Safe Payout or a Dividend Trap? 1 Royalty Stock With a 10.72% Yield

One high-yield royalty stock can be considered a dividend trap, because the payouts can spike or dip every quarter.

| More on:

The TMX Group’s website lists Labrador Iron Ore Royalty (TSX:LIF) as one of the stocks that pays the highest dividends. As of this writing, the royalty stock trades at $43.21 per share and yields an ultra-high 10.72%. The payout is very attractive, especially to yield-thirsty investors.

Investors, however, need to be extra careful and look beyond the juicy dividend. While the payout is fantastic, it might not be safe or sustainable. Double-digit yields are rare, and for all you know, Labrador could be a dividend trap.

Investment thesis

Labrador Iron Ore provides exposure to the iron ore market. Its subsidiary, Hollinger-Hanna Limited, has a 15.10% equity interest in Iron Ore Company of Canada (IOC). IOC is North America’s leading producer and exporter of premium iron ore pellets and high-grade concentrate.

IOC owns the infrastructure or assets that mine and produce iron ore pellets and high-grade concentrate. It transports finished products by rail to its destinations, specifically ship-loading facilities and marine terminals. Labrador derives its revenues (royalties and commissions) from IOC.

Labrador has yet to present its Q4 and full-year 2021 results, but it should be impressive due to higher ore prices and pellet premiums. In the nine months ended September 30, 2021, revenue and net income grew 48.5% and 96.9%, respectively, versus the same period in 2020. Cash from operations increased 398.1% year over year to $295.9 million.

Market outlook

Commodity producers like Labrador benefits from inflation and attendant commodity super cycle. According to Fitch Solutions, iron ore price will remain high (over US$100 per tonne) until 2023. The credit ratings agency added that supply will remain stable while demand will increase.

However, Fitch predicted that after 2023, iron ore prices will decline below US$100 per tonne from 2025 before it falls to US$50 per tonne by 2031.  

Factors to consider

Hollinger-Hanna collects a 7% gross overriding royalty from all iron ore products IOC produces, sells, delivers, and ships on top of the US$0.10-per-tonne commission interest on iron ore sales. Other interests, including leases, are economically dependent on IOC.

Seasonality is another factor to consider when investing in Labrador Iron Ore. The operations of this $2.76 billion royalty corporation depend on royalty and commission revenues from IOC. Since production and revenues from the source isn’t constant throughout the year, operations and operating cash flows vary from quarter to quarter. According to management, the winter months produce the lowest results.

Crazy dividends

The royalties Labrador gets from IOC are before expenses are deducted. While the royalty company has zero exposure to operating costs, cash flows are entirely dependent on the price of iron ore and IOC sales. Because of this structure or business model, expect dividend payouts to be irregular if not fluctuating constantly.

Since the basis for its dividends is exclusively off the royalties from IOC, the drawback is the unstable payouts. The return to shareholders is higher when cash flows are significant due to higher iron ore prices. Inversely, the yield is lower if iron ore prices fall and cash flow dips. Labrador isn’t exactly a dividend trap. However, investors must understand the nature of the business and then anticipate the dividend yield to move around.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Christopher Liew has no position in any of the stocks mentioned. The Motley Fool recommends TMX GROUP INC. / GROUPE TMX INC.

More on Dividend Stocks

Train cars pass over trestle bridge in the mountains
Dividend Stocks

Is CNR Stock a Buy, Sell, or Hold for 2025?

Can CNR stock continue its long-term outperformance into 2025 and beyond? Let's explore whether now is a good time to…

Read more »

coins jump into piggy bank
Dividend Stocks

The Smartest Dividend Stocks to Buy With $500 Right Now

These top dividend stocks both offer attractive yields and trade off their highs, making them two of the best to…

Read more »

Middle aged man drinks coffee
Dividend Stocks

Here’s the Average TFSA Balance at Age 35 in Canada

At age 35, it might not seem like you need to be thinking about your future cash flow. But ideally,…

Read more »

ETF stands for Exchange Traded Fund
Dividend Stocks

How to Invest Your $7,000 TFSA Contribution in 2024

Here's how I would prioritize a $7,000 TFSA contribution for growth and income.

Read more »

a man relaxes with his feet on a pile of books
Dividend Stocks

CPP Pensioners: Watch for These Important Updates

The CPP is an excellent tool for retirees, but be sure to stay on top of important updates like these.

Read more »

Technology
Dividend Stocks

TFSA Investors: 3 Dividend Stocks I’d Buy and Hold Forever

These TSX dividend stocks are likely to help TFSA investors earn steady and growing passive income for decades.

Read more »

four people hold happy emoji masks
Dividend Stocks

Love Dividend Growth? Check Out These 2 Income-Boosting Stocks

National Bank of Canada (TSX:NA) and another Canadian dividend-growth stock are looking like a bargain going into December 2024.

Read more »

An investor uses a tablet
Dividend Stocks

A Dividend Giant I’d Buy Over Enbridge Stock Right Now

Enbridge stock may seem like the best of the best in terms of dividends, but honestly this one is far…

Read more »