Seeking Alpha
Profile| Send Message| ()  

By Jason Born, CFA

With the paucity of yield in the form of interest rates in today's marketplace, it's clear that investors continue to place greater importance on dividends. In our minds this is a favorable shift from the extremes of the fading past when companies were expected to buy back their own shares in place of a dividend as a sign of solid capital stewardship.

However, as with all things involving human understanding, many investors have taken the dividend view to the extreme. We find more and more examples of investors becoming owners of companies, mutual funds, trusts, or the like simply because the financial pages littering the web sport yields that would certainly make the acrophobic folks among us weep.

Today's case in point is Great Northern Iron Ore (GNI). Cruising popular financial websites, an unsuspecting investor quickly finds that this staid-sounding investment carries a projected yield of over 15%. Yes, that is correct, we just typed 15%.

This terrific yield has turned some heads and caused more than a few quantitative screening programs to spit out GNI as a possible holding for the income-conscious investor. In fact, the month of June 2012 has brought out some bloggers who posted recommendations to purchase the holding partially based upon the yield. "But wait," you say. "I am not going to react to something simply based upon a yield posted on a free website. I want to understand the company." Hear, hear intrepid investor!

Notice in the preceding paragraphs, we have not referred to Great Northern Iron Ore as a company or a stock. We did this intentionally, for it is neither! It is a trust. That's right. It is more akin to an irrevocable trust where you may be named as a beneficiary than a real operating company. The difference is that this trust has been divided into units that can be freely traded on the New York Stock Exchange. The trust has trustees whose job it is to see that the document that created the trust in 1906 is followed and the current beneficiaries (unitholders) and the reversioner (Conoco) are treated fairly. The trust has its own website.

The trust is not in any way an operating company. So when posts on this website and others tout its magnificent operating data as indication of the "company's" fundamental strength, they would be equally as helpful in our pursuit of investment opportunities as to say that the sky is, in fact, blue. The very nature of the trust instrument means that the "operating" data will typically look extraordinary when compared with any other company in the business of mining iron ore.

The trust acts as a pass-through entity. The property of the trust generates revenue from leases for iron ore mines. The net lease revenue is then paid to the trustee based upon the tonnage mined in any given year. The trustee takes out some relatively minor fees for legal, audit, and administrative work and pays the rest out to unitholders. Therein lies the reason for the "tremendous" operating metrics, the revenue received from the trust is already net of any expenses the actual mine operator had in pulling out the ore in the first place. So comparing GNI to any other miner is truly meaningless.

"But what about that fantastically obese dividend yield of over 15%?" you ask. "So what that the trust is uber-efficient? That is good, right?"

Like any good investor you must read the underlying documents. This trust document, which was set in motion in 1906 actually stipulates its own termination date. Yes, that's right, this thing does not go on into perpetuity like a company. It will end exactly 20 years after the death of the last named person in that 1906 document. The last person died in 1995 and so we know without a doubt that the units of this trust will cease trading altogether on April 6, 2015. Now we're rolling!

The single largest dividend paid to unitholders over the past five years was in 2011 and amounted to $15. For the coming 12 months it is projected to be $12 per unit. For argument sake, let's assume that the miners working the trust's property are spurred on by fantastic iron ore prices and produce record tonnage from now through April 6, 2015. Let's further assume that after all expenses, this will mean an annual distribution of $20 per unit. We've got two more quarters remaining in 2012 and just over one quarter in 2015 so the cash flows described look like this:

12/31/2012

12/31/2013

12/31/2014

3/31/2015

4/6/2015

GNI Dividend

10.00

20.00

20.00

5.00

-

The most important fact is that on 4/6/2015 the unitholders are only owed whatever money the trustee has left on hand plus a small amount set aside in a special account. At the termination of the trust any and all rights to royalties and lease payments go back to the reversioner, Conoco, for the price of zero paid to the trust. Furthermore, there is no guarantee there will be any cash on hand or in this special account, but as of 12/31/2011 these amounts totaled about $8 per unit. So let's assume that the trustees continue to be fantastic stewards and the cash on hand grows so that this final distribution is $10. The cash flows to unitholders now look like the following:

12/31/2012

12/31/2013

12/31/2014

3/31/2015

4/6/2015

GNI Dividend

10.00

20.00

20.00

5.00

-

Residual Payout

-

-

-

-

10.00

Finally, discounting the above cash flows at an 8% interest rate, gives a present value of a single unit of this trust of about $56:

12/31/2012

12/31/2013

12/31/2014

3/31/2015

4/6/2015

GNI Dividend

10.00

20.00

20.00

5.00

-

Residual Payout

-

-

-

-

10.00

PV 6/30/12

9.62

17.81

16.49

4.04

8.08

56.03

At a price in the marketplace of about $80, this investment is clearly vastly overpriced, even based upon our generous, optimistic calculations. Adding any semblance of reality into our assumptions causes the present value of the units to quickly fall under $50. Our best recommendation to current holders of these units is to sell at these prices. Valuing this type of investment with a definite end date is actually quite simple, but we caution investors to do the work and definitely not take those of us in the blogosphere at our word.

Source: Not-So-Great Northern Iron Ore