Over the past four months, the stocks in the gold and silver mining sectors have fallen dramatically. This has provided an excellent opportunity to investigate companies in these sectors for investment purposes. One small-cap company worth looking at is Sandstorm Gold (NYSEMKT:SAND).
In this article, I would like to examine two different risk factors for Sandstorm Gold. As the company is very aggressive in acquiring streaming contracts, analyzing the debt side a company to assess if management is being too aggressive and taking on too much debt for the assets it is gaining is an important factor to monitor. Another risk factor that Sandstorm possesses is the sustainability of some of the micro-cap and small-cap companies that Sandstorm is dealing with. If commodity prices dropped how would be small- and micro-cap companies fare. At what commodity price would Sandstorm begin loosing streams due to mine closures and company failures?
Sandstorm Resources was founded by Nolan Watson (president and CEO) and David Awram (executive VP), who -- prior to Sandstorm -- were the first two employees of Silver Wheaton (NYSE:SLW). Since 2009, Sandstorm has compiled a portfolio of 10 gold streams and three NSR gold royalties, grown to $1 billion dollars in market capitalization and spun out a sister company called Sandstorm Metals & Energy (OTCPK:STTYF). Management plans to continue growing the company through the acquisition of accretive gold streams.
Q1 2013 was a continuation of excellent results from Sandstorm Gold. In Q1, the company reported record revenues of $15.364 million. Sandstorm reported gold sales of $14.031 million at a realized price of $1,635 per ounce. The company stated that they reported their first net income loss at ($12.254) million and added significantly to their liabilities.
The loss in net income and addition to their liabilities was incurred by Sandstorm Gold's very aggressive approach to acquisitions and streaming contracts. In Q1 2013 Sandstorm added two agreements to their portfolio. In January they acquired controlling interest in Premier Royalty Inc.(OTCPK:PIRGF), while in February they entered into a $55 million financing package with Entrée Gold (NYSEMKT:EGI).
In January 2013, Sandstorm Gold acquired 46,678,221 common shares and 6,965,676 warrants of Premier Royalty, representing approximately 59.9% of the currently issued and outstanding shares. Owning a controlling interest in Premier Royalty gives Sandstorm continued exposure to smaller stream and royalty acquisitions, allowing Sandstorm's team to focus on transactions that are material to shareholders.
Click to enlarge images.
Currently, Premier Royalty has a portfolio of 14 royalties, of which seven are producing and generating cash flow. The above JPEG indicates the seven royalties that are producing. Also, Sandstorm entered into a $55 million financing package with Entrée Gold. In this transaction Sandstorm has agreed to purchase metal credits equivalent to 25.7%, or 33.8% of Entrée's 20% share of the gold and silver by-products produced from the Heruga and Hugo North Extension deposits, respectively. The deposits are on the Entrée-Oyu Tolgoi LLC joint venture property in Mongolia, which forms part of the world-class Oyu Tolgoi copper mining complex.
In the transaction, Sandstorm will pay an upfront cash deposit of US$35 million to Entrée and ongoing payments equal to the lesser of the prevailing market price and US$220 per ounce of gold and US$5 per ounce of silver (subject to inflationary adjustments) until approximately 8.6 million ounces of gold and 40.3 million ounces of silver have been produced from the joint venture property. Thereafter, the purchase price will increase to the lesser of the prevailing market price of US$500 per ounce of gold and US$10 per ounce of silver. As Sandstorm has been very aggressive in its acquisitions over the past year and a half, Sandstorm has increased its liabilities significantly. Even though Sandstorm is a small-cap company, it is important to look at the debt side of the company to understand if the company has leveraged itself or created any financial red flags that might be a negative signal for investors.
Below I will calculate some important ratios in understanding the amount of liabilities the company has incurred. From this analysis, we will understand more about the rate increase and some of the risks associated with the company's debt and 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.
- 2011 -- $0.834 million
- 2012 -- $5.247 million
- 2013 TTM -- $12.493 million
In 2012 and 2013, Sandstorm Gold has been aggressively working to increase revenue streams for the company. In Q1 2013 Sandstorm acquired controlling interest in Premier Royalty. As they did this they increased their liabilities from $834 thousand in 2011 to $12.493 million in 2013.
As the company's amount of debt and amount of liabilities have increased significantly in Q1 2013, the next step will reveal if the company has the ability to pay them.
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 -- $0.834 million / $152.792 million = .006
- 2012 -- $5.247 million / $341.427 million = .02
- 2013 TTM -- $12.493 million / $445.476 million = .03
In looking at Sandstorm's total liabilities to total assets ratio over the past couple of years, we can see that the number has significantly increased. The ratio has increased from .006 in 2011 to .03 in 2013 TTM. Even though the ratio has significantly increased .03 in an extremely low number, indicating very little risk from a total liabilities to assets point of view.
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 vs. 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 -- $0.834 million / $151.958 million = .005
- 2012 -- $5.247 million / $336.180 million = .02
- 2013 TTM -- $12.493 million / $432.983 million = .03
Like the total liabilities to assets ratio, Sandstorm's debt-to-equity ratio has also increased. The ratio has increased from .005 to .03. As the ratio is currently well below 1, this indicates that shareholders have more invested than suppliers, lenders, creditors, and obligators. .03 indicates a very low amount of risk for the company. As the ratio is below 1 and considered very low, so is the risk for the company.
Cash Flow to Current Liabilities = Operating Cash Flow / Current Liabilities
This coverage ratio compares a company's operating cash flow with its current liabilities. This ratio provides an indication of a company's ability to cover its current liabilities with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to pay it obligations. The larger the ratio, the better a company can weather rough economic conditions.
- 2011 -- $13.47 million / $0.834 million = 16.15
- 2012 -- $25.17 million / $5.247 million = 4.80
- 2013 TTM -- $37.62 million / $2.871 million = 13.10
Over the past couple of years, the cash flow to current liabilities ratio has bounced around. As the current cash flow to total liabilities ratio is well above 1, this implies that the company does have the ability to cover its current liabilities with its yearly cash flow from operations.
Based on the thee debt ratios listed above, we can deduce that Sandstorm's financial risk due to debt and liabilities is very low. This indicates the overall stability of the company. The above analysis indicates that the company has not overleveraged itself or made it hard for the company to support its liabilities. 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.
Currently, Sandstorm Gold amended its revolving credit agreement to allow the company to borrow up to $100.00 million from a syndicate of banks including Bank of Nova Scotia (NYSE:BNS), Bank of Montreal (NYSE:BMO) and National Bank of Canada.
The agreement was for LiBOR plus 3.00% - 4.25% per annum. As of May 24, 2013, the Canadian LIBOR rate = 1.79% + 3.62% = 5.41%
Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- Current cost of Debt as of June 6, 2013 = 5.41%
Current tax rate
- Canadian federal and provincial income tax rates = 25.00%
In 2012-13, TTM Sandstorm has averaged tax rate of 25.00%.
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.
- .0541 x (1 - .25) = Cost of debt after tax
The cost of debt after tax for Sandstorm Gold is 4.06%
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 = 2.05% (Bloomberg)
- Average Market Return 1950 - 2013 = 7%
- Beta = (Globe and Mail) Sandstorm's Beta = 0.99
Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
- 2.05 + 0.99 (7- 2.05)
- 2.05 + 0.99 x 4.95
- 2.05 + 4.90 = 6.95%
Currently, Sandstorm has a cost of equity or R equity of 6.95%, so investors should expect to get a return of 6.95% 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 = 25.00%
Cost of Debt (before tax) or R debt = 5.41%
Cost of Equity or R equity = 6.95%
Debt (Total Liabilities) for 2012 or D = $12.493 million
Stock Price = $8.04 (June 6th, 2013)
Outstanding Shares = 90.503 million
Equity = Stock price x Outstanding Shares or E = $727.64 million
Debt + Equity or D+E = $751.29 million
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .25) x .0541 x ($.005/$.75129) + .0695 ($.72764/$.75129)
.75 x .0541 x .0067 + .0695 x .9685
.0003 + .0673
Based on the calculations above, we can conclude that Sandstorm Gold pays 6.76% on every dollar that it finances, or 6.76 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0676 plus the cost of the investment for the investment to be feasible for the company.
Debt Side Summary
All indications above reveal that Sandstorm Gold has increased its financial risk over the past few years. Even though, the liabilities have increased significantly over the past few years, the company's assets and cash flow from operations have increased thus indicating the company is gaining assets from its liabilities and making cash from its assets. As the ratios are still very low, the company indicates no risk of being highly leveraged, or in any financial distress from debt. The CAPM states that the investor needs 6.95% year over year over the long term to get good value on his or her money.
Streaming Risk Factors
Another risk factor moving forward regarding commodity prices is the ability for the companies Sandstorm has streams agreements with surviving an large drop in commodity prices. The list below will indicate the cost for production of the company Sandstorm currently has agreements with.
- Luna Gold (OTCPK:LGCUF) all-in sustaining cash cost estimate for 2013 = Just over $1,000.
- Brigus Gold (BRD) -- Cash cost per ounce of $630 and operating margin of $930 per ounce.
- SilverCrest Mines (NYSEMKT:SVLC) -- 2012 cash operating cost per silver equivalent ounce $7.39.
- Metanor Resources (OTCPK:MEAOF) -- Direct cash cost $464.
- Solitario Exploration & Royalty Corp.(NYSEMKT:XPL) -- $575 operating cash costs.
- Magellan Minerals Ltd.(OTCPK:MAGNF) -- The company has two advanced gold projects, Cuiu Cuiu and Coringa in Brazil. Currently, the Coringa project has a NPV of $110M at $1350/0z.
- Santa Fe Gold Corp. -- Operating cash cost of $1,132 per ounce (2013).
- Mutiny Gold Ltd. -- According to website Mutiny has a cash cost of $618/oz Au Eq.
- Donner Metals Ltd. (OTCPK:DONFF) -- Donner's flagship project is a partnership with Glencore Xstrata in the Matagami Mining Camp, covering both the current development of a new mine that began production May 15, 2013, and on-going exploration activities.
- Entrée Gold Inc. -- Average cash costs (net of by-product sales) of $1.46/lb copper.
- Rambler Metals & Mining PLC -- Cash Cost per oz. $1,000.
- Colossus Minerals Inc. (OTC:COLUF) -- Colossus is a development-stage mining company focused on bringing its 75% owned Serra Pelada gold-platinum-palladium mine into production.
- Premier Royalty -- The company also has a number of promising earlier stage exploration and development royalties in its growth pipeline and is actively assessing other potential royalty acquisitions and corporate development opportunities in stable jurisdictions with a focus on North and South America.
Even though the companies assess the cash costs differently, by looking at the micro-cap and small-cap companies above, most of the companies look to be able to bring in positive revenues even if gold falls between $900 and $1,000 ounce.
Based on the existing Gold Streams and excluding any attributable production relating to Premier Royalty, forecasted 2013 attributable production is between 33,000 and 40,000 Gold Equivalent ounces, increasing to approximately 70,000 of gold equivalent per annum by 2016. This growth is driven by the company's portfolio of Gold Streams with mines, all of which are either currently producing or expected to commence production by 2015.
- Finviz has a price target for Sandstorm at $9.34.
- Recently, RBC Capital Mkts gave the company an "outperform" rating.
- Casimir Capital analyst Eric Winmill gave Sandstorm a price target of $15.75.
The above analysis reveals that Sandstorm Gold is a solid company on the debt side. It has significantly increased its debt levels over the past couple of years, but all of the ratios imply that the company is not "over-leveraged" or currently in any financial distress. When looking at the companies that Sandstorm has agreements with the companies look to be able to sustain production as long as gold is around or above $1,000.00. If gold is to fall below the $1,000 mark, then some of these small and micro-cap stocks could be in danger of halting production or closing mines.
Based on the chart above, the stock is currently on a strong downtrend but seems to be forming a bottom. I believe patience is needed at this point. When the stock price ultimately begins break to the upside, it should prove be an excellent opportunity to invest in a company with an excellent growth profile.
Disclosure: I am long BMO, BNS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.