If you're looking to buy a precious-metals company, there's a lot to like about Royal Gold (NASDAQ:RGLD). But before you buy Royal Gold stock, you need to understand a few things about how the company is different from a miner. Here's what you need to know.
When you look at the precious-metals space, Royal Gold tends to stand out as a model of consistency. For example, it's increased its dividend annually for the past 15 years. Well-known miners such as Barrick Gold (NYSE:ABX) and Newmont Mining (NYSE:NEM), big names in the gold space, have both cut their dividends in recent years because of falling commodity prices.
Then there's the fact that Royal Gold has made money in each of the past 10 years. Neither Barrick nor Newmont can claim that. To be fair, some of their red ink is because of writedowns to the value of gold reserves, though that's not the only reason for the bleeding. But even with that caveat, it's important to remember that low commodity prices have cut into Royal Gold's earnings, too, but they haven't turned them negative.
These facts should make you wonder how Royal Gold has been able to outshine industry giants such as Barrick and Newmont. The answer is that all three are precious-metals companies, but one of this trio does something very different.
Cash for gold, down the road
Barrick and Newmont own and operate gold and silver mines. It's expensive to do that. You have to pay employees, buy and maintain mining equipment, and be constantly scouting for new mining opportunities to replace the precious metals you pull out of the ground. And when you do find a good place for a new mine, you have to invest lots of cash and time before any gold gets produced.
Here's the key question: How do you pay for all of that? One way is with cash from your business, but for big investments such as a new mine, that's usually not enough. In that case, miners can tap the public markets with stock and debt, or ask a bank for a loan. Depending on the market environment, these options may be cost prohibitive. And even if they aren't, there's a potentially better alternative.
That's where Royal Gold comes in. Royal Gold is what's known as a streaming company. It gives miners cash up front for the right to buy gold and silver at reduced rates in the future. For example, Royal Gold inked a deal with Barrick last year that allows it to buy gold at 30% of the spot price, based on production expectations, for around a decade or so. After a certain number of ounces is delivered, the price goes up to 60% of spot, still a pretty solid deal.
Streaming agreements like this work for existing mines, expansion projects, and mines being built from the ground up. What changes is the amount of money being discussed and the timing of the gold and silver delivery. Royal Gold likes streaming deals because it locks in low prices and the company doesn't have to do any mining. Miners like the deals because they provide an alternative source of cash that doesn't have a huge upfront cost, though the money is hardly free.
So how does Royal Gold get its money?
That brings up the question of Royal Gold's finding the money to do streaming deals. For example, it inked four deals last year in what was one of the worst years for precious-metals companies in recent memory.
The basic model is for Royal Gold to use short-term financing, such as bank lines of credit, to fund a deal. Once the deal is announced or competed, the company than taps the capital markets to pay down the short-term debt, usually by issuing stock. This is no small thing. A decade ago, Royal Gold had around 23 million shares out. In 2015 it had about 65 million.
The company's basic business model, however, sets up an odd dynamic. The best streaming deals are available when precious metals are in a funk and miners are desperate for cash -- as in the past couple of years. So that's when Royal Gold has the best growth opportunities. That helps explain why Royal Gold's shares are up about 10% since 2011, while Barrick and Newmont were down around 66% and 45%, respectively. But it also provides a clearer understanding of why Royal Gold may be able to tap the public markets at a time when miners can't.
Before you buy Royal Gold, you need to get a handle on just how different its business model is from that of a miner. It really changes the equation in a big way. But if you get it, then, by all means, go right ahead and buy this streaming company with an enviable dividend and earnings record.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.