Apr 2, 2010

An Amazing Opportunity In PM Royalty Companies - Sandstorm Resources

Aside from Silver Wheaton trading at just over $3/share back during the peak of the financial crisis, I have not seen such extremely attractive valuations among the Royalty Companies. Sure Royal Gold & Franco Nevada will provide investors with high annual returns over the next decade, but nothing compared to the returns some miners will produce. I'm a strong advocate of investing in mining companies, but believe having one or two royalty companies should be a core part of an individuals overall investment in this industry. Over the last two months, I have been watching two precious metal royalty companies most have yet to hear of and am very impressed with one of them in particular, personally initiating a generous core position which I look to incrementally increase throughout the next year. 

About Sandstorm Resources - A gold royalty company focusing on advanced stage or producing mines. Though they have only been operating for a basically a year and a half or so, they have already completed four royalty acquisitions. This is amazing accomplishment given they are a micro/small cap company ( <200m market capitalization ). They have an amazing management team headed by CEO Norman Watson ( former CFO of Silver Wheaton ). They are very well capitalized, following an acquisition in early march, with nearly 90m of cash on hand. This gives them ample room to deploy at least 60m of their cash balance off in the near term ( as they have a bit over 100m in long term debt). Available funding will dramatically increase, however, over the year as three of their four royalty streams will come online, with the fourth expected in 2011. They can also revert back to more equity financing ( which I personally think they should do ) as they recently moved up to top tier status on the venture exchange, thus they will attract more attention. They have made it clear they are and will continue to be very aggressive on the acquisition front going forward, recently commenting they are in several advanced stage talks with various companies. 

Similarities to Silver Wheaton - Silver Wheaton is recognized for their superior management as they have been able to grow future peak production levels from 0 in 2004 to 45m by early 2010 ( expected to be reached in 2013-2014). But what stands out is the fact they have been able make these acquisitions on extremely favorable terms, with all in costs amounting to more or less <8.00/oz of silver with the exception of a few deals such as Rosemont. One would expect having the former CFO of Silver Wheaton as CEO of Sandstorm, that acquisitions would be on comparable terms. In fact, they are currently the lowest cost producer relative to Royal Gold, Franco-Nevada and Gold Wheaton. The average cost per attributable ounce is less than <$400, making their net margins the highest among their peer group. Additionally, like Silver Wheaton, they have little tax liability , another comparative advantage to Royal Gold and Franco-Nevada. The following is a brief rundown of their royalty agreements thus far:

  • Aurizona Project - 17% of attributable gold production for LOM, which will initially produce 60k oz/year, ramping up to 80k year with cash costs of $400/oz. They also have the option to purchase 17% of the gold produced from the underground mine ( should Luna Corp decide to develop it). In this case annual gold production will increase to a range of 100k-125k/year.
  • Saint Elena - 20% of attributable of the projected 40k annual production. The kicker here is the purchase price of just $350/oz. Additionally this mine has underground potential which Sandstorm will have claim to should they develop it. This would bring total mine production to an estimated 60-70k/year.
  • Summit Mine - Sandstorm will initially receive 50% of the first 10k mined, followed by a 22% interest in this small mine. Production estimates are expected to be between 12-14k/ year. Cash costs again are at the low end $400/oz. The operator also has the right to offer Sandstorm an additional 25% interest. This is a key example of generating immediate cash flow ( indicated through the provision above). 
  • Ming Mine - Production expected to commence in mid 2011. Initially Sandstorm will receive 25% of the first 175k produced followed by 12% thereafter. Gold production is projected to be between 20-25k annually with excellent upside potential. 

In other words, Production levels will grow from approx 10k in 2010 to 30k by 2012 ( assuming none of the companies decide to pursue underground mines and Summit mines does not offer the additional 25% interest) or approx 36-28k assuming they do. This seems like small pickins relative to the other royalty companies but you have to put it into perspective. Investments are made in hopes of making the highest possible return given the risk involved. Sandstorm resources offers just that: Assuming no more acquisitions are made and the long term price of gold is $1,200, it is approx trading at 40 or 50% of the NPV of all future cash flows( in other words it is worth 2x as much as the prevailing price suggests). But assuming a $1,400 long term gold price the VPS jumps to approx 3x the prevailing price. These are of course are subjective values, but to have that big of a discount illustrates a substantial disconnect between price and value. 

Added Bonus- Sandstorm recently announced the proposed spin off Sandstorm Base Metals and Energy  whose business model will mirror that of its brother company but focus on base metals, oil & gas. Each shareholder of Sandstorm resources will receive 1 for 1 of the new company. Though it will dilute the brother company by 1/36th ( in order to give some financing to Sandstorm base metals & energy), the new company already has 500k of working capital in addition to an option on the Eagle Lake Uranium project. This will give investors two royalty companies which focus on a range of commodities.    

On the Royalty Front, I believe this may be the last Gold Royalty company that can provide abnormal returns to investors as the barriers to entry continue to grow in this niche market. The next big thing to watch regarding royalty companies will be agriculture which I would jump at the chance to invest in ( assuming mgmt has its head on straight). 

1 comment:

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