Evaluating Sandstorm Gold's Newest Stream With True Gold

Aug.12.14 | About: Sandstorm Gold (SAND)

Summary

Sandstorm Gold and Franco Nevada have partnered for the first syndicated gold stream deal the sector has ever seen, buying a gold stream on True Gold's Karma project.

Sandstorm will pay up to $30 million to receive 5,000 ounces of gold annually at 20% spot price for the first five years, followed by a 1.625% stream.

This looks like a good deal for Sandstorm Gold as the Karma project has robust economics and should start production at the end of 2015..

Sandstorm Gold (NYSEMKT:SAND) surprised many investors Monday evening when it announced a $120 million gold stream partnership deal with Franco Nevada (NYSE:FNV) on True Gold Mining's (OTCQX:RVREF) Karma project. The deal took me off guard as Franco Nevada is a competitor to Sandstorm, and this is the first gold stream partnership between two companies in this sector.

Sandstorm will provide 25% of the funding (or up to $30 million), with Franco Nevada providing the remaining 75% (up to $90 million). There are a few reasons why I like this deal for both Franco and Sandstorm - I will provide a brief overview of the Karma project and details of the deal below.

About the Karma Project

True Gold's Karma project is located in the mining-friendly country of Burkina Faso, West Africa. A feasibility study on the project showed the potential for a low-cost, heap-leach gold mine.

Based on probable mineral reserves of 949,000 ounces, the mine should produce 97,000 ounces of gold a year for a mine life of 8.5 years. However, Karma also contains 2.62 million ounces of gold in indicated resources and 2.36 million ounces of gold in the inferred category, and management believes there is an opportunity to add open-pittable leachable material close to the proposed processing facility (source: Karma feasibility). Therefore, I think the possibility of Karma becoming a 15+ year producing gold mine is pretty good, through further exploration and development at Karma.

At $1,300 gold, the project has a net present value of $195.7 million with very high internal rate of return of 46.2%; at $1,500 gold, the value jumps to $281.1 million and an internal rate of return of 59.8%. Direct cash operating costs are estimated at $591 an ounce, and first gold pour is expected at the end of 2015, according to True Gold. This means new-term cash flow potential to Sandstorm,

Terms of the Deal

The deal is a little confusing at first glance. Here are the details:

- Franco-Nevada will provide 75% of the funding, and Sandstorm will provide the remaining 25% of the funding. Both companies will provide True Gold with $100 million in initial funding ($75 million Franco Nevada, $25 million Sandstorm).

- True Gold can increase the gold stream up to $20 million during the next 18 months. If they elect to do so, True Gold would pay Franco and Sandstorm in quarterly gold deliveries up to 30,000 ounces of gold starting 18 months from when the first tranche is drawn down. This means Sandstorm would commit another $5 million and Franco another $15 million, with Sandstorm receiving up to 7,500 ounces of gold over two years at and Franco receiving up to 22,500 ounces.

- Over a 5-year period, True Gold will deliver 20,000 ounces of gold a year for a total of 100,000 ounces delivered (Sandstorm 5,000 ounces a year, Franco Nevada 15,000 ounces). Therefore, Sandstorm will receive 25,000 ounces of gold in the first 5 years.

- After five years has gone by, Franco Nevada will receive a 4.875% gold stream, with Sandstorm's share will be 1.625%.

- Both Sandstorm and Franco Nevada will pay True Gold 20% of the spot price of gold for each ounce delivered (at $1,300 gold, that would be $260, at $1,500 it's $300, etc). At $1,300 gold, this would result in margins of $1,040.

Potential Cash Flow to Sandstorm

With Sandstorm receiving 5,000 ounces a year for 5 years at $1,300 gold and ongoing costs of $260 an ounce, the company would net $1,040 per ounce or $5.2 million a year in cash flow. This means in five years, the company would record cash flow of $26 million should gold average $1,300 an ounce, making back its $25 million deposit in that time. If True Gold exercises its option to increase the stream up to $20 million, Sandstorm would pay another $5 million to receive 7,500 ounces. At $1,300 gold and $260 an ounce costs, Sandstorm could net another $7 million+ in cash flow.

After the fifth year is up, Sandstorm gets a 1.625% gold stream at 20% the spot price of gold; with True Gold producing 100,000 ounces of gold annually, and with $1,300 gold, Sandstorm would net approximately $1.69 million annually for the remaining life of the mine.

Of course, the deal will be far better for Sandstorm if the gold price were to rise. For example, if gold takes off an averages $1,600 an ounce when Karma begins production, then Sandstorm would net $1,280 per gold ounce delivered ($1,600 minus 20% cost), resulting in yearly cash flows of $6.4 million. Over 5 years, Sandstorm would net $32 million, which represents average yearly returns of 25.6% on Sandstorm's $25 million deposit. After the fifth year, Sandstorm would net 1.625% with margins of $1,280 an ounce, resulting in yearly cash flow over $2 million.

With a higher gold price and increased production, the gains could be far greater. Remember that True Gold contains well over 4 million ounces of gold in all categories (indicated and inferred). If the company were able to increase its resource and convert resources to reserves, it is conceivable that True Gold could end up producing well over 150,000 ounces of gold annually. At 200,000 ounces of gold production a year, Sandstorm would net 3,250 ounces; at $1,600 gold and costs of $320 per ounce, Sandstorm could net $4+ million annually. At $2,000 an ounce gold and $400 ongoing costs, margins would be $1,600; with 3,250 ounces to Sandstorm annually, cash flow would average $5.2 million. This leverage to the gold price is one of the biggest benefits to investing in a gold streaming company. Please keep in mind that these are bullish, upside scenario estimates.

Sandstorm: Well Positioned to Outperform

Following a $20 million equity investment in partner Luna Gold (OTCQX:LGCUF) and this $25 million investment, I estimate that Sandstorm has around $65 million in cash currently. Remember, the company no debt and a $100 million undrawn credit facility, so it has $165 million which to complete more gold streams if it wishes. There remain plenty of opportunities out there in my opinion, and I hope the company will be aggressive in the pursuit of its next deal. Please comment below if you are interested in some of my stream ideas.

While Luna Gold continues to have problems at its Aurizona mine, facing cost overruns, delaying completion of the Phase I expansion and recently lowering 2014 full-year guidance to 75,000 to 80,000 ounces of gold at all-in sustaining costs around $1,000 an ounce, I am optimistic that things will work out following the equity raise, with Luna having roughly $40 million in cash to work through the issues. With more than 4.6 million in gold resources and 80,000 ounces of gold production annually, huge production upside remains at Aurizona, and a higher gold price certainly wouldn't hurt.

In my opinion, Luna could also be a potential takeover candidate from a larger gold miner with deeper pockets; with Sandstorm holding a big equity position in the company and a member of the management team now on Luna's board of directors, this outcome could be more likely. Even without a takeover, I think Luna has tremendous upside potential and the company will work through its issues.

Sandstorm, meanwhile, will announce quarterly results on Wednesday, August 13, and investors will definitely want to listen in on the conference call to get management's thoughts on its latest stream. In my opinion, this could be the deal that gets Sandstorm back on the map.

Disclosure: The author is long SAND, LGCUF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.