Canada is a two-bit player when it comes to iron ore production, but that could be in for a dramatic change because of two words: Labrador Trough.
The trough is a little known geographical feature straddling Quebec and Labrador that is causing quite a stir in mining circles. The more than 1,000-kilometre-long, sausage-shaped landform hosts numerous iron ore deposits of a size and grade that suggest they will eventually lead to new mines. Investors should be taking notice because the trough's ferrous riches, only moderately exploited to date, appear to be on the cusp of rapid development.
"The Labrador Trough has the potential to be a major global area" for iron ore production, contends Jackie Przybylowski, an analyst at Desjardins Securities Inc. who has just issued a 64-page report devoted to the investment prospects of companies active in the region. The firm initiated coverage on five of the area's pure play iron ore prospects.
Raymond James, another dealer, has also been advancing the same theme with its clients. "In our view, the Labrador Trough is underutilized and has the potential to be a major iron district," the firm said last week in a note.
The drive for new mines is being spurred by the economic fundamentals of buoyant ore prices and demand growth in Asia for steel, which is derived from iron ore. But the prospects for development are receiving an additional helping hand from both the Quebec and federal governments.
Quebec announced in its recent budget three measures that could help jump-start more mining in the trough. It said the Caisse de dépôt et placement du Québec and Canadian National Railway Co. are planning a feasibility study for a second rail line into the region. Hydro-Québec has also been asked to study extending the provincial transmission grid, which would benefit new producers. The province has also earmarked up to $1-billion for investments in new mining and petroleum projects. In addition, Ottawa has announced it will invest up to $55-million to fund construction of a deepwater dock at Sept- Îles, Que., that will be used for shipping ore.
There are a number of junior Canadian stock plays offering exposure to the trough. Ms. Przybylowski deems the best of the bunch to be Labrador Iron Mines, the newest company to become a producer and a possible takeover target. The most logical acquirer is Rio Tinto through its Iron Ore Co. of Canada subsidiary, which has operations near Labrador's deposits.
Labrador Iron Mines began production last year from deposits containing so-called "direct shipping ore," a high grade material that requires little processing and carries a premium price.
In its report, Desjardins pegged Labrador Iron as "top pick" and set a one-year price target of $8.50, in the absence of a takeover, and even more if the company gets taken out by an acquirer.
"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 off-take agreement," the report said. "Off take" is mining jargon for a deal to sell production from a mine to a major steel producer.
Desjardins also has "buy" ratings on two companies hoping to open mines: Adriana Resources and Champion Minerals.
Adriana is trying to develop Canada's largest known iron ore deposit, at Lac Otelnuk, located in a remote area of northern Quebec. It may have a leg up because it's partnered with Wuhan Iron and Steel Group Corp., or Wisco, a major Chinese government-owned steel producer. A possible downside is the project's high capital costs.
Champion Minerals, Desjardins other "buy," is one of the largest landholders in the Fermont area in Quebec. The company has 17 iron ore properties, some of which could be sold to finance the development of its remaining holdings.
Raymond James also favours Champion, ranking it "outperform." It makes the same call on New Millennium Iron Corp., which has Tata Steel Ltd. as a strategic partner, a sign that its deposits have been reviewed and vetted by a major industry player.
One worry for investors is a hard landing in China that lowers demand for iron ore. Another potential problem is that additional supply from Canada and other new producers could be substantial enough to cut price levels.
While oversupply is a risk, it is unlikely to be severe enough to cause prices to tank, according to Ms. Przybylowski.
In a weakening price environment, the lowest risk play in the sector is Labrador Iron Ore Royalty Corp., she said. The company benefits from royalty revenue from the output of Iron Ore Co. of Canada, yet has upside should IOC fulfill its expansion plans.