What Rio Tinto’s IOC Sale Means for Canadian Iron Mining

On March 1, Reuters reported that Rio Tinto (NYSE:RIO,ASX:RIO,LSE:RIO) had appointed two banks to sell its stake in the Iron Ore Company of Canada (IOC).

Rio owns 58.7 percent of IOC and Mitsubishi (TSE:8058) holds 26.2 percent. Labrador Iron Ore Royalty (TSX:LIF.UN), which takes a 7-percent royalty and a $0.10-per-metric-ton (MT) commission on the iron ore that IOC sells, owns the remaining 15.1 percent.

IOC joins a growing list of Canadian mining assets that have recently been put on the market or sold, including two recent iron ore transactions by ArcelorMittal (NYSE:MT). In December, it sold 20 percent of its stake in Baffinland Iron Mines, which is developing the Mary River open-pit mine on Baffin Island, to its joint venture partner. That was followed by its sale of 15 percent of ArcelorMittal Mines Canada, which has two mines in the Labrador Trough, as well as a pellet plant and port facilities, to a consortium led by South Korean steelmaker POSCO (NYSE:PKX) for $1.1 billion.

Rio Tinto aims to get a handle on its debt

Like Arcelor, Rio is looking to cut debt, particularly after being forced to write down the value of its aluminum and coal assets by $14.4 billion last year. Rio’s gross debt rose to $26.7 billion in 2012, from $21.7 billion in 2011, prompting Standard & Poor’s to warn of a possible credit rating downgrade in the next 12 to 18 months, according to a February 26 Financial Times article.

Meanwhile, the company continues to work on controlling its costs: according to its 2012 earnings release, Rio will cut its capital expenditures to $13 billion in 2013 from $17.4 billion in 2012. It’s also aiming for cash cost savings of over $5 billion by the end of 2014. Overall, Rio lost $3 billion on the year, down from a profit of $5.8 billion in 2011. The latest results — particularly the massive writedown — prompted the resignation of CEO Tom Albanese. His replacement, Sam Walsh, has promised to rein in costs and tighten Rio’s focus.

“I am looking hard at divestments,” he said in a March 1 Globe and Mail article. “There are a number of assets for us that are not core or they are underperforming.” IOC will join other Rio assets currently up for sale around the world, including its diamond business and aluminum operations in Australia and New Zealand.

IOC fits the description of a non-core asset

IOC is Canada’s largest iron ore producer. The company traces its roots back to 1954, when it started production at its Schefferville mine in Quebec. It now produces roughly 17 million metric tons per year (mtpa) of iron ore at its Carol concetrator, which is located near Labrador City in the province of Newfoundland and Labrador.

The company also owns the 418-kilometer Quebec North Shore & Labrador railway, which links the project to IOC’s shipping terminal at the port of Sept-Îles, Quebec.

Rio’s IOC stake generated $1.97 billion of revenue in 2012, or just 3.8 percent of the company’s total, according to Rio’s annual report. The latest figure is also down from $2.47 billion a year earlier. Capital expenditures rose to $742 million from $653 million, as the company completed an expansion that will boost IOC’s output to 23.3 million mtpa. To put that in context, Rio aims to increase production at its Pilbara operations in Australia to 360 million mtpa by mid-2015.

Potential buyers include other majors, Asian investors

So what might a sale of IOC look like? Desjardins Capital Markets analyst Jackie Przybylowski believes that the large size of Rio’s stake, which she values at between $2 and $4 billion, would likely mean that Rio would end up selling a portion, rather than the whole thing.

“In our view, the full Rio Tinto stake would be too large an acquisition for most miners,” she wrote in a March 1 note to clients. “We believe the most likely sale, if there is one, would involve a minority stake similar to the recent 15% stake in Québec Cartier Mining sold by ArcelorMittal to a consortium led by POSCO for US$1.1 billion. The assets are of a similar size with similar infrastructure and are also located in the Labrador Trough.”

Still, she wrote, “[w]e continue to expect that the current ownership structure will be maintained.”

Whether all or part of Rio’s IOC stake changes hands, there is a short list of likely buyers. Here’s a look at three possibilities:

  • Teck Resources (TSX:TCK.B,NYSE:TCK), Canada’s largest diversified mining company, is one of the few majors that’s in a good position to acquire all of Rio’s 57-percent stake in IOC. As the Financial Post reported on February 7, Teck has largely repaired its balance sheet following its 2008 purchase of Fording Canadian Coal Trust for $13.6 billion. The company ended 2012 with $3.2 billion in cash. Iron ore, a key element in steelmaking, would also seem a natural fit with Teck’s metallurgical coal business. Management also seems more open to acquisitions, particularly in the iron ore space: “We still think [iron ore] is a good fit in our portfolio,” Teck CEO Don Lindsay said in the March 1 Reuters article. “The values have come down and also … a few new assets have become available.”
  • Glencore International (LSE:GLEN) is another possibility. The commodities trader recently made its first move into iron ore with its agreement to buy an unspecified stake in Brazil’s Ferrous Resources, which has three producing mines in that country. Glencore has also agreed to buy 20 million MT of iron ore from Ferrous over four years. Ferrous aims to sharply increase its output: it produced 3.2 million MT of iron ore in 2012 and wants to boost that to 17 million MT by 2016, according to a February 28 Mineweb article.
  • Asian steelmakers: Steel producers from China have taken an increasingly keen interest in the Labrador Trough. However, to date, these investors have mostly limited themselves to smaller stakes, with an emphasis on junior exploration firms. For example, last year, China’s Hebei Iron & Steel Group Company (SZSE:000709) bought 19.9 percent of Alderon Iron Ore (TSX:ADV) and 25 percent of Alderon’s Kami project for $194 million.

As well, India’s Tata Steel (BSE:500470) currently holds a 27-percent stake in New Millennium Iron (TSX:NML), which has three active projects in the Millennium Iron Range, near the town of Schefferville, Quebec. And China’s third-largest steelmaker, Wuhan Iron and Steel Company (SSE:600005), holds interests in projects operated by Adriana Resources (TSXV:ADI) and Century Iron Mines (TSX:FER), according to Mineweb.

Another wildcard is the Investment Canada Act, which requires foreign firms buying controlling stakes in Canadian companies to prove that the transaction is of “net benefit” to the country. In 2010, it allowed the government to block the $39-billion sale of Potash Corporation of Saskatchewan (TSX:POT,NYSE:POT) to BHP Billiton (NYSE:BHP,ASX:BHP,LSE:BLT). However, it has recently approved other sales, including that of oil producer Nexen to China’s state-owned CNOOC (NYSE:CEO,HKEX:0883) and Progress Energy to Malaysia’s Petronas.

 

Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article.

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