Most gold companies make money by digging the precious metal out of mines they operate and selling it on the open market. However, Royal Gold (RGLD 0.88%) doesn't own any gold mines because it approaches making money from the sector differently. It chooses instead to acquire streaming and royalty agreements with mining companies like Barrick Gold (GOLD 0.71%), New Gold (NGD), and Goldcorp (GG).
These contracts give it the right to purchase metals from certain mines at an agreed-upon price, or the right to receive a percentage of a mine's production. It's a high-margin business, which enables Royal Gold to generate robust cash flow. For example, last quarter, the company produced $76.1 million in operating cash flow on just $107 million in revenue.
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A stream of cash flow
Last quarter, 72% of Royal Gold's revenue came from streaming contracts. Two noteworthy streams cover the gold and silver produced at Barrick Gold's Pueblo Viejo mine in the Dominican Republic, which it acquired in 2015 for an upfront payment of $610 million. That fee entitled Royal Gold to 7.5% of the gold Barrick produces from the mine until it delivers 990,000 ounces to Royal; after that, the stream drops to 3.75%. On the first 500,000 ounces, Royal Gold only has to pay Barrick 30% of the spot price per ounce of gold, which then increases to 60% of the spot price. The companies have a similarly structured agreement in place covering the silver output. What's important to note about the deals is that they enable Royal Gold to pocket the difference between the price it pays Barrick and what it gets by selling the precious metals on the open market.
Last quarter, Royal Gold collected $24.5 million from these Barrick streams, up from $13.6 million in the year-ago period due to higher volumes of gold and silver produced at the mine. That increased its streaming revenue to $76.6 million for the quarter, up from $63.4 million in the year-ago period.
The company's streaming income should continue rising in the future because its partners have several mines in development, including New Gold's Rainy River mine in Canada. While New Gold has had its share of development problems at that mine, it expects to start production later this year. Once it does, Royal Gold has the rights to buy 6.5% of the gold and 60% of the silver at 25% of the spot price until New Gold delivers 230,000 ounces of gold and 3.1 million ounces of silver. After that, Royal Gold's entitlement will drop to 3.25% of the gold production and 30% of silver output for the life of the mine.
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A royal way to make money on metals
Royal Gold makes the rest of its money from royalty contracts with several miners. Last quarter, the company collected $30.4 million in royalty revenue, led by its investment in Goldcorp's Penasquito mine in Mexico, which holds one of the world's largest silver, gold, zinc, and lead reserves. Royal Gold's royalty interest in Penasquito entitles it to 2% of the value of the metals Goldcorp produces from the mine. Last quarter, for example, Goldcorp paid Royal Gold nearly $7 million in royalties from the gold, silver, lead, and zinc produced by the mine. That's an increase from the year-ago period, when Royal Gold collected $5.2 million in royalties off this mine thanks to higher production and realized prices.
Barrick Gold's Cortez Mine in the U.S., which was the first royalty Royal Gold ever acquired, is another noteworthy contributor. The company currently owns several royalties associated with that mine, which produced about $1 million in revenue last quarter. That said, the company increased its interest Cortez late last year by acquiring a 3.75% net value royalty from a private seller for $70 million. As a result of that deal, Royal Gold sees Cortez becoming a "significant contributor" to its results in the near future.
Investor takeaway
Royal Gold is a different kind of gold company because it doesn't make money from mines it develops and operates. Instead, it signs streaming and royalty agreements with other miners that give it the right to a portion of their production. Because of that, it earns high margins off of this output, which provides it with cash to invest in more streaming and royalty deals so it can pay a growing dividend.
