Mesabi Royalty Trust (MSB) – A long life royalty asset with massive operating leverage
|June 26, 2013||Posted by Nat Stewart under Cash Flow Stocks||
What if there was a business that profited handsomely from rising commodity prices, yet at the same time required no capital spending and suffered from no carrying costs? This same business has no management, no employees, and doesn’t actually do anything other than collect royalty payments and distribute them to shareholders. Almost all of the cash flow that is collected by this stock (98+ %) winds up as profits for stockholders. Sound interesting?
The stock we are talking about Mesabi Royalty Trust (MSB).
This stock makes for an interesting story. In 1961, a trust was set up to benefit 21 people, all of whom are named in the initial trust document. At the time the trust document was created, all of the beneficiaries were either young children or infants (As a side note, if you have ever wondered how wealthy people stay rich, you need to consider this type of arrangement. Most people think about tomorrow’s stock price, while others plan 100+ years into the future to create benefits for their family).
As Described on the Company’s web site, Mesabi Trust:
“…is a royalty trust organized under the laws of the State of New York in 1961 to derive income from an iron mine located near Babbitt, Minnesota, at the eastern end of the Mesabi Iron Range. Under various agreements the mine is operated by Northshore Mining Company, a subsidiary of Cleveland-Cliffs Inc. Northshore mines the ore, which is in the form of taconite, a hard rock containing approximately 21% recoverable iron, crushes it, separates the iron particles from the non-metallic, and forms the resulting concentrate into pellets which are shipped for use in steel-producing blast furnaces of customers of CCI, an international mining company, the largest producer of iron ore pellets in North America. Northshore pays royalties to the Trust primarily based on the selling price of pellets shipped from Northshore’s pellet plant at Silver Bay, Minnesota, on Lake Superior approximately 45 miles from the mine, plus a significantly smaller royalty based on tons of ore extracted at the mine. Information about the reserve capacity and current pellet production of the mine can be found in the Trust’s most current Annual Report on From 10-K filed with the U.S. Securities and Exchange Commission, and available through the “SEC Filings” tab on this website.”
Cleveland Cliffs (the operator of the mine) states that:
“Northshore’s processing facilities are located in Silver Bay, Minnesota, near Lake Superior. Crude ore is shipped by a wholly owned railroad from the mine to the processing and dock facilities at Silver Bay. Over the past five years, the Northshore mine has produced between 3.2 million and 5.8 million tons of iron ore pellets annually. The Northshore mine began production under our management and ownership on October 1, 1994. We own 100 percent of the mine. Mining is conducted on multiple mineral leases having varying expiration dates. Mining leases routinely are renegotiated and renewed as they approach their respective expiration dates. Northshore operations consist of an open pit truck and shovel mine where two stages of crushing occurs before the ore is transported along a Company-owned 47-mile rail line to the plant site in Silver Bay. At the plant site, two additional stages of crushing occurs before the ore is sent to the concentrator. The concentrator utilizes rod mills and magnetic separation to produce a magnetite concentrate, which is delivered to the pellet plant located on-site. The plant site has its own ship loading port located on Lake Superior.”
The royalties paid to Mesabi Royalty trust are determined by a formula that factors in how many tons of taconite are shipped and the sales price received by Cleveland-Cliffs during the current payment period.
The calculation is as follows:
• For the first one million tons shipped that year, MSB is owed 2.5% of what CLF sells them for
• The second million tons earns 3.5%
• The next million gets 5%
• The one after that gets 5.5%
• anything above 4M tons shipped in the year earns 6%
In addition to this distribution schedule, Mesabi Trust is also entitled to bonus payments if the price per ton that Cleveland cliffs gets for the ore exceeds a target price, which is called the adjusted threshold price. The company claims that the threshold price is adjusted by an inflation rate factor that is calculated by the government.
The schedule for these bonus payments is as follows. If a sale takes place at:
• $2 above the threshold price, MSB earns an extra 1% of the proceeds
• $4 above the threshold price earns an extra 1.5%
• $6 above the threshold price earns an extra 2%
• $8 above the threshold price earns an extra 2.5%
• $10 or more above the threshold price earns an extra 3%
As you can see, the royalty payments are heavily leveraged to both volume and the price of taconite. If taconite increases in price at a rate greater than the inflation rate for a substantial period of time, the payouts the trust receives will skyrocket due to the bonus payments described above.
The trust has a limited lifespan defined in the trust agreement this way:
“The Trust shall continue until twenty-one (21) years after the death of the survivor of the persons named in Exhibit I annexed herto and hereby made a part hereof”
A glance at exhibit one shows that six of the 21 individuals named were born in 1960 and one (the youngest) was born in 1961. If we use 1960 as our benchmark and assume at least one of these individuals’ lives to be at least 80 years old, the trust would terminate after the year 2061, or something around 50 years from now.
Coincidentally, Cleveland Cliffs (the mine operator) estimates that the mine has over 50 years’ worth of taconite reserves left at current production rates.
The Northshore property has the largest reserves of Cleveland Cliff’s mines which are located the United States:
The investment story is very long-term in nature and not one without substantial risks. We have no insight into current or future taconite price trends, and in fact have read solid arguments that the price trend for the immediate future will be down. Any large disruption to the Northshore mine’s productivity would seriously impact payouts to the Mesabi royalty trust and its share price, particularly over the short term. However, we believe that over a 20+ year time period the compounding of cash flows will make for a substantial return. This stock should make an excellent hedge against long term inflation, as it benefits from a rising price level while at the same time (because it has no capital or operating expenses) is not be hurt by increasing costs. This is an extremely important point. Most mining-related stocks need to make very substantial capital outlays to continue operations. MSB, on the other hand, benefits from the mining of raw materials but has zero capital expenses, and indeed almost no expenses of any kind. For those who are interested, I outline the concept behind this idea in this article.
We also believe it is highly likely that increasing environmental regulation will make it to open up new domestic sources of taconite supply. This will work to make the resources derived from facilities that are currently “grandfathered in” increasingly valuable.
This stock contains a great deal of optionality (potential for large gains relative to a fixed amount of risk) over the long term. Please note, however, the short term volatility of this stock is substantial. You can’t buy this stock for investment purposes if you will be frightened (or elated!) by short term volatility over a few months or even a few years.
One interesting note about this stock is that since December 1987, the total return (capital appreciation plus dividends) has been a stunning 14,750%, or 147.5X the initial investment. Yet who talks about this as one of the greatest stocks of the past 25 years? No one. It is basically unheard of.
I checked the total return of Great Northern Iron ore Trust (GNI), a similar trust that is not a good buy because it is set to expire in a few years. This stock has advanced (adjusted for dividends) from 20 cents to 72 dollars, and this is includes a large selloff that has recently occurred as more and more investors realize this stock will delist and become worthless in a few years. If you read this you might wonder if it GNI is a good short-sale opportunity. Unfortunately, it isn’t. The cost to borrow the shares in order to short-sell is extremely expensive, and the amount of shares available to borrow is extremely limited.
Mesabi Trust’s cash flows have a great deal of seasonality due to Transportation issues at the Soo Locks, which allow iron ore boats to leave Lake Superior. These locks close every winter, and don’t typically re-open until April.
Because Cleveland Cliffs relies on these locks to get its Northshore taconite (where Mesabi trust has the royalty) to market, there is seasonality to the distributions do to royalty trust holders. For example in between 2010 and 2011, the April dividend ranged from 5 to 13 cents, while the October dividend ranged from 91 cents to $1.12. Does this distribution seasonality affect MSB’s stock price movements? Royalty trusts with high dividend payouts often attract relatively unsophisticated owners who are attracted to the high yield, but know little if anything about the business. It would not be surprising to think these investors notice the high yield and buy after the high payments that occur late in the year, only to be disappointed when the April payment is announced at only a few cents or not at all. This behavioral effect could create a seasonal price effect.
In the following study I divided the data up into two groups (pre-2000 and post 2000) and looked at average monthly returns over the two periods. The following charts show the results:
It looks like positive returns cluster from late in the year to the first two months of the next year, from September to February. The strongest month was December, which had an average return of over 12% during this time period. The worst month of the year was March, which was the only month of the year that showed a negative average return.
Let’s look at monthly returns from 2000 to October 2012:
The overall pattern is remarkably similar. Returns cluster between September and February. The best month is still December, and the worst month is still March. By the way, for the full period, the Month of December showed significance as measured by a statistical T-Test of less than .25% (for those who care about such things). For the entire period, December’s return ranged from -12% to +32%, and it had a positive return 79% of the time.
The bottom line is that this stock does exhibit some seasonality that might be profitable to keep track of and trade. This information might be useful when timing either a long-term investment (which is my intent with the stock) or a shorter term trade.
I see no reason why the economics of the Mesabi Trust situation will change over the next 25 years. I purchased a small position in MSB for my children’s investment accounts, and I plan to re-invest all of the distributions. Will the stunning long term gains continue? It will be interesting to watch.