Predicting the outlook for iron ore and steel has become something akin to gazing at tea leaves and trying to determine what the future holds. Fears of a trade war between the U.S. and China coupled with less-than-stellar economic data from Beijing as well as slowing global growth were all weighing on the outlook for metals.
The base metal has been extremely volatile since the recovery in commodities began in 2016, peaking at over US$95 per tonne in early February, only to pull back to around US$85 in recent days. This run-up in value has a been a boon for iron ore miners.
Labrador Iron Ore Royalty Corp. (TSX:LIF) has gained 21% since the start of 2019. While those strong gains indicate that a pullback could occur, it shouldn’t deter income- and growth-hungry investors from acquiring the stock.
Solid income-producing asset
Unlike Rio Tinto, Vale S.A., and BHP Group, Labrador Iron Ore doesn’t engage in hazardous mining operations. Rather, it is essentially a royalty company that receives a 7% gross overriding royalty and $0.10 per tonne commission on iron ore products produced and sold by Iron Ore Company of Canada (IOC). Labrador Iron Ore also owns a 15.1% interest in IOC with the majority 58.7% owner being global diversified mining giant Rio Tinto.
This makes Labrador Iron Ore dependent on IOC’s performance, and its income can be impacted by operational outages, as witnessed during the first half of 2018, when a nine-week labour stoppage brought operations to a grinding halt.
That dispute had a sharp impact on the company’s full-year 2018 earnings, which fell by 18% year over year to $128.5 million because of a 22% decrease in iron ore sales by IOC. This negatively affected Labrador Iron Ore’s dividend payment, forcing it to slash the amount of special dividends paid because of this sharp decline in earnings.
As a result, Labrador Iron Ore’s 2018 dividend plunged by 34% year over year to $1.75 per share, because it shaved $0.90 per share off its special dividends. It did, however, pay a special dividend for the first, third, and final quarters of 2018. The company finished the year with a trailing 12-month yield of a juicy 6%. Labrador Iron Ore expects to maintain the pace of special dividend payments during 2019 if there are no unforeseen events that impact IOC’s operations and if iron ore prices remain firm.
The outlook for iron ore has improved
Predicting the price of iron ore has become extremely difficult with IOC’s majority owner Rio Tinto recently expressing caution over the outlook for the red metal because of the substantial uncertainty that currently exists.
Nonetheless, if a trade war between the U.S. and China is averted, there should be an uptick in global economic growth, which will boost consumption of iron ore. China’s demand for high-quality iron ore imports is also expected to expand because of Beijing’s focus on reducing air pollution, which has forced smelters to stop using lower-grade ore, which generates greater waste.
The catastrophic failure of Vale’s tailings dam in Brazil earlier this year has forced the mining giant to shutter operations at 10 sites. This — along with significant regulatory pressure — is expected to force Vale to reduce its 2019 iron ore output by 10% or roughly 40 million tonnes. That will compel Chinese steel mills to find other sources, such as the high-grade pellets and concentrate produced by IOC.
Why buy Labrador Iron Ore?
Firmer iron ore prices combined with a notable increase in production by IOC during 2019 will give Labrador Iron Ore’s earnings a solid boost, supporting further special dividend payments.
Even with management focused on restoring cash reserves, it isn’t difficult to see Labrador Iron Ore making similar special dividend payments to 2017, especially with it forecast that iron ore will average US$78 per tonne during 2019, which is US$8 per tonne greater than a year ago and US$6 a tonne higher than 2017.
That will not only give investors the opportunity to receive considerable income, which will see Labrador Iron Ore’s dividend yield 6% or more but also benefit from solid capital gains. This makes now the time for investors to add the stock to their portfolios.
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Fool contributor Matt Smith has no position in any of the stocks mentioned.