Jun 20, 2010

Which Royalty Will Come Out On Top?

For those who have read any of my past articles regarding silver or silver miners, you know Silver Wheaton (SLW) has been and continues to be my favorite player in the industry and one of the best ways to play the recent and future price appreciation in this very misunderstood metal. Despite having being one of the best performers relative to its peers, I think this unique company's days are ahead of it. It has a business model that has yet to be replicated (companies with at least a 600m market cap).
While many claim other companies (Franco (FNNVF.PK), Royal Gold (RGLD)) have similar business models, this is not always the case. Let me first clarify that Royal Gold and Franco-Nevada's business models differ in many ways.
  • Silver Wheaton (SLW) is a streaming company, as opposed to a royalty company. In other words, Silver Wheaton receives delivery of the physical asset as opposed to majority of royalty companies who typically receive GSRs, NSR, NPI w/ or w/o sliding scales (with the exception of Andacallo for RGLD and Palamarejo and Prosperity for FNNVF.PK). GSR’s/NSR’s, etc usually range between 2-5% while streams average 25-50%+.
  • Tax Structure – Royal Gold for example pays the statutory rate while SLW or GLW.TO have a much more favorable tax structure.
  • Focus is >95% is on silver and the rest on gold. Royal Gold, due to the acquisition of IRC, has a fair amount of base metals (namely copper). While Royal Gold has been diluting its revenue derived from gold as a percentage of total revenue, Franco has been doing the opposite (following their purchase for a 22% interest in the Prosperity project). But even with this recent acquisition and other cornerstone royalties (such as Tasiast, Detour, Afaho) coming online over the next 2-3 years, they will still derive approximately approx 30% of total revenue from oil & gas, platinum and base metals.
Now that I listed one of the many differences between a streaming and royalty company, I will break each company down and talk about some relatively unknown companies. Silver Wheaton has many potential catalysts that are overlooked to some degree by the market.
Additionally several past and recent events are being discounted:
  1. Most recently the amendment to the San Dimas stream, which Goldcorp (GG) agreed to sell to Mala Noche. Not only does the contract of the stream extend from 29 years to the life of the mine, but the attributable ounces receivable will increase both short and long term. As part of the amendment, Mala noche will sell the first 3.5m ounces mined and 50% of production beyond this point. Goldcorp will add 1.5m ounces on top of this for the first 4 years, at which time Mala Noche will sell the first 6m ounces mined and 50% of production beyond this point. But there are additional implications to this which most analysts either miss or choose to ignore. As Luisman was not a core asset to Goldcorp, there was far less incentive to maximize production and engage in aggressive exploration on the rest of the property. Mala Noche, on the other hand, has already laid out expansion and exploration plans which Silver Wheaton will benefit from. By 2012, total attributable ounces to Silver Wheaton will range from 7.8m-8m ounces as opposed to approx 5.8,m in 2009. Mala Noche has already said they plan a mill expansion at San Dimas, increasing throughput anywhere from 15%-20%. Assuming the high exploration potential only results in an additional 500-1m oz of silver (which is on the very conservative side of mgmt’s expectations), Long term silver payable to SLW should range between 8-8.5m oz by 2014-2015 ( as SLW is only entitled to 50% of production past 6m oz).This deal will make Luisman’s (which is combined of 3 different mines on the same property) NAV greater than that of Pascua-Lama.
  2. Contractual agreement with Ventana regarding SLW’s right of first refusal on the La Bodega mine. This option will likely be exercised as Ventana is faced with high capital requirements to bring La Bodega online. I could see Ventana selling 25-50% of the silver recovered to SLW in exchange for up front financing. Although annual gold and silver production is still unknown, drilling at La Bodega indicates a world class mine. I think it is safe to say this will at some point turn into at least a 2m oz stream, though somewhere between 4-5m+ is more likely.
  3. Pascua-Lama is likely to contribute more than the projected 9m ounces consensus. World class mines such as this more often than not increases production guidance as time goes on before commercial production begins. A great example is one of SLW’s cornerstone assets (Penasquito), which was estimated to be approx 5m attributable ounces to SLW when it was at a similar stage in the construction process as Pascua-Lama. This coupled with the exploration potential increases the likelihood production guidance will increase beyond the current estimates.
  4. It is looking increasingly more likely Goldcorp will pursue development of an underground operation at Penasquito sometime over the next 2-5 yrs. SLW is also entitled to purchase 25% of silver produced from the underground mine.
  5. SLW has numerous additional assets that are overlooked for the most part. These include a 15% in the Corani Project (Bear Creek), 17% interest in Revett Minerals Rock Creek project, 7% in Sabina’s Hackett River mine and a 11% interest in Mines mgmt’s Montanore Mine. While all but Corani is still in the pre-feasibility stage, Corani is expected to come online in 2013 with average annual production estimated to be 10-12m oz/year.
Coming back to the Royalty companies (Franco-Nevada, Royal Gold and Sandstorm). In my opinion, SLW is the best way to play silver in the equities market, but due to more competition in the gold arena, it is hard to say who will come out on top.
Franco-Nevada – Following the acquisition of a 22% interest in Taseko’s Prosperity project, I believe they are more attractive than their main competitor Royal Gold.
  • With the acquisition of Prosperity, Franco greatly increases its long term growth profile and will derive a greater percentage of total revenue from gold. This In turn will derive a higher multiple for their stock price as the market tends to penalize those with a lower percentage of total revenue from precious metals. While Franco only derives approximately 71% of total revenue (2009) from the yellow metal, this will increase over time to approx 78-82% (depending on the price of Oil & Gas, Platinum and various base metals). What differentiates Franco from Royal Gold is that the revenue derived from assets other than gold is that Oil & Gas and Platinum will account for approx 16-18%.
  • While Royal Gold has some well known key assets that will propel their short-midterm growth( i.e Voisey’s Bay, Andacallo , Cortez, Canadian Malartic, Pascua-Lama, Penasquito) Franco has many world class assets of its, some of which are relatively unknown. These assets include such royalties as Prosperity project (which will provide approx 76-80k attributable ounces initially to Franco, with a LOM average of 65-75k). Palamarejo ( Franco receives 50% of all gold produced, which currently stands at approx 55k attributable ounces but will likely be guided upwards towards 60k-65k attributable ounces). Franco’s investment in Tasiast (2% GSR) is turning out to be a brilliant move as they have dramatically increase annual production guidance post expansion from 450k to an astounding 1m oz by 2015. Their 2% NSR on the Detour Camp property is actually quite substantial as annual production will range between 650k-700k ounces, with upside potential. Hemlo and Subika are also expected to add approx 22-23k ounces ( assuming gold is $1,100/oz).
While Royal Gold is considered the better of the two by most, I think this will change over the next 1.5-2 years. While Royal Gold is more or less out of ammo on the acquisition front for the time being (barring an equity offering), Franco still has plenty of firepower in their arsenal, which will allow them to take advantage of the next one or two big deals that arise. The way they went about the Prosperity acquisition was far more strategic than Royal Gold’s buyout of IRC in that Franco will only deploy 350m (after certain requirements have been met) and 2017 warrants, which still leaves them with approx 450-500m to pursue additional acquisitions. They also have a slight advantage on the exploration front with 152 interests in various projects.
Gold Wheaton is definitely a company worth a look at current prices. Although the First Uranium issues have been resolved to a modest degree, they are still attractive excluding this stream altogether. The exclusion of this stream would have Gold Wheaton currently trading at 1x NAV. First Uranium, however, continues to deliver for the time being, giving GLW.TO operating cash flow to pursue additional streams. Gold Wheaton provides tremendous upside potential especially if they can acquire another stream, taking the markets focus off of First Uranium. I know many who have invested in GLW.TO in the past must be incredibly frustrated, but with the stock trading around $2.40, it has become grossly undervalued.
One of my favorite royalties, which most people have yet to hear of, is Sandstorm Resources. Aside from Silver Wheaton (SLW) trading at just over $3/share back during the peak of the financial crisis, I have not seen such a potentially attractive valuation among the Royalty companies. Sure Royal Gold (RGLD) and Franco- Nevada (FNNVF.PK) 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 individual’s 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 (SNDXF.PK) - 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 Nolan 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, 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/oz. 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 range from 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 36-38k assuming they do. This seems like small pickings 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 offer just that: When it comes to valuation, assuming a long term gold price of $1,300/oz, my valuation ranges between $1.72-$1.90/share. Of course valuations are very subjective with regards to required rate of return, LT gold price, etc, but such a price to value disconnect in the valuation mentioned above makes it worth a look.
So which is the best?
  1. Silver Wheaton’s superior management, ability to get deal done on a very accretive basis along with their ability to make 1 or 2 more cornerstone acquisitions and/or some smaller deals coupled with existing exploration potential puts them at number 1 on my list in terms of risk/reward. You can also translate their silver into GEO, which using the average ratio of 45:1 over the past 30 years ( as opposed to the long term historical average of 15:1) would yield them over 1m GEO or 3x as much as Franco.
  2. Sandstorm Resources – Having completed three acquisitions in their first years of operations, one already in 2010 and the financing to several more over the next 12-18 months, makes them extremely attractive at current prices. Assuming they only acquire two more streams worth a total of 50-70m should propel them to approx 50-65k ounces a year.
  3. Gold Wheaton – This is both a valuation play ( currently trading at about .45x NAV) as well as a potential growth story as they will most likely ink another deal before year end. Peak production is currently expected at 130k ounces/year, though I expect them to be closer to 175-200 over the next 12 months.
  4. Franco-Nevada – Doing all the right things with plenty of firepower to further grow their company. They have great management who didn’t succumb to over-paying for IRC relative to what else they could get for the money (Prosperity). They have a great mix of short, medium and Long term growth.
  5. Royal Gold – Although a long time favorite, their acquisition of IRC (which will prove to add significant shareholders value) leaves them unable to compete with Franco for the next big opportunity to take advantage of. That being said, they also have a great portfolio of producing, those nearing production and exploration projects.


  1. Thank you for the analysis on Gold Wheaton. I've also been thinking for some time now that they are incredibly undervalued. Now that the troubles with First Uranium are starting to fade perhaps we will see Gold Wheaton stock price begin to slowly rise to reflect the sound underlying value of the company.

  2. I agree completely, I did an in depth valuation model on GLW showing the price to value disconnect, for each ouces of GEO, one is paying less than $100. NAV is approx $5/share with 1200 gold, 1500 platinum and 450 palladium. Using a DCF with the same prices yields about 12.50 share, 15% discount rate. I still think sandstorm warrants are the way to go as they provide leverage adn dont expire for 4 years. They also have superior mgmt team which is very aggressive on the acquisition front.

  3. Why buy $0.60 warrants trading at $0.40 when the stock price is at $0.69?

    Stock price has backed off significantly more than warrants over last 3 months.

    Stock appears to be better deal.