As an analytically minded person with an interest in accounting, I am always interested in seeking how the numbers fit together for a company when doing in-depth research. This article is about how Great Northern Iron Ore Properties' (GNI) trust status caused its land to be drastically undervalued on its financial statements.
There is sufficient literature surrounding the general reasons why GNI does not make an attractive investment. I will refer to this adeptly written article by Paulo Santos as one example. Below is a brief summary of the main points relevant to this article:
GNI shares will cease to trade on April 6th 2015. Shareholders have a right receive the dividends before that date, as well as a final cash distribution. Total payments to shareholders are estimated to be roughly $70, yet the stock trades around $100. GNI is an attractive short position, but shares are relatively unavailable, so the cost to borrow shares is unusually high, which renders any short position essentially unprofitable. What is most relevant to this article is that upon termination of the trust the land owned by GNI will be transferred to Glacier Park Company (a subsidiary of Conoco Phillips (NYSE:COP)) for free.
I first came across GNI when looking at companies with high dividend yields in an attempt to find those that would cut their dividend in the near future and possibly make an attractive short position. When I came across GNI I was immediately intrigued by the profitability metrics shown in the table below.
|Return on Assets||75.07%|
|Return on Equity||225.68%|
The operating and profit margins can be explained by the business structure of GNI. It is not expensive to lease land, especially given the long duration of contracts GNI offers. The trust is highly limited in its businesses and must payout all cash it does not need for operations and therefore cannot grow the business. Management's primary incentive is to reduce costs as much as possible so with 10 full time employees 80%+ margins are feasible.
High return on equities are fairly common for companies that have very little equity, so this number was not totally unreasonable, but a 75% ROA seemed very strange to me. I have rarely encountered ROAs that high, and typically it is caused by drastically undervalued assets (book value) or a rare short term anomaly in net income.
I researched the situation further and found that the book value of the company's land is drastically undervalued. The 67,000 acres of iron ore properties in the Mesabi Range are valued on GNI's balance sheet at $2,277,931, or approximately $33 an acre for highly rich iron ore land. Initially this seemed entirely ridiculous to me, but after further research I realized that it accurately reflects the value of the land to GNI.
From their annual report, the land is carried on the books at the 1913 value of the land net of accumulated depreciation (straight line). The 1913 land value of $39,479,708 or $589 an acre is clearly not an accurate reflection of the current value of the land. This can be explained by inflation and increased demand for iron. Even if I only account for inflation using CPI data, the current value of the land is $914,478,951 or $13,647 an acre.
Furthermore, after the land has been depreciated over 98 years of the useful life of 104 years with no terminal value, it is carried at roughly 6% of its initial value. If the land were sold in a competitive bidding process, it would certainly yield orders of magnitude more than the value reflected on GNI's balance sheet. Certainly the land has lost some value from extraction, but GNI still has significant demand for its land, which indicates that there is still material value.
Ultimately this seeming anomaly makes complete sense given the terms of the trust that GNI's shareholders will receive nothing when the land is transferred to COP in 2015. I am unsure why the terms of the trust were structured this way, but I imagine it stems from the restrictive requirements required for a trust.
When I was initially conducting the research I wanted to double check this bizarre situation so I called investor relations at the company, and they confirmed that the land will be transferred for free. The shareholders have no way of unlocking the value of the land and COP gets 67,000 acres of highly profitable land for free.
This means that the land's value to the shareholders is only what it is able to yield in profits for GNI. I have not yet evaluated if the land will have a material impact for COP, but because COP is valued close to $100b, I would presume that the land won't have a significant effect.