Mining stock Labrador Iron Ore downgraded to 'hold'

We regularly review Toronto-based Labrador Iron Ore Royalty Corp. Since we published our June 5 issue of The Investment Reporter, this mining stock's shares continued to decline over the summer.

We've always liked Labrador Iron Ore Royalty Corporation (TSX?"EURLIF). Even so, we've downgraded its shares to a 'hold' for several reasons.

First, Labrador Iron Ore's dividend could be at risk. This year's expected earnings of 76 cents a share are significantly below the dividend of a dollar a share. Next year's expected earnings of 98 cents a share are slightly below the dividend.

This debt free Canadian mining stock can use its cash of $24.3 million for a while. But maintaining the dividend at a dollar would consume cash of $64.4 million a year. The dividend yield of 6.9 per cent looks too high.

Iron ore demand is weakening

China now produces half the steel in the world. But some think that the world's second-largest economy is slowing down sharply. If so, its demand for, and the price of, iron ore could weaken. Also, Australia, among others, also supplies China with iron ore. This could lead to a glut which, in turn, would further hurt the price of this commodity.

Keep in mind, too, that Labrador Iron Ore's shares are costly. Based on this year's earnings estimate, the shares trade at a forward price-to-earnings, or P/E, ratio of 19.1 times. That looks excessive for a stock with depressed earnings.

P/E not useful for cyclical mining stocks

Based on next year's estimate, the shares trade at a better forward P/E ratio of 14.8 times. But it's hard to accurately forecast volatile commodity prices and a producer's earnings per share. With cyclical commodity stocks, P/E ratios are less useful.

We've now downgraded Labrador Iron Ore Royalty to a 'hold'. But only if you can accept holding a mining stock that we rate 'Higher Risk'.

The Investment Reporter, MPL Communications Inc.133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846