I shot out about a company I have been buying shares when I saw something that might give it an extra boost.

If you are not following us on Twitter @PendulumInstit1 - you should because it is the fastest way to give you a quick heads up.

So what does Labrador Iron Ore Royalty Corporation (TSX: LIF) do?

Revenues are entirely dependent on the operations of the Iron Ore Company of Canada:

  • receives 7% top line royalty
  • receives 10¢ per ton commission on sales
  • receives dividends from 15.1% equity interest
  • revenue is affected by the price of iron ore and the Canadian – U.S. dollar exchange rate

82 years ago, Labrador Iron Ore Royalty Corporation received grants from Newfoundland of leases and surface rights to establish the town site that became Labrador City. These leases have recently been renewed for another 30 years.

$LIF sublets the leases to Iron Ore Company of Canada (IOC) and IOC, with major steel companies as original shareholders, built the infrastructure, mine, railway and port. Under the sublease, $LIF receives a 7% gross overriding royalty on iron ore products produced and sold by IOC.

Important: $LIF is not operating an iron ore mine - it simply receives royalties and dividend. That is why its financial metrics look so much more attractive:

Source: QuickFS.net

Corporate Structure

Great partners in Iron Ore Company of Canada

Rio Tinto (NYSE: RIO) is a great mining company and the Japanese trading house Mitsubishi Corp (8058.T) is another great partner. Remember $LIF do not operate the mine - they just receive royalty and dividends. I feel very comfortable having Rio Tinto in charge of mining operations.

Iron Ore Company of Canada (IOC) is a simple to understand business

I think this snapshot gives a summary of Iron Ore Company of Canada's business.

Products Sold

This is probably more than you care to know about Iron Ore, but it is important to note in their latest quarterly report they said demand for pellets was down so they were shipping a higher percentage as iron ore rather than pellets.

Lots of reserves for the next 25 years

We do not need to worry about the royalties suddenly stopping because they run out of Iron Ore - at least not for the next 25 years.

5 year snapshot of dividends and royalties received

Growing cash flow over past 4 years

But the movement in the USD$/CAD$ exchange rate makes the picture look different for USD$ investors. The company explained:

A decrease in the Canadian dollar increases IOC’s profitability because seaborne iron ore is priced in US dollars and IOC’s costs are predominantly incurred in Canadian dollars.

First Quarter cash flow dropped significantly

The nice thing about royalties - less dependent on price for profitability

The company discussed revenues in its 1st quarter report:

The COVID-19 pandemic situation caused a slowdown in demand for pellets in various markets and industries across Europe and North America. The quarterly Atlantic Basin blast furnace pellet premium, as reported by Platts, averaged US$29 per tonne in the first quarter of 2020, a 57% decrease over the first quarter of 2019 and 21% lower than the fourth quarter of 2019.
Despite lower pellet premiums, higher CFS prices together with higher concentrate and pellet tonnages, resulted in royalty revenue for LIORC in the first quarter of 2020 increasing 24% as compared to the royalty revenue in the first quarter of 2019

So what was the tweet about?

In the 2019 Annual report, $LIF attributed its improved performance in part to problems at another huge Iron Ore mine in Brazil called Vale S.A. (NYSE: VALE)

The collapse of the Brumadinho tailings dam had a profound effect on the market for seaborne iron ore in 2019. Vale’s total iron ore fines and pellet production in 2019 fell 21.5% and 24.4% to 302 million tonnes and 41.8 million tonnes, respectively.
While some growth in supply is expected, Vale production levels in 2020 are not expected to reach 2018 levels. Vale predicts that 15 million tonnes of capacity will come back on line in 2020 followed by a further 25 million tonnes in 2021. In its fourth quarter production report, Vale maintained its iron ore fines production guidance for 2020 at 340 to 355 million tonnes, of which 44 million tonnes is expected to be pellet production

NOTE: Vale will not be back to full production till the end of 2021 and $LIF are saying this disruption has increased prices for Iron Ore and Pellets.

China unhappy with Australia - Iron Ore Producers may be punished

The Daily Mail reported:

China has issued another warning to Australia by opening the door to new checks on Australian iron ore in an escalating trade row overshadowed by coronavirus.
Beijing's latest move comes after China banned Australian beef and slapped a tax on barley in the wake of Canberra's calls for an inquiry into the pandemic.
The new Chinese customs rules mean that Australia's $63billion (£34billion) iron ore exports could be singled out for extra checks, analysts say.
A source familiar with the situation told Daily Mail Australia it would not be surprising if Brazilian exporter Vale was prioritised over Australian exporters for streamlined customs processing.
China imported 1.07billion tonnes of iron ore last year, receiving 62 per cent from Australia and 21 per cent from Brazil.

But if Vale cannot increase production till 2022 because of Brumadinho tailings dam collapsing, then I am thinking $LIF and IOC maybe either direct (through sales) or indirect(through market price increases) beneficiaries of this move by China to punish Australia.

China has already lashed out with restrictions on Australian Beef and Barley:

Last week China introduced an 80 per cent tariff on Australian barley after suspending imports from four Australian beef suppliers for 30 days over alleged labelling issues.

so it does not seem unlikely they would target Australia's Iron Ore miners as well.

Why I bought $LIF

My decision to buy $LIF was made before this recent China/Australia development. I bought it because the bulk of its income is from royalties - so it is much less exposed to the ups and downs of commodity prices compared to actual mining companies. IOC needs to pay the royalty, no matter how profitable or unprofitable the mine is.

With a return on equity of 25% and a P/E ratio of 6.6 with a 10 year revenue growth rate (CAGR) of 8.7%, I think it makes a nice long term addition to our portfolio. Plus it pays out the majority of its cash flow each year to shareholders.

Not Investment Advice

As always, this is not investment advice. Do your own research. Consult your professional advisors.