CA - Labrador Iron Ore Royalty: Dividend Prospects Remain Robust

2023-12-16 04:30:39 ET

Summary

• Labrador Iron Ore Royalty Corporation is recommended as a "Hold" due to robust outlook for the dividend.
• The company offers a satisfactory dividend, with a current forward yield of 5.53%.
• The retail investor may also want to be open to the opportunities that arise due to the volatility of the commodity markets.

A "Hold" Recommendation on Labrador Iron Ore Royalty Corporation

This analysis suggests a "Hold" recommendation on Labrador Iron Ore Royalty Corporation (LIFZF), a Toronto, Canada-based company that holds a 15.1% equity interest in Iron Ore Company of Canada ((IOC)).

IOC produces and processes iron ores at its facilities in Labrador City, in the Canadian province of Newfoundland and Labrador.

The remaining percentage of equity interest in the IOC joint venture is held by Rio Tinto Group (RIO), a London, UK-based exploration developer and operator of globally available mineral resources, with 58.7%, and Tokyo-Japan-based conglomerate mineral resource markets exploiter Mitsubishi Corporation (MSBHF) with 26.2%.

In this article, "Labrador Iron Ore Royalty" or "LIFZF" is used interchangeably to refer to the company.

Essentially a Buy-and-Hold Approach for Labrador Iron Ore Royalty Corporation

Basically, this analysis assumes that this stock is suitable for a buy-and-hold strategy because its investment offers the possibility of getting a satisfactory dividend. The amount of the payout depends on the volatility of the iron ore and steel products markets. However, the shareholders have not complained in the last nine years as the company has paid the quarterly dividend quite regularly, in the sense of 9 years of continuous payment regardless of the amount that has varied.

The company currently pays a quarterly dividend of CA$0.45 per common share (?US$0.34/share as of the date of this article), based on the next payment of this amount scheduled for January 26, 2024. The previous quarterly dividend was CA$0.95 per common share (?US$0.70/share as of the date of this article), which was paid on October 26, 2023.

Assuming the company keeps the quarterly payment constant, it would provide a forward dividend yield of 5.53% at the time of writing.

This payout ratio is currently well above the market as the benchmark for US-listed stocks, here the S&P 500 index, pays a dividend yield of 1.47% at the time of writing. While the sector median is 2.24% for the dividend yield. So LIFZF stock shareholders can be happy with that.

In addition to the possibility of dividends, the retail investor should not miss the opportunity to take advantage of the volatility of the commodity markets and change his position, accordingly, applying the right investment strategy to achieve the objective: For example, one opportunity arose during the strong recovery in economic activity in the post-pandemic period, which led to robust demand for iron ore for steel production and very quickly drove up the market valuation of this stock. Or, even after the energy crisis in the summer of 2022, the share price showed interesting movements as significantly lower fossil fuels on the market raised hopes for dividend increases, since higher profits were considered possible with falling production costs.

The retail investor should also be aware that the best strategy for a "buy and hold" approach to pay off is to buy shares of LIFZF after a sharp downturn. The lower price would also make the transaction easier given the low trading volume: on average, only 10,300 shares were exchanged over the last three months (scroll down to the "Trading Data" section on this Seeking Alpha page). This was the case in mid-March 2020 due to the negative consequences of the outbreak of the pandemic caused by the COVID-19 virus on US-listed stocks. If the retail investor had held his nerve, which is the ideal condition for rational decision-making, while many in the market were probably panicking, and increased his bet on LIFZF, his investment would certainly have returned much more than what is shown in the above graph. The latter indicates that LIFZF stock price increased by 29.13% in the past 5 years versus Materials Select Sector SPDR Fund ( XLB ) +63.68% as a benchmark for the industry of LIFZF and compared to the SPDR® S&P 500 ETF Trust ( SPY ) +80.64% as a benchmark for US-listed stocks.

Be Aware of the Opportunities that Arise During the Cycle

But this analysis also reveals more to retail investors: by combining the core "buy and hold" approach with other investment activities, the investor might even have been able to beat the industry and the entire market. That is, in addition to the technique of buying on dips, the retail investor can make better use of the stock price cycles and thus buy the shares to keep in the portfolio, but also sell them to make a profit from a significant peak.

Not only the dividend, but the share price of LIFZF stock also reflects the price action of iron ore mined/processed by LIFZF's 15.1% interest stake in IOC.

Due to LIFZF's strong positive correlation with the iron ore price, this analysis recommends maintaining a stake in LIFZF to benefit from the commodity's promising long-term prospects in the market, and IOC is very well positioned to benefit from this outlook. The rosy outlook for the iron ore markets is expected to have a positive impact on IOC's profitability, which bodes well for LIFZF's future dividend and share price.

The gray area in the bottom section of the chart is a graphical representation of the positive correlation between the LIFZF stock price and the iron ore price. As a benchmark for iron ore price performance, this analysis uses Iron Ore 62% Fe, CFR China Futures (December 2023) with the symbol (TIOZ2023). The changes in its spread against the 62% Fe index are commonly used to determine whether the steel industry is experiencing low or higher production margins. Because steel production is characterized by low margins, mills may prefer lower fines to higher fines.

The two securities are positively correlated because, on average, they are driven by the same market sentiment over time: when the iron ore price is bullish, most likely the LIFZF stock price is also bullish, and when the iron ore price is bearish, most likely the LIFZF stock price is bearish too.

The retail investor need not be confused by the different performance of the two securities because correlation is not a measure of return and the two assets, even if correlated positively, can still perform very differently over time. Correlation is related to the type of market sentiment that affects securities over time. If the coefficient of correlation is negative (not positive), it means that if one of the two assets is bearish, the other asset is most likely bullish, and vice versa.

The chart above also shows that the positive correlation between LIFZF stock and the iron ore price is strong, as the gray zone has almost always been in positive territory (i.e. above the zero line) over the past 52 weeks, with a few exceptions. In the latter cases, the routine between the two assets was temporarily disrupted by certain events that led to increased market volatility. One of these occurred during the outbreak of the conflict in the Gaza Strip in Israel, triggered by Hamas attacks on Israeli citizens. The headwinds impacted LIFZF's market value as a pessimistic sentiment had formed on the earnings growth of US-listed stocks as the market feared another significant rise in energy prices.

The negative sentiment also weighed on LIFZF's dividend prospects and led to some decline in shares, although iron ore prices, which bode well for the 15.1% stake in OIC, continued to rise as China's new strategy to strengthen public infrastructure reflected in robust demand for iron ore for use in the steel industry.

Positive Outlook for LIFZF Dividend: The Crucial Role of Chinese Stimulus

It must be said that the recent drop in the price of rebar steel futures from a three-week high followed market suspicions that the Chinese government may be rethinking its strategy. This is because the capital raised through new yuan loans in November was less than analysts expected. However, retail investors need to be aware that market speculation that could affect short-term demand for iron ore is one thing and is usually short-lived, while investments promised by a central authority in China are another matter and are aiming to achieve long-lasting effects. Retail investors should have no doubts about China's commitment to giving stimuli to the economy. China's economic cycle is plagued by deflation as consumers and businesses delay consumption and investment in the expectation that prices will be even lower in the future, while China's strategy to mitigate the impact of the real estate crisis on GDP growth by financial support to public infrastructure, therefore seems consistent with the need to provide a floor for the price of goods and services. Maintaining an active market for ferrous and base metals through increased infrastructure spending is seen as a starting point for reversing the current trend in prices of goods and services. If they remain in deflation for too long, the vicious cycle could inflict major damage on an economy still struggling to recover from three years of strict restrictions and lockdowns against the COVID-19 virus infection.

The health of the Chinese economy is crucial for a successful investment in LIFZF stock, as the Asian country is the world's largest consumer of iron ore. It surpassed India, the fastest-growing G20 economy with an annual growth rate of 7.6% in the third quarter of 2023, and also surpassed Russia, and Japan which is home to the world's third-largest economy.

Therefore, the price of iron ore - the main driver of the LIFZF stock dividend - should benefit from the stimulus that the economy of the world's largest consumer of the commodity will continue to receive from the central government.

As of this writing, Trading Economics said iron ore was trading at $137.50 per tonne, and its analysts forecast the price to be at $150.54 in 12 months.

The Valuation of Current Stock Price

Then, the retail investor may be wondering whether the time is now to buy more shares given the positive outlook for iron ore prices: Shares do not appear expensive compared to their recent performance. However, since this analysis sees the possibility that stock prices will decline in the new year amid looming recessionary headwinds for U.S.-listed stocks, the retail investor may want to hold off for now and continue to benefit from the company's dividend as its outlook remains robust.

Shares were trading at $24.20 per unit giving it a market cap of $1.55 billion as of this writing. Shares are a little bit above the 200-day simple moving average of $23.26 and the 50-day simple moving average of $23.34.

Shares are still below the middle point of $25.095 in the 52-week range of $20.37 to $29.82.

The 14-day relative strength indicator at 62.23 says shares are neither overbought nor oversold. Under negative pressure from the headwinds of the looming recession expected as early as 2024, shares have plenty of room to move lower to create more attractive entry points.

These economists , along with the inverted yield curve for 10- to 3-month US Treasuries , predict that a recession will hit the US and Europe sometime in 2024, due to weaker consumption, a subsequent decline in business investment and a deterioration in employment conditions with the latter consequence showing up in a later stage.

In particular, the Fed's hawkish stance on rates to fight the increased inflation is leading to a significant downturn in the business cycle, and the scenario is supported by the following trends:

• declining actual third-quarter 2023 EPS compared to last year for major U.S. retailers , coupled with lower full-year 2023 sales forecasts for major U.S. retailers (as an indicator of weaker consumer spending).
• the cooling of investment activities, with Morgan Stanley's ( MS ) Q3 2023 IPO and M&A data providing a strong indication.
• a weakening labor condition as it appears from recent issues from Challenger, Gray and Christmas, Inc., the Automatic Data Processing, Inc., and from the U.S. Bureau of Labor Statistics on nonfarm payroll growth reported in November, as reported in this article Seeking Alpha .

Recession headwinds for US stocks should lead to LIFZF stock creating more favorable entry points thanks to LIFZF stock's 24-month beta of 1.24x (scroll down to the 'Risk' section of this Seeking Alpha web page ).

The situation in China, where the government is trying to strengthen infrastructure, will be the next growth catalyst for iron ore producers and the IOC (in which LIFZF has a 15.1% interest stake) as it awaits economic recovery among its main trading partners of the US and Europe.

The tailwinds from China combined with IOC production, which appears to be well positioned to meet the need to establish an increase the number of cleaner steel production operations worldwide that produce higher performing products, will allow LIFZF to continue generating positive numbers to support the dividend.

The Factors of the LIFZF Dividend

The LIFZF dividend is funded by a 7% gross overriding royalty and a commission of 10 cents per ton on all iron ore products produced and shipped from the 15.1% ownership interest in IOC.

LIORC royalty performed as follows in the third quarter of 2023 : Iron Ore Company of Canada Operations' ((IOC)) total iron ore sales tonnage of 3.9 million tons in the third quarter of 2023, which included iron ore concentrate for sale ((CFS)) and iron ore pellets, were down 14% YoY and down 11% sequentially due to inventory issues and shipment timing.

Lower sales volumes combined with lower iron ore pellet prices and an increase in unit operating costs result in the following year-over-year trends:

• Royalty revenue fell 26% year-over-year to $47 million.
• Equity earnings fell 50.6% year over year to $23.1 million.
• Net income per share fell 38% to $0.77.
• The dividend received by the IOC fell 10.5% year-on-year to $30.6 million.

Concentrate and fines iron ore prices rose from a year ago on expectations that China's stimulus measures will ease worries about the domestic economy by giving a boost to steel-hogging public infrastructure. Instead, pellet prices were lower year-over-year as high borrowing costs/increased inflation impacted the US/European economy, reflected in weaker demand for iron ore pellets.

In the short term, prices are expected to follow better pricing patterns than Q3 2023 given the economic stimulus in China, while sales volumes are expected to be more in line with 2022, when the IOC was able to produce 17.6 million of tons of salable iron ore, than this year. According to Rio Tinto data, IOC will produce between 15.8 million to 16.7 million tons of saleable iron ore, compared to the previous forecast of 17 million to 18.7 million tons for the full year 2023.

For 2024, activity may slow somewhat due to difficult global context, but on the other hand, the rate cut will spark optimism about the commodity's prospects.

Conclusion

Retail investors may want to continue holding onto their position in Labrador Iron Ore Royalty Corporation. The dividend appears well-positioned to benefit from iron ore's robust growth outlook as China's largest iron ore consumer continues to boost its economy. The recovery in China will provide solid conditions for a robust price and demand for iron ore, as the US and Europe economies work to overcome the negative consequences of aggressive monetary policy to combat elevated core inflation.

Labrador Iron Ore Royalty Corporation could create more attractive entry in 2024, when the recession is expected to be announced, and then this could be an opportunity to increase the participation in the company's dividend which growth prospects are generally positive.

In addition to the possibility of dividends, the retail investor may also want to be open to the opportunities that the volatility of the commodity markets from time to time brings to the price of this stock.

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