Well, that was unexpected. After easily outperforming peers since the start of 2018, shares of gold streaming and royalty company Royal Gold (NASDAQ:RGLD) dropped off a cliff in July, ending the month 10% below where they started it. A move of that magnitude is a little out of the ordinary for the gold stock, which has become a low-risk way to gain exposure to the gold mining industry. In fact, it's been one of the only gold stocks able to keep pace with the total return of the S&P 500 over the long haul.
Turns out there's a reasonable explanation for the stock's awful performance last month. Gold mines that were central to the gold streaming business' near-term growth strategy have encountered unexpected delays. Yet while it may suddenly seem like Royal Gold's future stock growth is shaky, these operational headwinds appear to be temporary.
Delays, delays, delays
There's some irony to seeing Royal Gold stock slip due to delays at new gold mines. After all, the entire point of the gold streaming and royalty business model is to ditch the risk of developing, permitting, and processing mining assets. Instead, the company gets to sit back, provide financing to gold mining peers, and collect precious metals at favorable prices, then flip them for a handsome profit.
But as the events of the last month demonstrate, not even gold streamers can completely escape the risks and uncertainties of gold mining operations. A delayed growth project is a delayed growth project for all parties involved, and Royal Gold has had to grapple with that not one, not two, but three times since the beginning of the calendar year.
While the company spreads risk across multiple streaming and royalty agreements, it counts on a comparatively few new or expanded projects each year for production growth. That's why Wall Street analysts are taking issue with two updates from July, which piled onto a massive asset impairment taken earlier this year.
On July 9, Royal Gold provided an update on operations for fiscal fourth-quarter 2018, which ended on June 30. A temporary shutdown of the mill processing facility at the Mount Milligan gold mine in Central Canada, owned by Centerra Gold, is still affecting deliveries to the streamer. On top of that, the mine has encountered delays securing water supply permits, which could reduce the mine's output in the final three months of the calendar year. The company has a streaming agreement to take 35% of all gold output and 18.75% of all copper output from the mine.
On July 26, gold miner New Gold announced delays at its all-important growth project Rainy River, which is experiencing a slower-than-expected ramp-up. The mine is a central piece of Royal Gold's near-term growth strategy as well, so Mr. Market sent shares of both companies tumbling after the update. Specifically, the streaming agreement provides 6.5% of gold production (until 230,000 ounces are delivered) and 60% of silver production (until 3.1 million ounces are delivered).
Delays at only one of these mines could have probably been brushed off, but considering Mount Milligan and Rainy River combine to account for 46% of the combined net value of production-stage streaming interests owned by Royal Gold, Mr. Market's sudden pessimism is understandable.
But there's reason for optimism, too, especially for long-term investors.
Timing has changed, but growth remains in place
The fact of the matter is that both delays are only temporary. Mount Milligan's woes were caused by less-than-normal snow melt in the region, which led to lower water levels available for mining activities. The mine's owner is working out a plan to safely bring water up from a nearby lake. While the permits may be delayed, it's not an existential threat to the gold mine, which has 22 years of life remaining.
The same can be said for Rainy River. In fact, the delays announced so far could even be characterized as par for the course. That's because when a new gold mine is brought online, it gradually builds up to a sustainable level of production, and the ramp up phase has a high degree of variability. Unfortunately, New Gold encountered the not-so-good end of that variability spectrum -- but the mine will eventually get up to speed and live up to its production potential.
In other words, the long-term potential of Royal Gold hasn't changed one bit. The business will still deliver above-average operating margins and convert a significant percentage of revenue to cash flow, something the owners of these mines cannot fall back on during the delays. The only real change for the gold streaming stock is that its near-term growth will just take a little longer to materialize. For a great business with an amazing track record of creating shareholder value, that's hardly anything to panic over.