In this article we will briefly explain what a royalty company is and take a look at three small caps dealing with gold: Abitibi Royalties (OTC:ATBYF), Almadex Minerals (OTCQX:AXDDF) and Maverix Metals (MACIF).
This article is sectioned in four parts. In the first part we will explain what a royalty company is and analyze how and why they are valued differently than miners. From here on we will briefly present each company in a separate section.
This article will not provide the reader with specific trade recommendations. Rather, it is a primer on how royalty companies operate and a review of three of these companies that I personally consider well-managed businesses. Hereby it should be noted that the reader should do his own due diligence before investing. The comment section will be open for discussion about royalty companies in general and specifically about these three. Feel free to participate.
What is a royalty company and how does it operate?
It is a well know fact that ounces in the ground and, in general, not-yet-mined ore, are valued at less than a sellable refined ounce would sell. The rationale of this being that there is still uncertainty about the ability to extract the ore in the first place, whilst also having to take into account the cost that we have to incur to extract it.
Different metals contained in different ore bodies are valued differently, not only because of direct mining costs but because of various risks specific to the extraction of said metals. Grade, jurisdiction and metallurgy, as well as the management's ability to execute the mining plan are for instance all important aspects to consider.
For all these reasons not all ounces in the ground are valued the same amount and this is where royalty companies come in; these devised a clever way to capitalize on execution risks by paying a lump sum to the mining companies upfront to build the mine, while retaining a royalty on the metals extracted. Herewith, all risk and liability lie upon the operator of the mine.
Before we move on, there is an important notion to retain: the difference between a royalty and a stream. Royalty companies come in two different forms, which should not be confused: the previously outlined lump-sum cases as well as streams. The owner of a royalty does not have to pay anything anymore to anybody and will only collect a % of the extracted metals. With a stream, the owner of the stream will pay the mining company a certain fixed or variable fraction of the price for every ounce that the mine owner gives him.
Below you can see a visual of how a stream works in practice. What is interesting is that ounces yet not mined by royalty companies are valued higher by the market than ounces in the ground owned by miners. This happens because the royalty owner does not have to bear the operational risks inherent to the actual mining of the ore (cost overruns, bankruptcy), while it gives the royalty owner continued exposure to future exploration upsides.
(Wheaton Precious Metals Corp (WPM) January 2017 Corporate Presentation).
If the mining company goes bankrupt, the royalty owner will not receive his share of course, as there will be no mining. The royalty does not disappear however and when (or if) the mine starts to produce again under another operator, the royalty owner will nevertheless receive his due share.
Below a Franco-Nevada (FNV) slide that schematically explains the risk/reward for royalty companies and miners.
To wrap all of this up, we just have to keep in mind that a royalty company gives you exposure to the underlying assets and eventual price increase, without the operational risks inherent to mining operation, while also retaining the eventual exploration upsides of the property. This is why royalty companies' ounces in the ground are valued higher than miner's ounces in the ground, as the risk is generally considered smaller and hence they can command a premium.
Almadex Minerals was originally a spin-off from Almaden Minerals (AAU), with which it shares part of the management: the father and son Poliquin duo. It was one of the success stories of 2016 following the sizable Cu-Au El Cobre discovery in August 2016 in Mexico.
The company has no debt and owns cash, bullion and shares of several mining companies (more below). Almadex owns several NSR royalties on projects managed by other companies, Mexico being the main jurisdiction. The company owns its own drilling and geophysical equipment in order to explore it portfolio of exploration properties.
Almadex' East Mexico discoveries include the El Cobre Gold-Copper Project (100% owned by Almadex), the Caballo Blanco Gold Deposit - which was sold in 2011 and recently bought by Candelaria Mining (OTCPK:CDELF), where Almadex retains a 1.5% NSR - and the Ixtaca Deposit that is currently developed by Almaden and where Almadex retains a 2% NSR. You can read more about the Ixtaca deposit and Almaden in a monography that I wrote in December 2016. Agnico-Eagle (AEM) acquired 9.9% of Candelaria in 2017, meaning that there is an interest from a major gold miner.
Almadex Minerals 1 year price chart.
All the three major royalties in the portfolio are PEA stage. The Ixtaxa deposit is being brought towards production and should be commissioned in H2 2019.
The Ixtaca Deposit is located east from Mexico City in the Puebla state (January 2017 Almadex Corporate Presentation).
Almadex also owns a 2% NSR on the ELK deposit operated by Trek Mining (LWLCF), a past producing gold mine located in Southern British Columbia, Canada. The portfolio is not limited to these properties and royalties but these are definitely the most important as the others are relatively early stage.
Almadex' royalties and property portfolio is concentrated in North America (August 2017 Corporate Presentation).
The company has an insider-ownership of around 15% and a relatively tight share structure. As you can see in the chart below, the share price went up substantially in 2016 after the El Cobre discovery.
Almadex capitalization structure (August 2017 Almadex Corporate Presentation).
MAVERIX METALS INC.
Maverix is a streaming and royalty company that very recently made a deal with Gold Fields Ltd. (GFI) to acquire a portfolio of GFI's owned royalty in exchange of 42.85m MMX shares and 10m MMX warrants (5 years exercisable at C$1.60 per share).
Originally Maverix was a spinoff of Pan American Silver Corp. (PAAS), which still retains 52.85M shares and is in fact the major shareholder. Both Gold Fields and Pan American Silver are now major shareholders alongside management and insiders.
Transaction history and shareholder composition (August 2017 Corporate Presentation).
Maverix has C$19M in cash, zero debt and a market cap of $139m. Below the 1 year chart of the company.
The royalty portfolio is concentrated in relatively safe jurisdictions such as Australia, Mexico and Chile. One of the most interesting royalties in Maverix's portfolio is a 2.5% NSR in the Silvertip project that was recently acquired by the US based Coeur Mining (CDE) for $250m from a private firm. Silvertip is a high-grade silver-lead-zinc mine with 30% zinc equivalent grade, which has been explored by different companies since 1957. The project sports a 26km access road, 2.7km of underground workings, 86'000m of drilling, two completed bulk sample programs, 20 years of environmental baseline data, with other significant infrastructure already being on site. I am not convinced that Coeur made a good decision to buy this project as the price looks steep in my opinion, but what is important for us to retain is that Coeur will almost certainly try to bring this project into production and if this happens, Maverix is poised to profit from it.
The other interesting streams in Maverix's portfolio is the one that includes 100% of the gold produced on the La Colorada mine in Mexico. Maverix has to pay $650 per oz. It is a core asset for Pan American (PAAS). This mine has an estimated residual life expectancy of more than 14 years. Moving to Australia, we find the Mt Carlton gold mine, which has one of the highest grade open pits in the world with an estimate mine life of over 7 years. Evolution Mining (OTCPK:CAHPF) is the operator and Maverix owns a 2.5% NSR on all properties, payable quarterly. Mt Carlton has significant potential to extend its mine life by adding to reserves below the current V2 pit.
On the Beta Hunt Mine, operated by RNC Minerals Inc. in Western Australia, Maverix owns a 7.5% GRR on gold royalty and a 1.5% NSR on nickel. The 2017 production guidance is for about 50 - 60koz Gold. Although the mine live is only 4-5 years, there is however a long history of resource extensions at this mine and there is exploration potential. Ramelius Resources (OTCPK:RMLRF) operates the Vivien Mine on which Maverix owns a 3.0 - 4.5% NSR payable on all metals mined from the Miranda and Vivien tenements. Mine life is expected to be 5-6 years with an ongoing exploration program aiming at extending the mine life.
The attributable gold equivalent of all streams and royalties is around 13500 oz Au per year for a revenue (using gold at $1225) of C20m in 2017.
The last company that we will peruse in this article is Abitibi Royalties. Abitibi has around $41m in cash and securities - split between shares of Agnico Eagle ($21m) and Yamana Gold (AUY) ($13) - no debt and 23 royalties, all in Canada and Turkey.
1 year share price of Abitibi Royalties
The most relevant of those royalties is the 3% NSR on a portion of the enormous Malartic deposit, one of Canada's largest gold mines, owned in partnership by Yamana and Agnio-Eagle. The company furthermore owns royalties around Eldorado (EGO) Efemcukuru Mine in Turkey, Goldcorp's Red Lake mine and New Gold's (NGD) Rainy River Mine.
The Malartic Mine and Abitibis royalty zone (Corporate Presentation September 2017).
Royalties in the Red Lake district (September 2017 Corporate Presentation).
Management owns 5% of the company whilst the legendary mining investor Rob McEwen owns 12% and Golden Valley (OTCQB:GLVMF) owns 49%. Moreover, the local government of Quebec owns another 5%, making only 23% of the shares free float, indicating that this company is held in strong hands. The company is cash flow positive with an estimate for 2017 of around $2m - $2.5m based on dividend payouts by Agnico Eagle and Yamana Gold and premiums generated from the sale of covered calls on shares owned by the Company and from the sale of puts aimed at repurchase some of the Agnico Eagle shares previously sold.
The company estimates that, while excluding Odyssey (part of the east extension of Malartic), different near pit targets and East Malartic, Abitibi will double the cash flow in 2019 to $4m.
Although royalty companies often offer a better risk/reward proposition than investing in the underlying companies, there are still risks inherent to investing in these companies. The three companies featured here are all small caps and the volatility of these stocks can be at times very high, with major price moves every day. Moreover, a very thin liquidity means that it would not be possible to sell at a reasonable price if you need your invested money rapidly. That said, and knowing the risks, I invite the reader to dig deeper into these companies and let's discuss them further in the comment section.
Disclosure: I am/we are long ATBYF. 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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.