Barrick Gold (GOLD -0.10%) just inked a deal to partner up with Newmont Mining (NEM -1.50%) in the United States. The deal was agreed to after Barrick's second attempt to buy Newmont failed. Both companies have made other big acquisition moves lately, and this partnership, even though it isn't a merger, is huge news in the precious-metals industry. The big benefit of all of this activity is cost savings. But here's the thing: Barrick and Newmont still won't be able to match the low costs of Royal Gold (RGLD -1.20%), Franco-Nevada (FNV -0.77%), and Wheaton Precious Metals (NYSE: WPM). Here's what you need to know to understand why.
The basic mining math
It takes a lot of time and money to build and operate a mine. There's no way around this fact. Miners have to find a good spot, get permission to build, construct a mine (hoping that their projects play out as expected), operate the mine, and then shut down the mine, returning the land to the way it was before the mine was built. The best way to get a handle on the costs is to use what the industry calls all-in sustaining costs.
That metric essentially adds the costs to produce precious metals and the costs to maintain or grow production over time. It's not perfect, but it's probably the best way to compare miners. Barrick's all-in sustaining costs were around $800 per ounce in 2018. Newmont's all-in sustaining costs were around $900 per ounce last year. These are actually pretty good numbers in the industry and leave plenty of room for profits today, with gold at nearly $1,300 an ounce.
But scale can be important in mining. And since both Barrick and Newmont have sizable U.S. operations in Nevada, there's an opportunity to save some cash. The joint venture, which will be a 61.5%/38.5% split between Barrick and Newmont, is expected to "unlock $5 billion in synergies" over the next 20 years. Whenever you hear the word "synergy" out of the mouths of a management team, you need to worry, because often the promised cost savings don't materialize. But, effectively, this pair of industry giants is teaming up so it can keep cutting costs. Note that while the big number sounds impressive, the impact on any one year won't be nearly as significant.
Even saving $250 million a year, however, they still won't be able to compete with the costs of streaming and royalty companies like Royal Gold, Franco-Nevada, and Wheaton Precious Metals. And for most precious-metals investors, going with a streaming company is generally the better investment choice.
Why streamers win
As noted, miners build mines. Streaming companies don't. They provide financing to miners in exchange for the right to buy precious metals at reduced rates in the future. Essentially, when a miner is looking to build a mine, it has to come up with a lot of cash before it will ever see an ounce of production. Mines can take a decade or more to get up and running. If capital markets are tight or banks are feeling stingy, it can be hard, or at least expensive, to get the money needed.
This is where streaming companies step in, providing up-front cash that doesn't require repayment right away. The cost of this money is inking a contract that guarantees the streaming company a low price for a portion of the mine's output. Often the precious metals involved are byproducts of producing other metals (gold is often found with copper, for example). So this trade-off doesn't impact the miner's main commodity focus. Other times, precious-metals prices are low and miners are desperate for cash, striking deals to help reduce debt and keep the lights on. It doesn't really matter why, however, because streaming companies are happy to provide the money and sign those long-term streaming deals.
But just how good are these deals for streaming companies? Royal Gold's top streaming deals allow it to buy gold at prices between 15% and 30% of spot gold prices. Do the math on that, and these deals mean it's paying around $400 an ounce for gold at the high end today. (The most expensive deal it has is price fixed at $435 an ounce, no matter what the gold price happens to be.) At the low end, its cost per ounce is roughly $200. And the price adjusts higher and lower with the price of gold.
Wheaton estimates that it's paying around $400 per ounce for gold and about $4.50 per ounce of silver (the spot price for silver is around $15.00 today). Franco-Nevada, meanwhile, is more diversified than its peers, including multiple metals and, more notably, oil and gas in its mix. It's a bit unique in the streaming space but still benefits from locked-in low costs, even on the oil and gas side of its business. In 2017, Franco-Nevada's revenues were $675 million, and its cost of sales was just $142 million, showing just how wide the margins are in the streaming and royalty space.
And those wide margins, because of the structure of the long-term contracts backing streaming and royalty deals, persist throughout the often deep and long cycles in the precious-metals space. Note in the chart above how steady the EBITDA margins are for Royal Gold, Franco-Nevada, and Wheaton. And then compare that stability to Barrick and Newmont, which each experienced periods in which their EBITDA margins fell into negative territory because of weak gold prices. The built-in low costs of the streaming business is the difference.
Time for a deeper dive
There's clearly more that investors need to know about Royal Gold, Franco-Nevada, and Wheaton. But when you watch Barrick and Newmont trump potential cost savings as they pair up their Nevada operations, you should take that opportunity with a grain of salt. And note that there are already options in the precious-metals space that beat them on cost and will likely continue to do so no matter how many synergies they find in Nevada.