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A Metals Stock Fit for a King
01/27/2012 7:45 am EST
By the end of 2011, precious metals and their stock counterparts had lost much of their luster, but that’s beginning to change again, writes Nathan Slaughter of Scarcity and Real Wealth.
Royal Gold (RGLD) buys royalty interests in gold mines around the world, paying an upfront fee to secure a fixed percentage of future production or revenues.
Royal Gold gets its hands on buckets of precious metals without having to get its hands dirty. It doesn’t assume any of the cost (or risk) of traditional mining—those burdens fall on the owners of the mines.
The most recent deal is a perfect example. In December, Royal Gold agreed to pay Chieftain Metals (Toronto: CFB) $60 million for an interest in the Tulsequah Chief project, a high-grade deposit just north of Juneau, Alaska.
Once production begins in 2015, Royal Gold will receive 12.5% of the mine’s gold production at a cost of $450 per ounce, and 22.5% of its silver production at a cost of just $5 per ounce. Even if gold retreats back to $1,000 per ounce and silver to $20 an ounce, this would still be a profitable venture.
The mine is expected to produce 45,000 ounces of gold and 1.4 million ounces of silver per year for almost a decade—and its owner will foot the bill for all the digging.
This is just one of dozens of royalty arrangements throughout the world. Royal Gold now has a royalty interest in 37 producing mines, including a stake in the mammoth Penasquito complex in Mexico.
The day-to-day management of these properties is left to trusted operators such as Goldcorp (GG) and Newmont Mining (NEM). On the horizon, the company has additional interest in 22 mines that are in development and 128 more that are in the early exploratory stages.
These passive ownership interests give Royal Gold a stake in mines that hold 84 million ounces of proven gold reserves (5 million attributable to the company), without any headaches, cost overruns, or operating mishaps.
With diesel fuel and other inflationary expenses on the rise, average cash costs in the gold mining industry rose 20% in 2011 to $581 per ounce. That still leaves a nice profit with prices near $1,600. But it doesn’t compare with Royal Gold’s costs of just $92 per ounce.
Regardless of where gold prices go, Royal Gold will always squeeze out more profit per ounce than just about anyone else.
Keep in mind, cash costs only reflect on-site operating expenses. They don’t include administrative office overhead or taxes. Nor do they count the upfront capital invested to locate the mines and get them ready for business.
Barrick Gold (ABX) is currently shelling out $2.3 billion in construction capital for a mine in the Dominican Republic (Pueblo Viejo) and $5 billion in expenditures for another in Peru (Pascua Lima). Those capital expenditures will weigh on the bottom line.
But Royal Gold, which has a 5.2% royalty interest in Pascua Lima, doesn’t have to make these heavy outlays.
By itself, all of this makes Royal Gold a highly attractive candidate for any precious metals investor. But there’s more.
Aside from its low costs, the company also has a robust growth forecast. As new mines come online or reach their full potential, the firm’s gold production is expected to double from 120,000 ounces in fiscal 2010 to 240,000 by 2014.
And few companies on the planet (in any industry) are as efficient at converting revenue growth into pure profit.
Royal Gold took in $65 million in royalty income in the quarter ended September 30 (up 42% year over year). And it churned out $46 million in operating cash flow—fully 70 cents from every dollar.
That’s a big reason Royal Gold has been able to increase its dividend distributions at a powerful 20% annual pace over the past ten years (over 500% cumulatively). And the company is at it again—announcing plans for a 36% hike to 60 cents per share annually.
However, on the flip side of this coin, there is a slight risk factor. Because it leaves the actual digging to its partners, Royal Gold is wholly dependent on the mining success of other operators.
Action to Take
My goal with any gold mining equity is to outpace bullion in a rising market. And Royal Gold has been up to the challenge.
From mid-2001 through mid-2011, the price of gold marched ahead 19% annually. Meanwhile, the firm’s revenues and earnings per share advanced 28% and 35%, respectively, over the same time frame. Last year alone, earnings soared 232% to $71.4 million, or $1.29 per share.
The market has rewarded that performance with a jaw-dropping 1,254% return over the past decade.
With dozens of new royalty interests lifting income (and dividends), there should be more to come in 2012 and beyond—particularly if gold prices continue their ascent.
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