Precious-metals streaming company Royal Gold, Inc. (NASDAQ:RGLD) makes money by selling gold and silver, but it never gets dirty mining the stuff the way, say, a gold miner does. This changes the risk equation in a huge way that you need to understand. It also helps explain why Royal Gold has managed to increase its dividend annually for more than a decade, including right through a deep commodity downturn. So lets take a look at the risks Royal Gold faces and the risks it avoids.
A typical example
In mid-2015, gold mining giant Barrick Gold (NYSE:ABX) was struggling with low commodity prices and looking for cash to shore up its balance sheet. Royal Gold stepped in and inked a $610 million streaming deal with Barrick for the Pueblo Viejo mine, one of the largest gold mines in the world. In return for that much-needed cash, Royal Gold got the right to buy gold and silver at 30% of the spot price up until a certain production threshold, and then at 60% of the spot price thereafter.
Locking in low costs is the obvious reason Royal Gold likes streaming deals like this, but miners like them, too. It provides access to cash when capital markets and banks are asking for undesirable terms. It's also a way to keep costs low for projects in the development stage, since there's generally no cost to the money until there's production from a mine. Royal Gold's streaming model, however, changes things in a big way, most notably when it comes to the risks of investing in the precious-metals space.
It knows in advance
For example, Royal Gold's costs are locked in by the streaming contracts it signs. In the Barrick example, the most it will ever have to pay for gold from the Pueblo Viejo mine is 60% of gold's spot price. Compare that with Newmont Mining (NYSE:NEM), which saw all-in sustaining costs balloon to $1,170 an ounce in 2012 before a commodity downturn forced it to get serious about cost-cutting. It brought that measure down to $912 last year, when commodities such as gold and silver finally found a bottom. That represents a lot of hard work, but the takeaway here is that Royal Gold never has to worry that its costs will get out of hand. It knows what they are going into every deal.
That's a big deal because, like miners, Royal Gold's top and bottom lines will be impacted by the often volatile prices of gold and silver. It's a risk you can't avoid: When precious metals prices are high Royal Gold does better than when they are low... but because the streaming company's costs are low and locked in it has historically managed to achieve consistently high margins. For example, during the recent downturn Royal Gold's EBITDA margins remained solidly in positive territory while miners like Newmont and Barrick watched their margins dip deep into the red.
Then there's the issue of growth. When times are bad for miners, Royal Gold has a golden opportunity (pardon the pun) to expand production. But what about when times are good for miners? That's when Royal Gold can benefit from providing funds for development and expansion projects. For example, in addition to 38 producing properties, Royal Gold has 24 development projects and 130 evaluation- and exploration-stage properties in its portfolio.
That's built-in growth that the company likes to say is "bought and paid for." And if one of these projects hits a snag that increases its costs, Royal Gold doesn't care. Its costs are already locked in. Moreover, the company often builds safeguards into its contracts, allowing it to recoup its cash if a development doesn't work out. That's great, but because Royal Gold puts money up at the start of a deal, busted projects are dead money that could have been better spent elsewhere. In a worst case scenario, however, the entire investment can be lost. The company's portfolio diversification, however, helps to limit the pain of such extreme events.
On that score Royal Gold has over 190 investments in play. That spreads its bets over a huge number of assets. Yes, some are more important than others, but a problem at one of its 38 producing mine investments will be less material than for a miner focused on just a handful of operating properties, such as Goldcorp, which has only 11 producing mines. So, yes you need to watch Royal Gold's biggest properties, since trouble at any one will impact earnings, but it has plenty of other assets to backstop results if one mine hits a snag.
And if one of Royal Gold's 150-plus evaluation and development projects doesn't pan out, it's not a good thing, but it certainly won't derail Royal Gold's growth. Compare that with Silver Standard Resources, which is betting big on its SeaBee mine expansion. If there's problems with this one project, Silver Standard doesn't have much to fall back on.
The proof is in the dividend
With all of that background, you get the overall feel for Royal Gold's business model. It's very different from that of a miner, offering low costs, diversification, and the opportunity to grow in good times and bad. Perhaps the best evidence of Royal Gold's strength, however, shows up in its dividend. The yield is a miserly 1.1%, but the company has increased the dividend annually for 16 consecutive years, including through the deep commodity downturn. That's a record that few companies, let alone miners, can match.
So how risky is Royal Gold? Its results will be affected by often volatile commodity prices, of course. It also faces risks around the operation and success of the mines and development projects in which it has invested. So it is not a risk free investment by any stretch of the imagination. But when you compare it with alternatives in the precious-metals space, it's a pretty low-risk option.