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Over the past few months, stocks in the gold mining sector have fallen dramatically. This has provided an excellent opportunity to investigate companies in this sector for investment purposes. One company worth considering is Royal Gold Inc. (RGLD). While there are many different factors to look at and consider when investing, in the article below, I will look at the debt side of the company. I will analyze Royal Gold's total debt, total liabilities, debt ratios and WACC. From this analysis, we should get an idea if the company is highly leveraged, how much it is paying for its debt, what it's paying in taxes and how much to expect in return for investing in this company over the long term.

Gaining knowledge about a company's debt and liabilities is a key component in understanding the risk of a company. In 2008 and 2009, we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to. Taking into account the debt side of a company might not reveal the "pop" on the upside that an investor would like, but it will help ensure that the company is able to keep its capital and use it for growth in the future.

Royal Gold's principal activity is the acquisition and management of precious metal royalties and similar interests, including precious metal streams. By partnering with capable operators, we focus on building and managing a diversified, cash-flowing portfolio of precious metal assets.

Royalties are acquired outright from either a mineral resource company or a private party. These are called existing royalties. New royalties are created by providing capital to an operator or explorer in exchange for a royalty. Precious metal streams are obtained by providing financing to base metal operators, allowing them to monetize their precious metal by-product production. In either case, the capital provided by Royal Gold is typically used for the development and construction of a mine, mine expansion, or funding exploration work.

In the article below, I will calculate important ratios in understanding the amount of debt and liabilities the company has incurred. From this analysis we will understand more about the company's debt, liabilities and financial risk.

Debt Ratios

1. Total Debt = Long-Term Debt + Short-Term Debt

Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt due within one year.

  • 2010 - $223 million + $26 million = $249 million
  • 2011 - $211 million + $16 million = $237 million
  • 2012 - $293 million + $0 million = $293 million
  • 2013 TTM - $298 million + $0 million = $298 million

Royal Gold's total debt has increased over the past four years. In 2009 Royal Gold posted a total debt of $249 million while in 2013 TTM the company posted a total debt of $298 million. This signifies an increase of 19.68%.

2. Total Liabilities

Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities are the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.

  • 2010 - $458 million
  • 2011 - $443 million
  • 2012 - $535 million
  • 2013 TTM - $539 million

Over the past four years Royal Gold's liabilities have also increased. In 2009, Royal Gold reported liabilities of $458 million while in 2013 TTM Royal Gold reported liabilities at $539 million. This marks an increase of 17.69%.

In analyzing Royal Gold's total debt and liabilities, we can see that the company currently has a total debt of $298 million and liabilities at $539 million. From the numbers above, we can see that over the past four years, Royal Gold's total debt has increased by 19.68%, while the total liabilities have increased by 17.69%. As the company's amount of debt and amount of liabilities have increased, the next step will reveal if the company has the ability to pay them.

1. Total Debt to Total Assets Ratio = Total Debt / Total Assets

This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.

A debt ratio of greater than 1 indicates that a company has more total debt than assets. Meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.

  • 2011 - $237 million / $1.903 billion = .12
  • 2012 - $293 million / $2.373 billion = .12
  • 2013 TTM - $298 million / $2.887 billion = .10

Royal Gold currently has a total debt to total assets ratio of .10. The total debt to total assets ratio has decreased over the past three years. As the total debt to total assets ratio has decreased, this indicates a decrease in risk to the company. Because this number is low, this metric indicates low financial risk to the company.

4. Debt ratio = Total Liabilities / Total Assets

Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.

  • 2011 - $443 million / $1.903 billion = .23
  • 2012 - $535 million / $2.373 billion = .23
  • 2013 TTM - $539 million / $2.887 billion = .19

In looking at Royal Gold's total liabilities to total assets ratio over the past three years, we can see that this ratio has also decreased. The ratio has decreased from .23 in 2012 to .23 in 2013 TTM. As the 2013 TTM numbers are still below the 0.50 mark, this indicates that Royal Gold has not financed the company's assets through debt. As the number has decreased over the past couple of years, so has the risk to the company.

5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity

The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.

A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.

  • 2011 - $443 million / $1.460 billion = .30
  • 2012 - $535 million / $1.838 billion = .29
  • 2013 TTM - $539 million / $2.348 billion = .23

Compared with 2011, Royal Gold's debt-to-equity ratio has decreased. The ratio has decreased from .30 to .23. As the ratio is currently well below 1, this indicates that shareholders have more invested than suppliers, lenders, creditors and obligators. .23 indicates a low amount of risk for the company. As the ratio is below 1 and considered low, so is the risk for the company.

6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity

(LT Debt = Long-Term Debt)

The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.

  • 2011 - $211 million / $1.671 billion = .13
  • 2012 - $293 million / $2.131 billion = .14
  • 2013 TTM - $298 million / $2.646 billion = .11

Over the past three years, Royal Gold's capitalization ratio has decreased from .13 to .11. As these ratios are extremely low, financially this implies a very low amount of risk to the company.

7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt

This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.

  • 2011 - $147 million / $237 million = .62
  • 2012 - $162 million / $293 million = .55
  • 2013 TTM - $151 million / $298 million = .51

The 2013 TTM cash flow to total debt ratio is less than the 2011 ratio. As the ratio has decreased over the past few years this indicates that the company has had less of the ability to pay its total debt from its operating cash flow. As the current cash flow to debt ratio is below 1, this implies that the company has the ability to cover its total debt with its yearly cash flow from operations.

Based on the five debt ratios listed above, we can see that Royal Gold is a very financially stable company from a debt point of view. The ratios above indicate that Royal Gold should be able to make money on its assets and will not be burdened by massive amounts of debt and debt obligations. The next step will reveal how much the company will pay for the debt incurred.

Cost of Debt

The cost of debt is the effective rate that a company pays on its total debt.

As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing. This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.

8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.

9. Current tax rate

  • 2011 - $39 million / $116 million = 33.62%
  • 2012 - $55 million / $153 million = 35.95%
  • 2013 TTM - $61 million / $162 million = 37.65%

2010 - 2012 3-year average = 35.74%

From 2011 - 2013 TTM Royal Gold has averaged tax rate of 35.74%.

10. Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 - Tax Rate)

The effective rate that a company pays on its current debt after tax.

  • .02875 x (1 - .3574) = Cost of debt after tax

The cost of debt after tax for Royal Gold is 2.53%

Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)

The cost of equity is the return a firm theoretically pays to its equity investors (for example, shareholders) to compensate for the risk they undertake by investing in their company.

  • Risk Free Rate = U.S. 10-year bond = 1.66% (Bloomberg)
  • Average Market Return 1950 - 2012 = 7%
  • Beta = (Google Finance) Royal Gold's Beta = 0.34

Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)

  • 1.66 + 0.34 (7- 1.66)
  • 1.66 + 0.34 x 5.34
  • 1.66 + 1.82 = 3.51%

Currently, Royal Gold has a Cost of Equity or R Equity of 3.51%, so investors should expect to get a return of 3.51% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.

(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate, which is susceptible to daily change and Google Finance beta.)

Weighted Average Cost of Capital or WACC

The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.

As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk. By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances. For this calculation, you will need to know the following listed below:

Tax Rate = 35.74%

Cost of Debt (before tax) or R debt = 2.875%

Cost of Equity or R equity = 3.51%

Debt (Total Liabilities) for 2012 or D = $539 million

Stock Price = $53.57 (April 26th, 2013)

Outstanding Shares = 65.04 million

Equity = Stock price x Outstanding Shares or E = $3.484 billion

Debt + Equity or D+E = $4.023 billion

WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 - .3574) x .02875 x ($.539/$4.023) + .0351 ($3.484/$4.023)

.6426 x .02875 x .134 + .0351 x .866

.0025 + .0304

= 3.29%

Based on the calculations above, we can conclude that Royal Gold pays 3.29% on every dollar that it finances, or 3.29 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0329 plus the cost of the investment for the investment to be feasible for the company.

Debt Side Summary

All indications above reveal that Royal Gold has very little risk from a debt point of view. As all of the ratios indicated above are low, this indicates that Royal Gold shows no risk of being highly leveraged, or in any financial distress. The CAPM supports the stability of the company by revealing that the investor needs 3.51% year-over-year over the long term to get good value on his or her money.

Seasonality for Gold

As the price of gold has come off over the past few months this will have a negative effect on the earnings for the company moving forward. From a seasonal point of view, May is usually a strong month for gold (GLD); this is supported as over the past 20 years. Gold has produced a positive return 63% of the time. Having stated this, over the past 20 years, gold and gold stocks have continued their decline until mid July. In mid July the seasonality for gold usually turns positive.

Analysts' Outlook

Analysts at MSN Money are predicting a strong couple of years ahead for Royal Gold. Analysts are expecting Royal Gold to have an EPS of $1.63 for FY 2013 and an EPS of $2.43 for FY 2014. In April of 2013, BB&T Capital Mkts gave Royal Gold a rating of "Buy" with a target price of $85.00 while Finviz has a stock price target price of $84.81 for the company.

Charts sourced by FINVIZ

Summary

The above analysis reveals that Royal Gold is a solid company on the debt side. The analysis indicates that the company has very limited debt compared to the assets the company holds. Currently, analysts have a $85.00 price target on the stock with strong growth in earnings moving forward. Based on the chart above, the stock is currently on a strong downtrend. If patience is exercised and the stock price begins to form a bottom and break to the upside, it could prove be an excellent opportunity.

Source: Royal Gold Should Shine This Summer