Get Royalty Treatment with Royal Gold

Includes: RGLD, SLW
by: Hyperinflation

To supplement my numerous articles regarding royalty giant Silver Wheaton (NYSE:SLW), the following may interest those that fear mining is too inherently risky but desire exposure to appreciation in the precious metals. I will focus on one of the two largest streaming gold producers.

The aforementioned companies had one thing in common - a great grasp of the future of the precious metals and the foresight to purchase the majority of their royalties at a deep discount at a time when credit was very easy to come by. These acquisitions look like a stroked of genius in hindsight because they were. Royal Gold took advantage of easy money to purchase real assets. This has made it much more difficult for those who lacked this foresight to enter the market, as the financial crisis made it extremely difficult for smaller companies to access financing (both debt and equity). A great example of this is Gold Wheaton, which can't compete with the likes of a Silver Wheaton or Franco Nevada (FNNVF.PK).

Before the solid quarter reported by Royal Gold (NASDAQ:RGLD) , the stock was about 15% cheaper, but the recent announcement has pushed Royal Gold near its 52-week high. Estimating an intrinsic value for these two royalty companies is far more difficult than something like Silver Wheaton or another mid/top tier gold producer. This is due to the variation in the sliding scales for each individual royalties as well as the variation regarding the conditions of these royalties and how they may or may not change over time.

But on the other hand, it is also fairly easy to forecast cash flows if you put in the time and focus more time on the major flagship streams, which should help you get a rough estimate. Though many say otherwise, these royalty companies reduce operating risk substantially due to the fact they aren't reliant on one or two streams for 80-100% of their income. Of course there is risk involved, but the business models of something like Royal Gold, minimizes this risk. Not to mention the fact they have royalties around the world making it geopolitically diverse as well.

Royal Gold

  • Royalty Interests in the US, Mexico, Africa, Argentina, Chile, Australia, Finland, Guinea, Central America and more.
  • Flagship streams contracted with the largest Gold producers (Barrick Gold (NYSE:ABX), Goldcorp (NYSE:GG), Newmont Mining (NYSE:NEM)) and others.
  • 22 Royalty streams on-line with 12 more in advanced stage development including Barrick's world class Pascua-Luma mine (expected to commence in 2013), over 20 evaluation stage projects and over 60 in the exploration stage. This excludes the Andacollo property bought from Teck (TCK) (purchased at an all in costs per ounce under $450).
  • Executing brilliantly - reported at 62% increase in year over year revenue and more importantly a 70% year over year increase in free cash flow.
  • Well capitalized - Miners are trying to move their projects ahead as they are aware of the beginning of a sustained bull market in gold and want to reach full capacity sooner than later. Many of these projects will need external financing from sources like Royal Gold. It is likely they are in several talks at the moment but as Silver Wheaton has shown, talks can go on for extended periods without anyone noticing.
  • They also have set themselves up for a nice growth spurt over the next several years. Penaquito, Dolores, Holt and Canadian Malartic will provide an additional 45-50m in revenue from 2010-2012 as key growth drivers come online and ramp up production. This is assuming a sub $1,000 gold price, so gold at 1300-1600 by 2012 should add an additional 20-30 million.
  • Following the next stage of growth will be the production (expected to commence in 2013) from Pacua-Luma and Andacollo, which at sub- $1,000 gold, would still add 45-50 million in revenue.
  • I can almost guarantee accumulating royalty streams to supports future growth is still far from complete. They hold over $310 million in cash, have access to $125 million of debt and has no debt currently outstanding. They have also increased their payout ratio above 30%, making this a likely dividend machine within a few years.

Like Silver Wheaton, they have contractual agreements to purchase gold at a specified price with a minimal annual inflation adjustment. In other words, they will not be subject to rising input costs, which will allow them to maintain a superior operating margin profile relative to the complex. I would assume those who are invested in Silver Wheaton would also have an interest in this gold counterpart.

Disclosure: Long SLW, RGLD (Common Stock and Calls) , FNNVF.PK (Warrants)