Royal Gold (RGLD -2.53%) has a unique business model. Instead of building or buying mines, the company makes its money from streaming and royalty contracts with other miners. It typically pays an upfront fee to these partners; then it either receives a share of the revenue generated from the mine, or it can purchase a portion of the metals produced at a below-market price. The company grows by acquiring more of these agreements.
However, so far in 2017, the company hasn't made one deal. In fact, it has been rather quiet on the deal front over the past 18 months, only making one small transaction last year to buy a royalty associated with Barrick Gold's (GOLD -0.79%) Cortez gold mine. That said, while the company hasn't made any splashes in mergers and acquisitions, it made two brilliant moves that increased its flexibility to make future deals.
Allocating cash flow to strengthen the balance sheet
Thanks to higher volumes from recently completed mines by its partners, and an improvement in the price of gold, Royal Gold reported record operating cash flow in its recently completed fiscal third quarter of 2017. Overall, operating cash flow hit $76.1 million, up 15% from the year-ago period. The company used $15.7 million of that money to pay dividends to investors, leaving it with a windfall for other purposes.
However, because it has no additional funding obligations to its current partners and plenty of cash on the balance sheet, the company chose to pay down $45 million in debt during the quarter. That smart decision freed up additional capacity on the company's $650 million revolving-credit facility. That provided the company with a bit more breathing room, which it needed after spending $70 million to purchase the royalty in Barrick Gold's Cortez mine last year, leaving it with only $345 million of credit remaining on that facility.
Taking its deal-making capacity to a whole new level
Royal Gold followed that move up in June by agreeing to a new $1 billion five-year revolving-credit facility with its banks, which has the potential to expand up to $1.25 billion in the future. The company used that facility, plus $50 million in cash on hand, to fully repay its former facility. As a result, the company's outstanding borrowings under the new facility stood at $250 million, leaving it with $750 million of borrowing capacity at its disposal. While the company doesn't need that additional borrowing capacity at the moment, CEO Tony Jensen pointed out that "it is also prudent to always be prepared for future opportunities." When combined with cash on hand, and the continued strong cash flow from its stream and royalty contracts, Royal Gold has quite the war chest to make additional deals.
That said, the company is in no rush to make a deal, since it has three new or expanding revenue sources coming down the pipeline. These projects include New Gold's (NGD -3.50%) Rainy River mine, Barrick Gold's Cortez Crossroads mine, and Goldcorp's (GG) Pyrite Leach Project at its Penasquito mine, which should all start producing over the next three years. The Rainy River mine by New Gold is next on the docket and should start commercial production this November if everything goes according to plan. While New Gold has had its share of delays on the mine in the past, it doesn't anticipate any new issues cropping up. If that holds true, then Royal Gold's cash flow could see a nice boost later this year if gold prices hold up, which would further expand its deal-making capacity.
Royal Gold has benefited from previous acquisitions this year, catapulting its cash flow to record levels. However, instead of rushing to spend that money on new deals, the company has wisely chosen to strengthen its balance sheet, which gives it the flexibility to pounce on better opportunities in the future. The company can afford to be patient, since its partners have three new projects in development that should provide it with additional revenue streams in each of the next three years. Given that visible growth, Royal Gold can bide its time until a needle-moving deal falls into its lap.