Three Metal Miners: Three Dynamic Business Models, Three Great Quarters

Silver Wheaton (SLW) followed in the footsteps of fellow royalty giants, Royal Gold (RGLD) and Franco-Nevada (FNNVF.PK) with regards to their quarterly results. These royalty companies not only have a high leverage to gold and silver but have other comparative advantages over a typical mining company. While many premier gold companies had atrocious quarters, these three companies are firing on all cylinders coming off the back of a quarter characterized by the highest average gold price recorded and more importantly, at the footsteps of a new decade that will see unprecedented domestic and worldwide inflation.

RISK: Precious metal royalty companies by their very nature have a more favorable risk profile, as they can diversify some of the risk away through a large portfolio (opposed to most miners, who rely on one or two flagship operations).

Silver Wheaton -

• 15 Income producing streams, Pascua-Lama (8-10m oz/yr) on the back burner until 2013, 5 in advanced or exploration stage and options to purchase 2 different zinc streams (should the price of Zinc be right).
  

• These streams have at least 25% ownership interest (Pascua-Lama and Penaquito, both for the Life of the Mine) and several contracts of 50, 75 and 100% interests (notably Luismin and Yauliyacu).

Though Silver Wheaton does have three flagship streams and several of moderate size, they have their largest contracts with some of the biggest miners in the world (Goldcorp (GG), Barrick (ABX), Lundin Mining (LUNMF.PK)). Goldcorp will supply 15-16 (SEO) million ounces a year through Penaquisto and Luismin. Barrick will provide 2.5 million ounces until 2013 at which time it will ramp up to 9m oz a year. Glencore and Lundin will provide 5.5m/oz annually, while the three streams acquired in the Silverstone acquisition will add 5-6m annually. A large royalty portfolio also diversifies the geopolitical risks.

In other words, they aren’t as reliant on just one or two operations. It isn’t to say this is a niche market in mining that has very little risk, but rather far less risk relative to the overall industry. Silver Wheaton has royalty streams based out of Mexico, Chile, Argentina, Sweden, Peru, Greece, Canada, Portugal and the USA.

Q3 Highlights:

- Record attributable production of 4.3 million silver equivalent ounces (4.0 million ounces of silver and 3,698 ounces of gold) at a total cash cost of US$3.97 (1) per silver ounce, representing an increase of 59% over the comparable period in 2008.
- Record silver equivalent sales of 4.6 million ounces (4.0 million ounces of silver and 9,953 ounces of gold), representing an increase of 70% over the comparable period in 2008.
- As of the end of the third quarter, approximately 1.0 million silver equivalent payable ounces attributable to the Company have been produced at the various mines and will be recognized in future sales as they are delivered to the Company under the terms of their contracts.
- Record net earnings of US$33.6 million (US$0.11 per share) compared to US$20.2 million (US$0.09 per share) for the comparable period in 2008.
- Record operating cash flows of US$45.4 million (US$0.14 per share) compared to US$26.7 million (US$0.11 per share) for the comparable period in 2008.

Royal Gold –

• 21 producing streams, 13 development, 25 evaluation and 60 exploration projects.
• Like Silver Wheaton, Royal gold’s flagship royalties are also produced by the world’s largest gold miners.
• They will have several streams come on-line over the next several years, providing them with more diversification.
• They also have a diversified portfolio, geopolitically speaking. Most of their current revenue is from Canada, USA , Mexico, various places in Central America, Australia as well as an interest In the world class Pascua-Lama project in Argentina (2013).

Q3 Highlights: Can Be Found Here.

Dramatic Increase In Reserves and Production: Click Here.

Franco-Nevada –

• Franco Nevada is a bit unique in that 20% of their royalty revenues come from Oil & Gas and a few others commodities, i.e potash, base metals, platinum
• Like Royal Gold, but has a larger portfolio of royalties in the advanced and exploration stages. They focus mainly on the USA, Canada, Mexico, Australia and Indonesia, and also do business with the like of Barrick, Goldcorp, Coeur d”Alene (CDE), New Gold (NGD), IAMGOLD (IAG), among others.
• They have 27 streams online (16 of which are gold, 3 Oil and Gas, 3 Platinum and Potash and 5 base metals) 19 advanced stage projects and nearly 300 exploration stage projects.
  
• They continue to increase the size of their portfolio, adding purchasing three streams over the last twelve months which will be their anchor for growth going forward.
  
• Though they have already added the Palmarejo and Gold strike streams so far in 2009, adding even more diversification, they announced Tuesday a $58 million purchase for a 2% smelter royalty from Newmont's (NEM) gold mine in Ghana. This leaves them will $400 million in cash and no debt.

Q3 Highlights

• Gold Royalty Revenue(1) for the quarter of $25.5 million was a record high. Overall Royalty Revenue was $36.4 million and the contribution from precious metals was 77%.

• Free Cash Flow (3) was $32.5 million ($0.29 per share) representing a margin of 89% of Royalty Revenue.

• Net income for the quarter was $12.3 million ($0.11 per share). Adjusted Net Income(4) for the quarter was $7.3 million ($0.07 per share).

• 75% of Royalty Revenue in the quarter was earned in the US, Canada and Australia.

• At September 30, 2009, Franco-Nevada had a strong financial position with no debt or hedges and working capital of $559.0 million, marketable securities of $59.4 million and an undrawn $150 million revolving credit facility.

Recent Acquisition Details:

Growth:

The previously mentioned companies also have great production growth profiles led by Silver Wheaton, Royal Gold and the Franco-Nevada . The growth potential is enormous going forward as they are all incredibly well financed.

Silver Wheaton has made it clear they are seeking another flagship stream or several medium size streams. They have a credit facility available to draw upon in addition to funding some with operating cash flow and further possible equity offerings.

Royal Gold has Andacollo, Penaquito and Pascua-Lama to help propel high growth out to 2013-2014. They are also likely on the prowl for more acquisitions as they have about $150 million in net cash.

Franco-Nevada’s growth will come more from the ramp up of some streams currently online, but will also see some advanced stage projects contribute to future growth (not to mention their recent acquisition). The more or less recent acquisitions of Palmarejo and Gold Strike are nice additions to the portfolio and key to sustaining strong production growth out to 2012-2013. But having 400 million in cash with no debt allows Franco to potentially add 2 or 3 flagship royalties. It is worth noting Franco will be able to purchase the best deal that may come along as their superior balance sheet (relative to Royal Gold) allows them to beat any bid made by Royal Gold. A bidding war is unlikely to erupt as both companies will try to allocate capital as efficiently as possible, so I wouldn't worry about any of them overpaying.

Leverage to the Underlying Commodity: As these companies will meet expectations compared to the mining complex as a whole, it is much easier to determine cash flows, and thus narrow the likely range for the intrinsic value of the company. This makes it more of a leveraged play to the underlying commodity, and less to company specific developments (development setbacks, etc). Cash Flow estimation will also be aided by fixed input costs, which is important in an inflationary environment.

Dividends: These companies have said they plan to, and in some cases have already, started paying dividends. Silver Wheaton will payout all excess profits after it can no longer acquire assets on an economic level, in order to maintain its tax exempt status. Royal Gold already has a 34% payout ratio, with Franco around the same area.

I mention these companies for those who don’t feel they know enough about the mining industry and feel the inherent nature of the business is too risky. All three of the aforementioned equities reduce a lot, but not all of this risk, so it can almost be looked at like an ETF or Mutual Fund in that one bad asset will not necessarily ruin the whole bunch. It isn’t a coincidence that all three met or beat expectations while many premier miners failed to execute their goals. Kinross (KGC) had a very ugly quarter and Agnico- Eagle (AEM) had a sub-par quarter, among several others.

Disclosure: Long SLW, RGLD, FNV.TO Warrants

Comments

[Value Added:]

Thanks, good article. I agree with your recommendations.
Disclosure: long SLW.

Nov 11 08:48 AM

[mbkelly75:]

Well done - Thank You.

Nov 11 09:39 AM

[GMiki1:]

Long SLW. And happy.

Nov 11 12:07 PM

[User 440042:]

Excellent recommendations !

Nov 11 12:18 PM

[Jeff Nielson:]

I've been sticking with the smaller miners because of the superior growth potential (although I have held SLW in the past).

The author's point about these being ideal means of getting exposure to precious metals for novices to this sector is a good one.

That said, if my "juniors" continue to prosper I'll certainly look to funnel some of those profits into (at least) one of these companies - as they are essentially "blue chip" companies (for this sector).

Nov 11 01:21 PM

[tripleblack:]

I am long silver and getting longer all the time. I own SLW, and intend to keep it long term as well. The more I learn about their business plan, the more I like what I see.

Nov 11 03:00 PM

[Hyperinflation:]

I'm in the same boat to a degree, I own a many junior miners i.e Jaguar, Red back, Kirkland Lake, Great Basin Gold, Aurizon, First Majestic etc but they constitute about 30% of my mining equities, while the mid-tier group i.e Lihir, Yamana, Newcrest, Coeur d'Alene, Silver Standard, ECU silver make up another 30% and the rest is comprised of the three mentioned above.
-Franco-Nevada is already generating $50 of Free Cash Flow per every $1000 invested. This hold many implications as they have no capital requirements, have growing record attributable gold ounces, higher annual gold prices and higher annual oil prices. Just taking into account Palmarejo, Gold Strike and $1000 annual gold prices, FCF should rise dramatically. Looking out to 2011-2012, Free cash flow per $1000 invested should rise 4 fold or $220 or 22%.


On Nov 11 01:21 PM Jeff Nielson wrote:

> I've been sticking with the smaller miners because of the superior
> growth potential (although I have held SLW in the past).
>
> The author's point about these being ideal means of getting exposure
> to precious metals for novices to this sector is a good one.
>
> That said, if my "juniors" continue to prosper I'll certainly look
> to funnel some of those profits into (at least) one of these companies
> - as they are essentially "blue chip" companies (for this sector).

Nov 11 07:41 PM

[Hyperinflation:]

Go listen to the Q3 conference call if you haven't already, they go rather in depth regarding their 1-2 year strategy.


On Nov 11 03:00 PM tripleblack wrote:

> I am long silver and getting longer all the time. I own SLW, and
> intend to keep it long term as well. The more I learn about their
> business plan, the more I like what I see.

Nov 11 07:43 PM

[brianr:]

I have loaded up on physical silver as well as silver through SLV. Has any one heard of Altius mineral company? I am long that SLW and ROY. They are all royalty companies. Wish I had looked into the mining stocks last year. Seeing SLW at 2.5 kills me.

It has been a long time since I have gotten excited about an investment that had a legitimate chance of sky rocketing like silver and its related stocks do. So few people have any knowledge about gold let alone silver. Correct me if I am wrong but it seems like there is only about 500 million ounces of silver available to investors. Is that true? That is less than $10 billion dollars. This could and should be a spectacular ride......Everyone was laughing at me as I told them about my metal fetish..

Nov 11 11:23 PM

[wardco:]

Many say that silver is an industrial metal that will not be recognized as a currency as has obviously happened with gold recently. This is why gold coins were in Bond's attaché case. Right? Since I don't travel in those circles, but rather in the swirl of my hot tub, I have noticed that a bit of silver here and there is a very good thing. The Far East is making money on industrial goods not monetary ones. Leave the gold to the bankers..in the West..they need it bad. It is the fast money. I will hold the silver in case they want some at a much higher price.
Thanks for the table pounding
Disclosure: long SLW

Nov 12 02:26 AM