Royal Gold, Inc. (NASDAQ: RGLD) makes most of its money by selling gold. However, it isn't a miner, it's a streaming company. In fact, it's the benefits of the streaming model that have allowed Royal Gold to increase its dividend for 17 consecutive years -- an incredible streak for a company tied to often volatile commodity markets. If you are looking at gold, then you need to get to know Royal Gold. Here's everything you need to get your research started.
What is streaming?
The first and most important thing to understand here is that Royal Gold is not a miner. Miners have to find a place with gold, build a mine, dig up the gold, and finally sell it. That's an oversimplification of an incredibly complex, difficult, and expensive process, but it covers the high points. Royal Gold doesn't do any of that, but it does add to the process by providing miners with cash.
Image source: Getty Images
Essentially, Royal Gold gives miners cash up front for the right to buy gold, and other metals, at reduced rates in the future. Miners use that cash to build mines, expand existing assets, or pay down debt they've accumulated. These deals, known as streams, provide miners an additional source of capital outside of banks and capital markets, which can, at times, be expensive ways to finance their operations.
Royal Gold benefits from streaming agreements because it locks in low prices for the gold and other metals, such as silver and copper, that it will eventually sell to support its top line. That, in turn, leads to wide margins even when gold prices are falling, since the prices it pays are usually tied to a percentage of the going spot price.
A quick margin example
To put a number on that, Royal Gold's trailing EBITDA margin has been in positive territory over the past decade. EBITDA is a key profitably metric in mining, which tends to have high depreciation expenses. Over the same period, miners like Barrick Gold (NYSE: ABX) and GoldCorp watched their margins dip into the red one or more times because of a deep drop in the price of gold. But Royal Gold's trailing EBITDA margin never fell below 40% over that time span, an impressive performance for an industry that was facing stiff headwinds.
That said, Royal Gold isn't unique in this strength. Trailing EBITDA margins at streaming peers Wheaton Precious Metals Corp. (NYSE: WPM) and Franco-Nevada Corporation (NYSE: FNV) also held up well relative to miners over the past decade. Indeed, strong margins are a byproduct of the streaming model.
A bit of background
Royal Gold didn't start off in the streaming business. It was founded in 1981 as an oil and gas exploration and production company. That worked well for a few years until oil prices collapsed. At that point, the company shifted its focus to gold mining by acquiring Denver Mining Finance Corporation, a merchant bank providing merger and acquisition and funding services to mining firms. The company was initially looking to acquire mines, but the 1987 stock market crash changed its model again. After that sell-off, the company decided to own minority interests in mines operated by large miners. That's the basic model that Royal Gold still uses today.
What does Royal Gold look like now?
From those somewhat humble beginnings -- including zero exposure to precious metals -- Royal Gold has turned itself into one of the largest publicly traded royalty and streaming companies. Today it has around 200 investments in gold, silver, and copper mines, the vast majority of which are located in the Americas. Nearly 40 of those mines are operating today, with 22 mines in development. The rest are in earlier stages of the development cycle.
In fiscal 2017 the streaming company reported record gold equivalent ounce volumes of 350,100 ounces (a 14% advance over the previous year); it set revenue and net income records as well. Although revenues will naturally fluctuate with the price of gold, which makes up roughly 85% of its top line, Royal Gold's sales have been heading generally higher over the past decade, rising from $66 million in fiscal 2008 to $441 million in fiscal 2017. Net income rose from $24 million to $102 million over that span.
While financial results over the last decade have moved generally higher, there were fluctuations in between. That's to be expected in a commodity-related business. However, one thing that only went higher was Royal Gold's dividend. The dividend has been increasing for 17 consecutive years, backed by the long uptrend in the company's business results -- backed, in turn, by the expansion of its streaming portfolio.
Downturns are good for business
This is a notable point today because commodity downturns like the one that started in 2011 are a headwind for Royal Gold's financial results: Low commodity prices lead to lower revenues. However, downturns also present the company with an opportunity to expand, since miners are most likely to need cash when times are tough.
Royal Gold, like its peers, was active during the most recent gold downturn, and now it has a number of notable streams that it expects to push results higher over the next few years as new mines get built and expansions are completed. The early impact of investments made during the downturn was on clear display in fiscal 2017's record-setting results.
Think of it like this...
That said, Royal Gold is best looked at as a specialty finance company that gets paid in precious metals. The streams it owns really amount to a portfolio that has been acquired over time and that has to be managed. That can include selling older streams, helping streaming partners transition to new ownership, and investing in mines across the development spectrum to ensure that gold equivalent ounce volume continues to move generally higher.
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The benefit of investing in mines is notable when you compare an investment in Royal Gold to buying gold coins and bullion. Over the past decade through early 2018 the price of gold has gone up around 60%. Royal Gold's stock price has advanced 160%, largely because it not only benefits from price changes in gold but from its ongoing and active investment in streaming deals.
Watch Royal Gold's balance sheet
The basic model for Royal Gold's sector is to use short-term debt on the acquisition side and either pay down that debt with cash flow or permanently finance the acquisition with stock sales or long-term debt. This is why the company's long-term debt has grown from roughly $3 billion in fiscal 2008 to around $20 billion at the end of fiscal 2016 when commodity markets started to turn higher again.
Long-term debt on the balance sheet has since been reduced by around 17% as Royal Gold has used cash flow to reduce its leverage. That said, investors should keep an eye on the debt profile of the company. Although long-term debt only makes up around 18% of the company's capital structure, that's a material increase from just 3% or so a decade ago. Note that the company hasn't issued new shares since 2014 and, assuming gold prices hold where they are in early 2018, Royal Gold expects to continue to use cash flow to trim its debt balance. Longer term, however, keep in mind that the more debt Royal Gold has, the less cash it will have available to fund future streaming deals.
Is Royal Gold worth owning?
If you're looking to invest in gold, streaming companies like Royal Gold and its peers should definitely be on your radar. And dividend-focused investors should be particularly interested in Royal Gold, which has the longest dividend increase streak of its major peers. Although the yield, at around 1%, isn't much, the company's wide margins and a steadily rising dividend can help keep you invested when gold prices are weak to achieve the full cycle diversification benefit that gold and precious metals offer to a portfolio.
Royal Gold's price to tangible book value is well off the lows seen at the nadir of the commodity downturn, but nowhere near the peak levels it has seen in the past. To put it another way, it isn't a screaming bargain but doesn't look particularly overpriced either.
Investors today are likely paying full price for an advantaged precious metals business model -- which is important to note since Royal Gold's price to tangible book value ratio is higher than that of many large gold miners. Yes, there are cheaper ways to get exposure to the yellow metal, but it's probably worth paying up for a better approach to the space.
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