Is Labrador Iron Ore’s (TSE:LIF) Dividend Too Good to Be True?

Financial independence and retiring early is a goal many Canadians dream about. More often than not, they get there through generating a passive income stream via dividend stocks.

When seeking out these top Canadian dividend stocks, people often look for those that are providing better than average yields. The more you can yield on your money, the more passive income you generate and ultimately the quicker you can quit that 9 to 5.

But, a lot of companies are not as cut and dry as they seem, particularly ones that offer double digit yields, and investors can get into a lot of trouble not knowing exactly what they’re purchasing. Its important that those seeking income know how to pick apart a company’s dividend, especially those learning how to buy stocks, and even experienced investors.

Today we’re going to be looking over a company with a complex income structure in Labrador Iron Ore Royalty Corporation (TSE:LIF), and why you might not want to bank on receiving its 10.88% yield moving forward.

So what exactly does Labrador Iron Ore (TSE:LIF) do?

Labrador Iron Ore Royalty Corporation, or LIORC as I’ll refer to it from now on, is a royalty company that derives all of its revenue from its investment in the Iron Ore Company of Canada.

IOC is a leading North American producer and exporter of iron ore pellets. The company’s operations are all located in Canada and it has a 24~ year expected mine life based on its current reserves.

Back to LIORC, it is structured in a way that its royalties are taken “off-the-top” which means the cash LIORC receives from IOC comes before expenses are deducted. A royalty compensation business model like this is similar to a company like the A&W Royalty Income Fund (AW.UN).

Also, much like a gold streamer like Franco Nevada (TSE:FNV), LIORC is not exposed to operating costs, and thus is strictly dependent on the price of iron ore and total sales generated by IOC.

Why does Labrador Iron Ore yield nearly 11% right now?

Because the company will generate cash flow dependent on the sales generated from the IOC, and the sales generated from the IOC will be dependent on the price of iron ore, LIORC’s dividend will fluctuate significantly.

This is because during times of high iron ore prices, cash flows will be significant and more will be returned to shareholders. And as prices dip, cash flows will subsequently drop and less will be paid out. As a result, we get a dividend chart that looks like the one below.

To provide more clarity on LIORC’s dividend when it comes to the price of iron ore, here is a chart that shows its dividend when compared to the price of iron ore itself.

So as you can see, the price of iron ore has skyrocketed in 2020 and 2021, and as a result so has LIORC’s dividend.

If you look at the history of the company’s dividend (which you can find here) you’ll notice one thing. The company pays a regular $0.250 dividend on a quarterly basis, and everything else is considered a special dividend up until the end of 2020.

Those special dividends are the result of excess cash flow because of rising prices. In fact, the company paid out more than 2.5X the income over the last 3 quarters than it did in all of 2018.

So, the company’s dividend is likely to remain high as long as iron ore prices follow suit. But, if the commodity dips in price, LIORC’s dividend will no doubt follow.

Recent price action will show you Labrador Iron Ore’s reliance on commodity pricing.

If we look to the chart below, we can see that as the price of iron ore has started to flatline and even decrease, Labrador Iron Ore’s share price has plummeted as a result.

Much like a gold miner, an oil producer, or a copper miner, the company’s share price is going to be susceptible to commodity prices.

This is something many investors are unaware of, and some simply chase the company for its excess yield.

The dip in price is not an indication of a poor company, although many will make this assumption if they bought at peak prices and iron ore continues to fall. It is simply the typical price action you would see out of a royalty company that bases its dividend solely off the royalties collected by a company who is impacted severely by the price of iron ore.

Overall, if you’re investing in LIF, make sure you know what you’re buying

If we look to the dividend yield history of LIF, you can clearly see that it is anything but stable. We can see quick spikes or subsequent dips in yield. This is simply the release of special dividends based on cash flow.

So, although buying Labrador Iron Ore at todays prices gets you a near 11% yield, we have to understand that this is a TTM (trailing twelve month) yield, and is zero indication of what you will receive moving forward, unlike most typical equities.

If iron ore continues to fall in price, so will the company’s distributions and ultimately its yield. So if you’re looking for consistent reliable income, as you can tell by the chart above, this likely isn’t the stock for you.

What now? Check out updates on some Canadian Dividend All-Stars as of week of September 13th.