Should You Invest in Streaming and Royalty Companies?

Are streaming and royalty companies a viable alternative to ETFs and mining stocks?

Vladimir Zernov
Vladimir Zernov
Apr 2, 2014 at 7:52AM
Energy, Materials, and Utilities

Investors who want exposure to precious metals despite prolonged silver and gold price softness could choose to invest in streaming and royalty companies like Silver Wheaton (NYSE:SLW), Franco-Nevada (NYSE:FNV), and Royal Gold (NASDAQ:RGLD). These companies have performed reasonably well this year, while shares of many other precious metals miners have been under pressure due to the low price environment. Will this trend continue?

Good business environment to make new deals
Royalty contracts assume that only one upfront payment will be made in exchange for a percentage of future production from the mine. Streaming contracts provide rights to purchase production from precious metals miners at a predefined price in exchange for the upfront payment. These prices are typically low. For example, Silver Wheaton buys silver from Goldcorp's Penasquito mine for $3.99 per ounce, while it buys gold from Vale's Salobo mine at $400 per ounce.

This model of business offers some protection in times of low prices, as costs are fixed. What's more, obtaining financing for new project through debt or equity is increasingly difficult for precious metals miners. In such conditions, miners turn their eyes to streaming and royalty companies in order to receive the much-needed money. As a result, streaming and royalty companies are provided with the opportunity to grow their businesses.

Franco-Nevada finished the year with $770 million of cash on the balance sheet and no debt. Royal Gold also has significant resources to grow its business with $659 million of cash and just $307 million of debt. It is highly likely that those companies will take a look at several opportunities this year. Acquiring new streams will be more difficult for Silver Wheaton, which finished the year with $95.8 million of cash. The company has taken on significant debt to acquire gold streams from Vale's mines last year, and now will probably reduce its activity in obtaining new deals.

Pascua-Lama highlights risks
The fact that streaming and gold companies do not control mining operations leads to their inability to influence operators' decisions. The example of Barrick Gold's Pascua-Lama project highlights this fact. Barrick Gold decided to suspend all Pascua-Lama construction activities except for the building of the water management system. The future of the project is still unclear.

Both Silver Wheaton and Royal Gold have invested in Pascua-Lama, so their production growth attributed to the project is postponed. However, as gold and streaming companies hold a variety of assets in their portfolios, their risks are thoroughly diversified. Even without Pascua-Lama, Silver Wheaton projects 35% production growth in five years.

Bottom line
Streaming and royalty companies are a viable alternative to gold or silver ETFs. While ETFs charge fees, these companies pay dividends. Currently, Franco-Nevada yields 1.57%, Silver Wheaton yields 1.23% and Royal Gold yields 1.34%. These are no sky-high figures, but the dividends will increase should precious metals prices trend higher. In fact, Franco-Nevada has already stated that it will increase its quarterly dividend to $0.20 per share in the second quarter of 2014, bringing the yield to 1.76% at the current share price.

Low costs are another advantage of streaming and royalty companies. Miners who obtain the financing through streaming or royalty contracts have to sacrifice part of their future revenue in order to get money in the present. This translates into favorable deal terms for Silver Wheaton, Franco-Nevada, and Royal Gold.

All in all, if you are interested in precious metals investing, streaming and royalty companies are good candidates to consider. 

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