Great Northern Iron Ore Properties: Mining dependable cash flows
Investors are often blinded by growth, forgetting that intrinsic value is determined by the present value of future cash flows. Some investors consider EBIDTA a reasonable proxy for cash flow, others consider cash flow from operations, and some just use earnings. But why use a proxy, when you can use dividends? After all, your cash flow, not the company's, is what matters.
We think we've found a reliable dividend source in Great Northern Iron Ore Properties (NYSE:GNI), a non-voting trust that owns interests in both mineral and non-mineral lands on the Mesabi Iron Range in northeastern Minnesota.
Great Northern pays virtually all its net income as dividends, a requisite practice among publicly traded trusts. The income is derived form royalties on taconite — an iron-bearing, high-silica flint-like rock that's ground into a fine powder so that the iron ore can be separated by strong magnets.
Great Northern's royalty income depends on the number of tons of taconite shipped from its properties by its lessees, which include some of the sector's biggest movers and shakers: United States Steel Corporation (NYSE:X), Arcelor-Mittal (NYSE:MT), Cleveland-Cliffs Inc. (NYSE:CLF) and Essar Steel Holdings.
Great Northern is about as pure as a commodity play gets in the steel sector. The company undertakes no value-adding activities and is wholly dependent on the fortunes of its steel-producing customers and their demand for iron ore.
And those fortunes have been in a secular upswing. According to the International Iron and Steel Institute (IISI), world crude steel output reached 1,343.5 million metric tons in 2007, a 7.5% increase over 2006, marking the fifth consecutive year that annual world crude steel production growth exceeded 7%.
China, not surprisingly, has been the primary engine driving growth. The IISI reports that in 2007, Chinese steel production hit 489 metric tons, a 15.7% increase on 2006, which seems almost snail-like compared to 18.8% achieved in 2006, 26.8% in 2005 and 26.1% in 2004. Other so-called BRIC countries also maintained relatively high growth, with India and Brazil recording 7.3% and 9.3% increases, respectively. The BRIC share of world production has grown to 48.2% today from 31% in 2001.
The upswing is unlikely to reverse course anytime soon. Roskill Information Services forecasts world steel demand will increase another 7% in 2008 and then average 4% to 5% per year through 2015 on continued, and unprecedented, world-wide wealth creation.
Great Northern's fortunes haven't grown at China's rate, but they've outpaced U.S steel output, which increased to 98.2 million tons in 2007 from 91.6 million ton in 2002 — a 1.4% compounded average annual growth rate (CAGR). In comparison, Great Northern's revenue nearly doubled to $17.2 million in 2007 from $9.23 million in 2002, while dividends grew to $10 a share from $5.50 a share — an approximate 13% CAGR for both.
Given Great Northern's positively correlated and causative relationship with the steel sector, valuing its shares would seem a straightforward exercise: based on its 12-month-trailing distribution of $10 a share, steel demand increase of 7% this year, an average annual demand growth rate of 4.5% into the relevant future and an 11% discount rate, I calculate intrinsic value of $164 a share — a 22% premium to its current share price.
If only it were that simple. On April 6, 2015, Great Northern will terminate the trust and its shares will cease to trade on the NYSE. Shareholders will be entitled to certain cash distributions payable at the time of the termination, while all other trust property — most notably the mineral properties and the active leases — must be conveyed and transferred to the reversioner, currently Glacier Park Company, a wholly owned subsidiary of ConocoPhillips (NYSE:COP).
Great Northern offers a hypothetical example of how this final-payment scenario would have played out had the trust terminated at the end of 2007: on Dec. 31, 2007, net monies were approximately $8.1 million and the principal charges account balance was approximately $5.1 million, resulting in a final distribution payable of approximately $13.2 million, or about $8.78 per share.
Based on our growth estimates, we project total distributions of roughly $90 a share through 2014. The wildcard is the final distribution, which we calculate at around $12.25 a share.
So does it make sense to buy an estimated $102 in total future (non-discounted) cash flow for $130 today? It might. For one, our growth estimates are conservative compared to recent company CAGRs, so cash flows could be significantly higher. (Changing growth assumptions to 13% per annum produces $138 in total distributions.)
Taxes are another consideration. Publicly traded trusts like Great Northern are different animals compared to C-corporations in that earnings avoid double taxation; there is no taxation at the corporate level, only at the shareholder level. In addition, Great Northern's (GNI) cash flows are an amalgam of interest and ordinary dividends, capital gains and losses, supplemental income and losses, and sales of business property that could produce tax-advantaged distributions for shareholders.
Bottom line: Great Northern is a proven cash-producing investment, but it's one you might consider running past your tax advisor.
