Central banks around the world are instituting monetary easing policies with no end in sight. Although they deny that steadily increasing the money supply for an undefined length of time won't decrease the value of their respective currencies, many investors are taking matters into their own hands to protect their portfolios from the corrosive effects of inflation.
As such, gold has become a popular buy as of late. But since relatively few have the resources to hold the physical commodity or the sophistication to engage in futures contracts, the stocks of gold producing companies have become many investors' primary exposure to the counter-inflationary aspects of gold.
Gold miners are notoriously inconsistent though, making a recent entrant into the U.S. equity markets - Sandstorm Gold (SAND) - an attractive alternative. The company loans money to fledgling gold miners, and in return the mines sell Sandstorm a fixed amount of the gold they produce at fixed rates significantly below the current spot price of gold.
Sandstorm seems like a great investment, since they'll have a steady stream of gold to consistently sell for a profit, and their shareholders are removed from the inconsistency and risk involved with the gold miners themselves.
However, I argue that although Sandstorm's business model is sound and that the company no doubt has a bright future ahead, the stock is vastly overvalued at its current price, and prudent investors should wait before making Sandstorm a part of their portfolios.
A Great Company
Sandstorm's business model is simple. They loan money to cash-strapped gold miners, who pay off their loans by selling gold back to Sandstorm throughout the life of the mine at rates significantly below the market price of the metal. As a result, Sandstorm is provided with a steady stream of cheap gold to sell into an expensive market, hence the name of their business model: gold streaming.
It's beautifully simple, and once Sandstorm issues their loans, they're removed from the day to day operations and overhead costs of the mines they fund. On occasion, they'll provide additional funds to a mine they've invested in, but once the mine is up and running, all they need to do is sit back and rake in the profits.
The amount of gold they receive from each mine and the price they pay the miner for each ounce of gold varies, but it's shown on the table below, taken from the company's Q3 2012 statement.
click to enlarge images
The business model is sound. Sandstorm receives a significant amount of the gold that each mine produces, and they pay only a fraction of the market price - $1729 per ounce at the time of this article's writing - for each ounce of gold they receive. They've even included measures to protect their investments from inflation, as many of these mines have life expectancies of a decade or more.
In addition to the 9 mines with which they currently have streaming agreements, they command royalty payments from three additional mines, and have many prospects for future growth. They haven't released anything concrete yet, but in their most recent earnings conference call, Sandstorm's CEO, President, and Director Nolan Watson said:
There is enough things in the pipeline that I am confident that here in the New Year probably Q1 or Q2 we should have more deals to announce ... We finally have a significant amount of capital, a significant amount of cash flow, a significant amount of debt facility that we can draw to take advantage of all these opportunities in our pipeline and I think the future looks pretty bright for Sandstorm.
And I agree with him. Sandstorm does have a bright future as a company. But when it comes to Sandstorm's future as a stock, all that glitters is not gold.
An Expensive Stock
Although Sandstorm only became available for trade on the NYSE on August 20, 2012, the company has been listed on the CVE since mid-2008. Early buyers of the stock have done quite well, as Sandstorm proved the viability of the gold-streaming model and began to profit.
Volume surged this year when it began trade in America, and as of the time of this article's writing, the company's stock trades at $11.82 per share, giving it a market capitalization of $1.01 billion and a P/E ratio of 53.86
And therein lies the problem with buying into Sandstorm at its current valuation. It's a good company. It's a profitable company. It's a company with a bright future. But it's not a billion dollar company, nor will it probably be at any time in the next few years.
The chart below shows the proven and probable reserves attributable to Sandstorm at each of their current streaming projects.
If we give the company the most generous valuation possible and assume a market price of $1,800 per ounce and the successful extraction of 100% of the proven and probable gold, we can value their assets at $472,887,000. This is of course the raw value of their reserves, and does not take into account their net profits after purchasing the gold from the mines.
In addition to their streaming mines, they command 11,690 ounces of proven and probable gold reserves from royalties at their Mt. Hamilton project. At the same $1,800 per ounce price, this brings their gold-related asset valuation to $493,929,000.
The company's Q3 2012 financial statements list other current cash and credit related assets at $123,312,000. Combining this with the very generous assessment of gold assets above gives Sandstorm $617,241,000 worth of bankable assets - a far cry from the $1 billion value that Mr. Market has assigned to the company.
Watch And Wait
My rough valuation above makes Sandstorm look like the hopelessly overpriced victim of an irrationally exuberant bull market in gold. But although I firmly believe that the stock is currently trading far above its true value, I also think that Sandstorm is a well run company with great prospects for future growth and profit. I want to own a piece of this company. I just don't like the idea of initiating a position at the current level of the stock's price and the company's valuation.
There are three factors that potential investors in Sandstorm should watch carefully before pulling the trigger.
The first - obviously - is the price of the stock. As you can see in the chart below, it recently underwent a sizable correction during the market-wide sell off after election day.
If another sell off occurs in the near future, Sandstorm will likely correct again. If it corrects enough to bring its market capitalization more in line with the value of the company's assets, it will become a much more attractive option. I would consider initiating a position if the stock traded back at its 2011 levels. If it continued to drop below $7 per share, I'd become an eager buyer.
Sandstorm's high P/E ratio doesn't concern me at the moment. As more of its streaming mines increase their production, the company's earnings will increase. Additionally, I wouldn't mind purchasing the company's stock at a premium to the company's assets. This is essentially a growth play, and the future growth will most likely remain priced into the stock for some time. I would certainly not expect the stock's price to drop to a level where it would be considered undervalued or cheap. I just don't feel comfortable buying in at its current premium.
The second factor that potential investors need to watch carefully is the price of gold. If gold takes a dive in the future, Sandstorm's value will decrease substantially. Not only will their current assets be worth less, but their "opportunities in the pipeline" will disappear if the profit margins on gold mining shrink. It could be an opportunity to buy on the dip. Or it could be a sign to look for another stock in which to invest, depending on the future outlook of the gold market.
On the other hand, if gold can break through its current resistance at $1,800 per ounce and begin the second stage of its bull market, then obviously Sandstorm will benefit. Their current assets will be worth more, and more miners will seek financing through the company.
The third factor is related to the price of gold, but not entirely dependent on it. Sandstorm has claims to 274,405 ounces of proven and probable reserves of gold. But within its current streams and royalties projects, it also has claims to 1,069,975 ounces of measured, indicated, and inferred gold resources.
The difference between reserves and resources is simple: reserves are deposits of gold that are proven or probable to be economically viable for extraction. Reserves are bankable assets, and can generally be relied upon in terms of both quantity and cost of extraction.
Resources have not yet been demonstrated to be able to be mined at a cost that would ensure a reasonable profit. Even if the price of gold moves sideways for a while, some of these resources may become reserves after further study. If the price of gold rises though, a larger portion of the resources that Sandstorm can claim may become economically viable to extract as the rising revenues from sales would offset the rising cost of mining.
Whatever direction gold moves in the future, potential investors in Sandstorm would be wise to scrutinize the company's financial statements over the next few quarters for the amount of gold that the company has listed under reserves and resources. They have access to an astronomical amount of potential gold. But at the end of the day, if it costs too much to dig up, it stays buried.
Sandstorm Gold has pioneered the concept of gold streaming, and proven the viability of the business model. It's a successful company with a bright future, but its stock currently trades at too high of a premium to the company's value.
Potential investors should watch the price movements of both SAND and gold in the future to identify better entry points into the stock. Also, should a substantial portion of the gold resources that Sandstorm can potentially claim become proven and probable reserves, the company's value may rise enough to make its current market capitalization of over $1 billion a more reasonable valuation.
Barring a massive price correction in the next few months, I don't see Sandstorm Gold becoming a "buy" soon. But that doesn't mean it won't be worth buying in the future. It's still a good company with a lot of potential. It just costs too much at the moment.