For an investor looking to avoid the risks associated with development stage gold mining, but also looking to gain exposure to the sector’s upside potential, gold royalty stream companies are an option. In the US, there’s no bigger player in gold royalty than Franco Nevada Corp (NYSE:FNV). The company just reported its first quarter earnings, beating out expectations, and makes for a potentially rewarding, low risk allocation as we head into the latter half 2016. There are also a number of other players in the industry that offer alternative exposures, for an investor looking to diversify across a risk spectrum. Here is a look at what’s available.
First, what’s gold royalty streaming? Capital in the developing stage mining space is hard to come by. Traditional financial institutions are often reluctant to lend capital to junior gold miners, especially at the level required to fund exploration, and this forces development stage mining companies to seek alternative forms of financing. Royalty streaming is one such alternative form. Unlike a standard loan, where an institution or individual lends money to a company based on an interest rate, royalty stream companies lend to miners in return for a percentage of the revenues generated through operational activity.
Say, for example, a junior miner has a proven resource, but needs capital for permitting, or t update its processing plant to bring the machinery in line with present day code. They can approach a royalty stream company, or join a consortium who will approach the company on their behalf, and apply for capital. In return, the royalty stream company might agree to accept a 20% royalty on the gold that the junior miner produces and sells, once the capital gets put to use. The terms vary greatly depending on the deal in question, and are generally rooted in risk. A royalty stream might only agree to lend at a 70% rate if the miner has yet to prove its resource, for example. At their core, however, they all follow this standard structure. One way to think of it is that the stream companies are buying royalty streams, rather than lending capital.
The important thing to note here is that this model means the royalty stream companies are not gold mining companies. Instead, they are financial services organization. This structural difference allows them to operate at a much lower overhead than a gold miner might. It also allows them to diversify their risk across a host of streams, rather than rely on one mine, or piece of real estate.
This risk diversification and low cost model makes them an attractive allocation for the individual investor looking to gain exposure to gold. So why is Franco Nevada attractive at current prices?
The company just reported its Q1 2016 financials, and in doing so, has reaffirmed its position as the leading large cap allocation in the space. The company recorded a net income of $28 million or $0.17 per share in Q1 2016, up from $22.9 million or $0.15 per share during the comparable quarter a year earlier, on record gold equivalent ounces GEOs) at 106,621 sold. EBITDA came in at just short of $104 million.
What makes Franco Nevada even more attractive than some of its peers in the royalty streaming space is the company’s balance sheet. At the end of last year, management reported debt of $430 million. In March, the company paid off its this entre $430 million, and now holds zero debt. Further, it’s got cash and cash equivalents of $186 million, and unrestricted access to a credit facility of $1 billion. Throw in working capital, and the capital available to Franco for the acquisition of fresh streams is a little over $1.3 billion. For a company that expects per dollar return in the region of 60-70% on every dollar it allocates, this makes its market capitalization of $15 billion, and in turn, its current price, look cheap.
Quantitative data aside, and one benefit not just enjoyed by Franco, but also a number of other players in the space, the structure of the deals made in the royalty streaming sector affords an investor a relatively unique opportunity – to get a picture of what the company in question’s financials might look like a decade, or three, down the line. How? Because the deals that Franco strikes with the companies it helps to finance last a minimum of 40 years. On top of this, the company has an option to extend by a decade at a time, at its discretion. That is, if Franco wants to buy an extension for a prespecified price and continue to collect royalties from a junior miner after its initial 40-year contract expires, it can do so, and the miner has little or no say in the matter.
Franco Nevada is strong from a financial standpoint, but its size limits its near term upside (say, across the next 3-5 years). Low risk, but low reward.
For an investor looking for something with a little more potential for return, a company like Royal Gold, (Inc USA) (NASDAQ:RGLD) could be an attractive option. Royal Gold has a little over $630 million in debt, but it had nearly $123 million cash on hand at March 31, and just reported a jump of 26% revenues gain for the third fiscal quarter.
With a market capitalization of a little over $3.68 billion, it’s somewhat smaller than Franco, and it’s just reported a net loss, despite the above mentioned gain in profits. However, as an investor looking for an exposure to the gold space, Royal is likely more attractive. Why? Because Royal Gold generates the higher majority of its revenues from gold (as opposed to other metals or oil, as dies Franco Nevada). It’s also got some extremely attractive agreements in place. Take its Mount Milligan gold project in British Columbia, Canada, as an example. The company paid $782 million prior to commercialization at this project, but has the ability to pick up the gold it produces at $435 per ounce, for the lifespan of the mine. At a 52.5% delivery proportion, and a 6.2 million reserve, this accounts to the company paying about $1.3 billion for its share of the reserves. At current prices, this is gold that could sell for circa $3.6 billion. If gold increases in price, this disparity in price paid and available selling price widens.
Moving on, another option is Preston Corp (OTCMKTS:PSNP). Preston is just getting started in the space, and is probably the riskiest of the three companies discussed here, but a few recent updates and some ambitious (but achievable) five-year stream targets make it an interesting consideration.
The company just joined forces with a body called Gold Production Acquisition Corp, which holds a large portfolio of gold production real estate; real estate that needs capital for development purposes. Across the next twelve months, Preston expects to report a number of royalty stream deals relating to the Gold Production Acquisition Corp arrangement, and each of these have the potential to act as upside catalysts.
The company hit markets with the first of these deals to come to fruition at the beginning of this month. Preston will fund the development of a Sacramento based property to the tune of $250,000 this season and a further $4-5 million going forward, and expects a 50% ROI annually on the deal.
Within five years Preston’s management expect to be have optioned somewhere in the region of 50 properties, and generate $100 million annual revenue on these properties’ production.
This one, therefore, is a pretty high risk exposure – at least when compared to Franco or Royal, which are more established streamers. From a potential upside perspective, however, it outshines both of its larger competitors.
To summarize, gold and other metals are going to draw a lot of attention over the next few years, as a return to exploration and an increase in prices draws speculative capital to the space. Royalty stream companies offer a risk balanced exposure to this attention, rooted in the diversification inherent in their business models. Franco is one of the sector leaders, and is strong financially. However, it might not offer the return potential speculative investors are looking for as part of a small scale allocation. Royal Gold or Preston Corp look to be valid alternatives for an investor seeking this latter type of exposure.