Is This Gold Company Overvalued?

Has Royal Gold's recent meteoric rise been overblown? How is this company measuring up to other gold companies?

Feb 6, 2014 at 9:09AM

Royal Gold's (NASDAQ:RGLD), a company that manages precious metal royalties and streams, showed a 34% drop in revenue in its most recent quarterly report, and its earning-per-share plunged by 62% year over year. Nonetheless, shares rallied by over 23% during 2014. Is the stock now overvalued? How is the company measuring up compared to other precious metals companies such as Barrick Gold (NYSE:ABX) and Silver Wheaton (NYSE:SLW)

When gold is up, Royal Gold follows
One of the reasons for the recent rally of Royal Gold's stock is the recovery of gold. The price of gold rose by more than by 3% during January. As a result, during January shares of Barrick Gold and Silver Wheaton have also increased by 10.6% and 8.3%, respectively. If the price of gold continues to recover, expected revenues are likely to improve in the coming quarters. Nonetheless, the recovery in gold prices wasn't the only factor that pulled up Royal Gold's stock. In the coming quarters, the company expects to augment its production in its Peñasquito and Mt. Milligan gold and copper mines. This increase is likely to improve Royal Gold's revenue in the near future. This increase may also offset the expected decline in Andacollo's production. 

In the meantime, during the fourth quarter of 2013, Royal Gold's production volume dropped by 11% and the average price of gold by 26%. These two factors led to a 34% plunge in the company's revenue. But Royal Gold isn't the only precious metals company that experienced a decline in revenue in the last quarter of 2013: Barrick's revenue is likely to drop not only due to the lower price of gold, but also due to the expected decline in its production. Based on the company's guidance of producing 7.2 million ounces of gold and the amount of gold produced in the first three quarters of 2013, Barrick's gold production is likely to be 13% lower than in the fourth quarter of 2012.  

Conversely, Silver Wheaton is likely to augment its precious metals production mainly due to its Sudbury and Salobo mines, which were acquired early last year.

It's worth noting that even though all three companies are in the precious metals industry, the level of risk that Royal Gold and Silver Wheaton incur is lower than Barrick's. The latter is a gold producer that incurs risk related to production, including changes in production costs, delays and more. Royal Gold and Silver Wheaton don't face these risks – they have contracts with precious metals producers to receive gold and silver at a pre-determined price. Despite Barrick's higher risk, the reward is minimal. In the third quarter, the company's profitability was 30%. In comparison, Royal Gold and Silver Wheaton recorded higher profitability of 43% in the fourth quarter and 47% in the third quarter, respectively. So Royal Gold and Silver Wheaton not only have higher profit margins than leading gold and silver producers, they are less risky and are expected to increase their production in the coming quarters. 

Therefore, even though Royal Gold, Silver Wheaton and Barrick work in the precious metals market, they have different level of risks. Taking into consideration their business operations, let's compare the current valuation of Royal Gold with other precious metals companies.

Is the price right?
I'm using the enterprise-to-EBITDA ratio here because of the different financial structures these companies use, such as their debt and cash on hand. Looking at these numbers, Royal Gold appears to be in a better position in terms of debt than Silver Wheaton and Barrick are. Their different debt structures are partly considered in this calculation. 

The table below shows the enterprise-to-EBITDA ratios of the above-mentioned precious metals companies and the precious metals market. 

Royal Gold Value

Source of Data: Yahoo Finance and Damodaran's site

As you can see, due to the sharp rise in Royal Gold's stock in the past several weeks, its EV-to-EBITDA ratio is much higher than the precious metals market and slightly higher than Silver Wheaton's valuation (Barrick's EBITDA is without one-time provisions such as impairment of assets). These numbers suggest Royal Gold's valuation is slightly high even after considering the company's debt and cash on hand. 

Royal Gold is a strong company with low financial and operational risk compared to some other precious metals companies, such as Barrick. The expected rise in production is likely to benefit its investors. But the current valuation of the company might be high, and there are other alternatives such as Silver Wheaton that have similar attributes, such as level of risk, potential growth and high profitability, but are slightly less expensive. 

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