An Unconventional Way to Play a Rebound in Iron Ore Prices

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Whenever the iron ore industry comes under discussion, investors normally only limit their discussion to the ‘Big Three,’ which are Vale, BHP Billiton and Rio Tinto (NYSE: RIO). Sometimes, Cliffs Natural Resources (NYSE: CLF) (I will use CNR the rest of my article) is also added to the list. With the exception of CNR, hardly any other Canada-based iron ore company/trust is discussed in the market. The following briefly discusses the earnings preview of two Canada-based iron ore companies (including CLF) and one open-ended trust.

Cliffs Natural Resources (NYSE: CLF)

It is hardly a surprise that CNR’s stock price has not seen a rally as strong as its ‘Big Three’ peers. The following chart shows how these stocks have rallied after a surge in the spot iron ore prices since September last year: 

<img src="/media/images/user_15211/capture1_15_large.PNG" />

The main reason for this has been that CNR is one of the highest cost operators among the major iron ore players. Therefore, the market has not bought this stock as they believe that the company is extremely vulnerable to a much-expected fall in iron ore prices (the rise is temporary given the recent stockpiling at Chinese steel mills). Nonetheless, the company seems to be an attractive short-term investment given that it is expected to report a strong 4Q on the back of strong iron ore prices in the last quarter (The company makes more than 80% of its revenues from its iron ore operations).

4Q Estimates: For CNR’s iron ore operations, a sale of 6.1mt from the US, 2.2mt from Eastern Canada and 2.5mt from Asia Pacific is expected. For US coal, the Street expects a sale of 1.6mt. In terms of revenue and EPS, the Street expects the company to make $1.54 billion and 59 cents, respectively.

Key themes for the quarter are likely to be:

1) Bloom Lake impairment (the sector seems to have established a pattern of combining this with a management change);

2) The street is likely to be disappointed with the US iron ore realized price guidance; and

3) Disappointing 4Q volumes - estimates imply misses relative to the full year guidance.

The company is expected to report on Feb 13.

Labrador Iron Ore Royalty Corporation (NASDAQOTH: LIFZF)

LIF is an interesting open-ended unincorporated trust. The trust gets 7% royalty on all sales of iron ore products by Iron Ore Company of Canada (IOC). This is the same company in which RIO has a 58.7% stake, followed by Mitsubishi (26.2%) and the trust itself (15.1%).           

RIO reported DecQ12 sales and production for IOC of 3.8mt and 3.9mt respectively. With a 7% sales royalty from IOC, LIF is expected to generate revenues of $31.7 million with an estimated IOC average cash cost for the quarter of $61.6/ton.

Rio Tinto continues the commissioning of its 22 million tons per annum (mtpa) expansion (currently producing at around 72% of nameplate capacity), and has made no change to previous guidance for completion of its 23.3mtpa expansion for MarQ13. Credit Suisse is targeting DecQ12 EPS of $0.50 (relative to the consensus $0.46).

Alderon Iron Ore Corporation (NYSEMKT: AXX)

As a developer with a project startup expected in 2016, Alderon will not have a sales figure to report.

The bears are looking for a DecQ12 loss per share of $0.10 (relative to the consensus $0.07), although this is a largely irrelevant number for a development stage business. Alderon recently released its Feasibility Study on its Kami project. I look forward to the company’s earnings call for company guidance on project scheduling and project financing.

Foolish Bottom Line

There are many other ways trade the movement in iron ore prices rather than investing in the major iron ore players. In this context, the Canadian-based iron ore players deserve a special mention. Let’s see how these stocks perform in the ongoing earnings season after a strong quarter for iron ore prices. 

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