01 December 2011 Americas/Canada&United States Equity Research Steel (Metals & Mining -Steel) North American Iron Ore Research Analysts INITIATION Nathan Littlewood 416 352 4585 [email protected] Initiating coverage North America’s combination of under utilised infrastructure, skilled labour, low jurisdictional risk, and cheap power make it a region that global iron ore investors should not ignore. The steel industry’s requirements for higher quality raw materials combined with trends of decreasing DSO grades from more traditional iron ore regions are likely to make high quality ‘manufactured’ iron ore products, such as those produced in parts of North America, an important part of the seaborne market going forwards. Exhibit 9 summarises our global iron ore coverage, and illustrates that the North American stocks are currently trading on the lowest multiples globally. Exhibit 1: Target Price and Rating summary (based on 29 Nov 2011 close) Share Target Rating P/NAV 12m Price Price PER Alderon Iron Ore Corporation ADV.TO C$ 2.36 2.60 N 0.40 n.m. Cliffs Natural Resources CLF US$ 67.81 90.00 O 0.91 5.2 Labrador Iron Ore Royalty LIF-U.TO C$ 37.22 45.00 O 0.70 9.3 Corporation Labrador Iron Mines LIM.TO C$ 6.74 8.30 O 0.7 4.8 New Millennium NML.TO C$ 1.51 1.90 O 0.24 n.m. Source: Company data, Credit Suisse estimates. We use a range of valuation tools to look at these stocks both on a stand-alone basis and through the eyes of potential acquirers. From our global database of almost 300 assets and 80 companies, we have handpicked the most relevant comparables for each stock, taking into account life cycle status, diversification, ore body / product type, infrastructure access, and other key value determinants. Our investment views differ from the rest of the street on: ■ ADV.TO – TP puts us at bottom of the street. Although we like this asset and the team that is putting it together, we do not believe the stock deserves the takeover premium it currently attracts. ■ CLF – Our global coverage universe provides multiple valuation perspectives, most of which make CLF look cheap relative US metals peers. We see LIF-U.TO as a more logical acquisition target than the more commonly speculated ADV.TO. ■ LIF-U.TO – TP puts us as top of the street, and we believe that the market has under-appreciated the potential opportunity in this business as the Labrador Trough moves from a state of mine to infrastructure constraint. ■ NML.TO / LIM.TO – We see a compelling case for a corporate combination, with LIM.TO appearing the more logical acquirer. If LIM.TO is smart enough, we see an opportunity for it to be the consolidator of the sector. DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 01 December 2011 Table of contents Introduction 5 Global context 7 North American snap shot 8 Why produce iron ore in Canada? 10 Capitalising North America’s natural advantages 11 Alderon Iron Ore Corporation (ADV.TO) 14 Bloom Lake II – tougher the second time around? 14 Investment Thesis 15 Valuation 19 Summary 19 Net Present Value 19 NAV sensitivities 20 As an acquisition target 22 Earnings multiples 24 Comparable company analysis 25 Company-Specific Risks 27 Asset Review 28 Summary 28 Background 28 Products & Pricing 28 Mining and Processing 31 Transport and Logistics 32 Costs 34 Reserves and Resources 37 Corporate 39 Balance Sheet & Cash Flow 39 Management 40 Ownership 42 Cliffs Natural Resources (CLF) 44 2012 will be about addressing diversification concerns 44 Investment Thesis 45 Valuation 49 Summary 49 Net Asset Value 50 NAV sensitivities 51 Earning Multiples 52 Comparable company analysis 54 Company-Specific Risks 58 Asset Review 59 Summary 59 United States Iron Ore 62 Eastern Canadian Iron Ore 64 Asia Pacific Iron Ore 66 Minority Iron Ore Interests 68 North American Coal 68 Asia Pacific Coal (Australia) 69 Ferroalloys 69 Financials 74 Balance Sheet 74 Cash Flows 75 Management & Board 76 Ownership 79 Labrador Iron Ore Royalty Corporation (LIF_u.TO) 80 North American Iron Ore 2 01 December 2011 Don’t underestimate the value of infrastructure 80 Investment Thesis 81 Valuation 84 Summary 84 Net Present Value 85 NAV sensitivities 86 Price to Earnings Ratio 88 Comparable Company Analysis 89 As an acquisition target 90 Company-Specific Risks 92 Asset Review 93 LIF-U.TO ’s interests in IOC 93 Background 94 Products and Pricing 94 Mining and Processing 96 Transport and Logistics 97 Corporate 99 Company Structure 99 Balance Sheet 100 Cash Flows 100 Management 101 Ownership 102 Labrador Iron Mines (LIM.TO) 103 Actions speak louder than words, for now 103 Investment Thesis 104 Valuation 107 Summary 107 Net Present Value 107 NAV Sensitivities 108 Earning multiples 110 Comparable Company Analysis 111 LIM.TO as the Labrador Trough consolidator 113 Company-Specific Risks 115 Asset Review 116 Overview 116 Products & Pricing 117 Mining and Processing 119 Transport and Logistics 120 Operating Costs 124 Capital Costs 125 Resources 126 Corporate 128 Company Structure 128 Balance Sheet 129 Cash Flows 129 Management 130 Ownership 132 New Millennium Iron Corporation (NML.TO) 133 Cheap resource tonnes, but not without funding and development challenges 133 Investment Thesis 134 Valuation 136 Summary 136 Net Present Value 136 NAV Sensitivities 137 As an acquisition target 138 NML.TO as a Tata Steel acquisition target 141 North American Iron Ore 3 01 December 2011 Earning multiples 143 Comparable company analysis 143 Company-Specific Risks 145 Asset Review 146 Summary 146 Overview 146 Hematite Project 148 Taconite (Magnetite) Project 153 Capital Costs 158 Operating Costs 161 Reserves and Resources 161 Corporate 163 Company Structure 163 Balance Sheet 163 Cash Flows 166 Ownership 167 Management 169 Appendix 1: Canadian Iron Ore Production 171 Background 171 Production 173 Infrastructure 175 Appendix 2 – Credit Suisse Global Supply/Demand model 177 Appendix 3 – Credit Suisse Commodity Price Forecasts 178 Appendix 4 – Iron Ore products summary 179 Appendix 5 – companies mentioned 180 North American Iron Ore 4 01 December 2011 Introduction We initiate coverage of the North American Iron Ore Mining sector, launching with: ■ 1 NYSE name (Cliffs Natural Resources) and 4 TSE/TSV names (Alderon Iron Ore, Labrador Iron Ore Royalty Corporation, Labrador Iron Mines and New Millennium Iron Corporation), or ■ 3 producers (Cliffs Natural Resources, Labrador Iron Ore Royalty Corporation and Labrador Iron Mines) and 2 developers (Alderon Iron Ore and New Millennium Iron Corporation). As illustrated in Exhibit 2, our valuations are somewhat more cautious than the rest of the street, but we are in fact top of the street for LIF-U.TO with our C$45/sh target price. Exhibit 2: Credit Suisse Target Price upside/downside relative to the street 300% 200% 100% 66% 18% 21% 23% 0% 10% Alderon Iron Ore Cliffs Natural Labrador Iron Ore Labrador Iron Mines New Millennium Iron Resources Royalty Corp -100% Consensus range Credit Suisse Target Price Consensus mean NAV CS base case NAV spot NAV mid-cycle NAV consensus Source: IBES, Credit Suisse estimates (Note: NML.TO consensus upside continues > 500% off page) North America’s combination of under utilised infrastructure, skilled labour, low jurisdictional risk, and cheap power make it a region that global iron ore investors should not ignore. We demonstrate that the steel industry’s requirements for higher quality raw materials combined with trends of decreasing DSO grades from more traditional iron ore regions, are likely to make high quality ‘manufactured’ iron ore products such as those produced in North America an increasingly important part of the seaborne iron ore market. ■ Appendix 1 provides a geographical, geological, and infrastructure overview of the Canadian iron ore industry and forms an important part of this report, particularly for those who are relatively new to the sector. ■ Appendix 2 contains a summary of our global supply demand model ■ Appendix 3 sets out the commodity price assumptions that have been used in all our modelling, and ■ Appendix 4 contains an overview of the various types of iron ore products and how they are inter-related. North American Iron Ore 5 01 December 2011 Alderon Iron Ore Corporation (ADV.TO) The Kami project is located on some of the best real estate in the Labrador Trough; surrounded by existing iron ore mines (Exhibit 10). Management are not shy of the Bloom Lake / Consolidated Thompson comparisons, and while there are numerous direct comparisons between these projects (scale, grade, location, management) there are also some important differences (Exhibit 11). In our opinion this project faces a number of headwinds that were not present for Bloom Lake, and which the market has overlooked. These under-appreciated differences are the basis of our below-consensus valuation call. Cliffs Natural Resources (CLF) CLF was beneficiating low grade iron ore in North America before iron ore was even discovered in the Pilbara, and there are few mining businesses globally that come close in terms of iron ore mining longevity. That said, the company is currently going through one of its cyclical diversification phases, and has so far struggled with leveraging its iron ore expertise into other commodities. 2012 looks set to be a ‘show me’ year as continuation of recently acquired coal activities is assessed.