Labrador Iron Ore Royalty Corp. Stock: Paying Out The Entirety Of Its Cash Flow (LIFZF) | Seeking Alpha

2022-10-26 12:15:04 By : Ms. Grace Yang

The following segment was excerpted from this fund letter.

In a number of strategies, a new position was established in Labrador Iron Ore Royalty Corp. This is of a kind with our other 'hard asset' holdings, the most prominent of which is Texas Pacific Land Corp. ( TPL) The description of Labrador Iron Ore Royalty will serve double duty as a review of the hard asset business model.

A hard asset company derives its revenues directly from an asset, like gold or oil, without any intervening operating expense or capital investment. As a contractual arrangement, it receives a proportion of the revenues - a royalty - generated by the third parties that undertake those burdens.

That is how the hard asset company can be directly and positively exposed to any increases in production volumes and prices without operating cost exposure. It is a powerful and elegant business model that has no peer in terms of profitability. It can generate substantial returns even when the underlying asset price does not rise. A few statistics will demonstrate.

Labrador Iron Ore receives royalties on a major iron ore mine in the northeastern corner of Canada. It also has an equity interest in the miner, IOC, which is controlled by Rio Tinto (OTCPK:RTPPF). The mine has many decades of reserves. Last year, the company had $280 million of revenues (Canadian $). That's before substantial equity earnings from the mining company. Operating expenses were a mere $3 million, about 1% of revenues. Net of that and taxes, the free cash flow margin was 62%.

That level of profitability is pretty much without parallel, with the exception of another business model we own much of: securities exchanges.

Labrador Iron Ore has an extra source of earnings, its equity interest in IOC, the mining company, from which it received a dividend of $228 million last year. With the dividend, the profit margin was near 80%.

A brief compare-and-contrast with the actual mining company, IOC, illustrates the business-model difference. Aside from the Chair of the Board, Labrador Iron Ore Royalty has 3 employees. Its office space totals 355 square feet. It has no debt. IOC has 2,754 employees. It has a mine to operate and maintain, a railroad, a crusher, a 4-mile conveyor, a concentrator, a pellet plant. It's profitable and debt free, and in a typical year might have a 25% or 30% free cash flow margin after capital expenditures. If the cost of equipment or labor rise, its profit margin contracts, unless it can offset that with price increases.

Labrador Iron Ore Royalty pays out the entirety of its cash flow. The most recent quarterly dividend, annualized, is C$4.00/share. The current share price is C$27, so the dividend yield is 14.8%. Last year, when ore prices were higher, the dividend was C$6.00, 50% higher.

One should also observe this very important investment characteristic, which can be seen with other royalty companies: in the 10 years to January 2022, iron ore prices were only up about 8% in total, or by less than 1% per year. Very few businesses can generate a satisfactory return with a decade of practically unchanged revenues. Yet, Labrador Iron Ore Royalty, with dividends, returned an annualized 10%. The S&P TSX Composite Index annual total return was 9.2%.

The charts in this material are for illustrative purposes only and are not indicative of what will occur in the future. In general, they are intended to show how investors view performance over differing time periods.

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