labrador Iron Ore Royalty Income Fund (the “Fund”). The non-operating, royalty structure of the Fund and its exceptionally strong balance sheet have allowed it to achieve a higher rating than most of the commodity-based, non-royalty funds that DBRS rates, which are generally in the STA-4 to STA-6 range.

DBRS notes that the Fund’s cash available for distribution is driven by its 7% gross overriding royalty on revenue from Iron Ore Company of Canada (‘IOC”). IOC’s revenue is driven by its iron ore volumes and pricing. Industry practice is that volumes are sold under a long-term contract with pricing renegotiated annually, so pricing from year-to-year can be volatile. Notwithstanding this factor, IOC’s revenue is much more stable than earnings. The main determinant for the Fund’s rating is the royalty stream. As long as IOC produces and sells its iron ore concentrates and pellets, the Fund receives its royalty. IOC is majority owned (58.72%) by Rio Tinto Group, one of the world’s largest mining companies, and is rated AA (low). IOC is the fifth-largest pellet producer worldwide and is well regarded for its high quality products. Furthermore, access to low cost power from Hydro-Québec helps cement its favourable cost structure (second quartile on the cost curve). DBRS sees minimal risk in IOC ceasing operations, so the royalty is well protected.

The Fund is essentially debt free and, if necessary, could temporarily fund distributions through borrowings (bank lines in place out to 2009) if the royalty stream is impacted by one-time events. Due to its non-operating nature, the Fund does not have any capital expenditures to finance.

The main issues facing the Fund are its reliance on IOC, which itself is a highly concentrated one-operation business, and a high exposure to the Canadian dollar. The Fund receives its royalty stream from IOC in U.S. dollars, so a stronger Canadian dollar will lower the amount of cash available for distribution in Canadian currency. Despite the issues facing the Fund, it rates in the STA-3 rating category given the sustainability of its distributions, which are underpinned by its royalty stream, and the long-life iron ore reserves at Labrador City. Even during the last cyclical downturn, the Fund was able to essentially keep its payout ratio near 100% exclusive of one-off events.