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Having recently written about Thompson Creek Metals (NYSE:TC), I decided to look at Thompson Creek's partner in the Mount Milligan mine, and assess how the mine will affect Royal Gold's (NASDAQ:RGLD) financial status. Royal Gold received some good news recently with the report from Thompson Creek that the Mount Milligan mine was on track for an August 2013 opening.

The Mount Milligan mine is expected to produce 262,100 ounces of gold per year over the first six years of mine life. Royal Gold paid $781.5 million for a 52.25% share of Mount Milligan's gold stream for a payment of $435 per ounce.

Importance of Mount Milligan

Royal Gold's $781.5 million investment in Mount Milligan represents the largest single investment in Royal Gold's history. As such, it is expected to contribute a huge amount to Royal Gold's future cash flow and earnings. The gross margin contribution from Royal Gold's gold stream in Mount Milligan is likely to be nearly double that of the next most important royalty interest in their portfolio - Chile's Andacollo.

The below table illustrates the impact of the Mount Milligan mine on Royal Gold's annual earnings. Gross margin is calculated at the price of gold minus the $435 per ounce that Royal Gold pays for its share. Depreciation, depletion and amortization is estimated at $350 per ounce based on Royal Gold's investment in Mount Milligan, and its expected share of gold over the lifetime of the mine. We are assuming there are 65 million outstanding shares, although this may change if Royal Gold issues more shares to finance investments.

The Mount Milligan gold streaming transaction is structured through a Swiss holding company, which results in a 9% effective tax rate on that income. This is much less than its general 35%+ tax rate. Those funds will be held in and reinvested from Switzerland.

Price of Gold (Per Ounce)

Gross Margin ($ Million)

DD&A ($ Million)

Income Tax ($ Million)

Net Income ($ Million)

Effect on EPS

$1,200

$104.8

$47.9

$5.1

$51.8

$0.80

$1,300

$118.5

$47.9

$6.4

$64.2

$0.99

$1,400

$132.2

$47.9

$7.6

$76.7

$1.18

$1,500

$145.8

$47.9

$8.8

$89.1

$1.37

$1,600

$159.5

$47.9

$10.0

$101.6

$1.56

$1,700

$173.2

$47.9

$11.3

$114.0

$1.75

$1,800

$186.9

$47.9

$12.5

$126.5

$1.95

Production in Mount Milligan should start by the fourth quarter of this calendar year, with revenue coming in for Royal Gold starting in the first quarter of 2014 (Royal Gold's Q3 FY14). As noted in the above table, at current gold prices of $1,450 per ounce, Royal Gold can expect to make up to an additional $1.28 per share in net income. Higher gold prices of $1,800 per ounce could result in earnings per share of nearly $2. As well, at current gold prices, the project should generate $131 million (or $2.02 per share) in cash flow. Even with a lower gold price of $1,200 per ounce, Royal Gold's share of Mount Milligan will generate $100 million in annual cash flow. This is a huge boost since Royal Gold generated $172 million in cash flow from operating activities over the last four quarters.

Price of Gold (Per Ounce)

Gross Margin ($ Million)

Income Tax ($ Million)

Cash Flow ($ Million)

Cash Flow / Share

$1,200

$104.8

$5.1

$99.7

$1.53

$1,300

$118.5

$6.4

$112.1

$1.72

$1,400

$132.2

$7.6

$124.6

$1.92

$1,500

$145.8

$8.8

$137.0

$2.11

$1,600

$159.5

$10.0

$149.5

$2.30

$1,700

$173.2

$11.3

$161.9

$2.49

$1,800

$186.9

$12.5

$174.4

$2.68

Risks Associated With Mount Milligan

The risk of construction delays deferring the revenue streams from Mount Milligan seem to be over now as the mine is near completion and the winter weather at the site is over. The main remaining risks involves Thompson Creek's financial health, and the possibility of operational problems delaying full gold production as the mine ramps up. The latter risk is likely to have a temporary impact if it occurs. As for Thompson Creek's financial health, Thompson Creek's recent strong earnings results are also a boost. Thompson Creek had difficulties with rising construction costs combined with falling molybdenum prices, which forced them to sell additional parts of the gold stream to Royal Gold. The most recent earnings show that they are managing their remaining cash and their molybdenum assets very well, and are unlikely to encounter financial difficulties before Mount Milligan starts generating cash flow for them. Barring a massive crash in metal prices, Thompson Creek should be fine.

Conclusion

The completion of Mount Milligan is a very significant boost to Royal Gold. They have invested $781.5 million in that mine, and are now finally going to see the returns on their investment. Due to the tax advantages with the Swiss holding company they are using for this transaction, income tax is minimal, and the deal will generate a very large amount of operational cash flow. The net cash generated from operations will increase by about 76% ($131 million) at current gold prices. If gold prices are lower, then while cash flows will also be lower, they will still likely be generating over $100 million annually and would be able to strike more advantageous deals with miners struggling for financing. Potential delays at its Pascua Lama investment are something to monitor, although Mount Milligan is likely to produce over double the cash flow of Pascua Lama. Regardless of what happens at Pascua Lama, the near completion of Mount Milligan is a major milestone, with cash flows that will significantly help Royal Gold continue to make deals for many years.

Source: Royal Gold: Mount Milligan To Add Over $100 Million In Annual Cash Flow