Description

Great Northern Iron is an idea that has been written on VIC a couple times before. I believe that it has become a highly timely short as the trust only has 23 months left to expiration and is trading 100% higher than the undiscounted cash flows remaining before the trust terminates.

As a quick background, GNI is a 107 year old trust whose principal asset is ownership of a fee interest in 12,033 acres on the Mesabi Iron Range Formation in northeastern Minnesota. GNI has been traded on the New York Stock Exchange for over 100 years and currently has market capitalization around $100 million. GNI collects mineral fees from iron ore companies for mining iron on its lands. GNI pays out to its trustholders a distribution roughly equal to its net income in each calendar quarter. Over the last 12 months, GNI has paid out $14/share in distributions to its unitholders implying a trailing twelve month yield of 19.7% on its current $71/share price.

Retail investors have been attracted to GNI for its high yield and continue to purchase the shares at current levels even while iron ore prices fall and investors sell most iron ore equities (CLF, VALE, RIO, BHP, et cetera.) The decline in iron ore pricing has resulted in GNI’s significantly lower revenues and earnings over the last 3 quarters.

What investors in GNI are missing is that its yield is all return of capital and not return on capital. By design, the trust expires on April 6, 2015 at which point the trust’s assets outside of its cash and marketable securities (ie all of its mineral interests) revert to ConocoPhillips. The company’s Most recent 10-Q is quite explicit:

At the end of the Trust on April 6, 2015, the certificates of beneficial interest (shares) in the Trust will cease to trade on the New York Stock Exchange and thereafter will represent only the right to receive certain distributions payable to the certificate holders of record at the time of the termination of the Trust. Upon termination, the Trust is obligated to distribute ratably to these certificate holders the net monies remaining in the hands of the Trustees (after paying and providing for all expenses and obligations of the Trust), plus the balance in the Principal Charges account (this account is explained in the Trust’s Annual Report sent to all certificate holders every year). All other Trust property (most notably the Trust’s mineral properties and the active leases) must be conveyed and transferred to the reversioner (currently Glacier Park Company, a wholly owned subsidiary of ConocoPhillips Company) under the terms of the Trust Agreement.

We have previously provided information in our various Securities and Exchange Commission filings, including our Annual Report, about the final distribution payable to the certificate holders upon the Trust’s termination. The exact final distribution, though not determinable at this time, will generally consist of the sum of the Trust’s net monies (essentially, total assets less liabilities and properties) and the balance in the Principal Charges account, less any and all expenses and obligations of the Trust upon termination. To offer a hypothetical example, without factoring in any expenses and obligations of the Trust upon its termination, and using the financial statement values as of December 31, 2012, the net monies were approximately $7,719,000 and the Principal Charges account balance was approximately $4,871,000, resulting in a final distribution payable of approximately $12,590,000, or about $8.39 per share. After payment of this final distribution, the certificates of beneficial interest (shares) would be cancelled and have no further value. It is important to note, however, that the actual net monies on hand and the Principal Charges account balance will most likely fluctuate during the ensuing years and will not be “final” until after the termination and wind-down of the Trust. The Trust offers this example to further inform investors about the conceptual nature of the final distribution and does not imply or guarantee a specific known final distribution amount.

In other words, investors in the trust will only receive 8 more quarters of distributions as well as a final distribution payment currently estimated at $8.39/share.

Simplistically, assuming no change in iron ore pricing or volume of iron mined on GNI’s land (a conservative assumption given recent declines in iron ore pricing and the resulting recent deterioration in GNI’s earnings) and therefore no change in the trust’s distributions, investors in the trust will receive $36.39/share of distributions on an undiscounted basis over the remaining life of the trust. For the right to receive these distributions, investors are currently paying $71/share which equates to a guaranteed loss of roughly 50% of their investment or a negative IRR of roughly 33%.

Given current iron prices, distributions are more likely to be $2.50/quarter over the remainder of the trust which would imply undiscounted cash flows to investors in the trust of $28.39/share and implying a fair value for the trust around $25/share.

Catalyst