The mining industry has disappointed many investors through the decades. Mining companies can only focus on a few properties which have high development costs only to face many risks while the mine is operating. These risks can have a very significant impact on the companies and damage shareholders and their profits. However, royalty companies can provide what mine operators do while isolating investors from some of the risks.
Gold Royalty's Business
The royalty model is fairly new in the mining industry. The royalty company provides financing in the early stages of the mining project and the mine operator gives a royalty in exchange once the mine is producing. The contribution of the royalty company is typically financing for PEAs or other exploration or development activities that need capital.
The royalties can take various forms. The main one in Gold Royalty’s portfolio is an NSR, which means that the royalty is applicable to the top line of the mine, while other types of royalty like an NPI royalty are applicable to the bottom like, making them less reliable. The vast majority of the company’s royalties are NSR.
The royalty model is fairly new in the mining industry. The royalty company provides financing in the early stages of the mining project and the mine operator gives a royalty in exchange once the mine is producing. The contribution of the royalty company is typically financing for PEAs or other exploration or development activities that need capital.
The royalties can take various forms. The main one in Gold Royalty’s portfolio is an NSR, which means that the royalty is applicable to the top line of the mine, while other types of royalty like an NPI royalty are applicable to the bottom like, making them less reliable. The vast majority of the company’s royalties are NSR.
The royalty model provides many advantages:
• It is a contractual business. There is no need for working capital or equipment, all it takes are offices with a few employees to review contracts and supervise how underlying properties are developing. It is an easy business to operate and royalty companies have one of the highest revenue per employee ratios. Gold Royalty has said that they “can manage a business ten times this size with the same people”.
• All the capital is already deployed. Once the contract is signed, there are no further commitments from the royalty company, all it has to do is wait and collect the payments. This means no capital expenditures are required to grow the revenue, it is only needed to sign new royalty contracts.
• Exploration Upside. The royalties cover all the gold extracted from a predetermined surface area. If mining companies do further excavations on that land or update their resource estimates, the royalty contracts cover those minerals and royalty companies do not need to pay anything, those new resources are already covered by the contract. It is important to note that the royalty holders are entitled to receive the payment once the gold is extracted from the ground and processed.
• Gold Price Exposure. Were there to be a rally in the price of gold, royalty companies would also benefit from it without having to pay a dime. In this inflationary environment, where fiat currencies are devalued, gold holds its purchasing power and therefore the price of gold expressed in dollars rises during these times. I believe it is possible that we live through another inflationary period in the coming years. If this happens, gold royalty will benefit from it. And, of course, Gold Royalty is already benefiting from the rising gold price.
• Top-Line share of profits. The most typical royalty is NSR (for Gold Royalty), which means that it does not matter if the mine operator or the mine itself are profitable, the royalty holder receives its share first and then all the production costs, salaries, etc. are paid.
Short Company History
Gold Royalty was created in 2021 as a spinoff of GoldMining Inc. GoldMining created royalties on 15 of their properties as gave them to Gold Royalty. After the IPO, GR started growing their business via acquisitions. They acquired 3 companies (Abitibi Royalties, Golden Valley Mines and Royalties and Ely Gold Royalties) and did another 4 transactions. They now own over 240 royalties, a highly diversified portfolio. They also acquired a few royalties in individual transactions and signed some option agreements.
The acquisitions have been paid for mostly with shares, thus increasing the share count significantly. Nevertheless, they have managed to achieve that growth while creating value per share, which is up 40% since the IPO, according to analyst estimates.
Management Team
The key figure is David Garofalo. He was the President and CEO of GoldCorp, one of the biggest mining companies, until its merger with Newmont, a transaction he directed. He has also served as Senior Vice President, Finance and CFO of Agnico Eagle Ltd and has had management positions in several other mining companies over the last 30 years. Gold Royalty has many directors and managers, but most of them do not work full-time in Gold Royalty as the day-to-day operations of the business are very simple. Their role and influence on the company are more limited.
Royalty Portfolio
Gold Royalty owns over 240 royalties. Most of them are in early exploration or advanced exploration, several in development and a few are producing. The royalties can cover several resources, for Gold Royalty gold represents 94% of their royalties, copper 5% and 1% other minerals. 54% of those resources are located in Canada and 33% in the US, with the other 13% being mostly in South America.
Key Assets
Gold Royalty owns a few assets that are key to its future because of their size and the timing the initial production. These assets are: the Odyssey Project (part of Canadian Malarctic), Côte Gold and the REN Project (part of Carlin Complex).
The Odyssey Project is a part of the Canadian Malarctic Mine, more specifically the underground part of a specific area. $GROY holds a 3% NSR over this project. This royalty is just started producing in Q2 2023 and it is expected to produce 50koz in 2023 and 80koz in 2024. This translates into 1,500 ounces of royalty in 2023 and 2,400 in 2024. This is an important addition to the producing royalties and should push the company into profitability. By the end of 2024, this mine will cover more than half of Gold Royalty’s recurring operating expenses, which are expected to be about $8M. Based on current resources and processing capabilities, the mine should last until 2042.
Côte Gold just started production today, April 1st 2024 with the first gold pour. IAMGold, the operator of the mine, has said that they expect to reach commercial production by Q3. The royalty covers 0.75% NSR over the southern portion of the mine. The entire mine is expected to produce 495 koz in the first six years and 365 koz of average production for the life of the mine, which is expected to last until 2041. For 2024, the mine will produce 220koz to 290koz, for an equivalent 1,500 royalty ounces, since the royalty does not cover the mine entirely.
Other Producing Assets
Borden is expected to produce 100 koz annually and the mine is expected to last at least until 2027. Gold Royalty holds a 0.5% NSR over the underground part of the mine. It is operated by Newmont.
Isabella Pearl is a different type of royalty, a GRR. In a GRR the royalty holder is entitled to a fixed portion of the gross revenues generated from the sales of mineral production from the property (i.e. the royalty company gets paid in dollars and not it gold, as occurs with an NSR). Gold Royalty owns a 0.375% GRR over this mine, as well as another 2.5% on the Isabella Pearl Extension, which is currently in the early exploration stage. Isabella Pearl is expected to produce 40 koz per year until 2026 at least
Cozamin was recently acquired for $7.5M. They hold a 1% NSR royalty over the silver mine, which yields about $1M annually. They expect this operation to have a ROI of 8.5% to 12.5%. It was done to enhance near-term cash flows. The life of the mine could last until 2036.
Gold Royalty recently acquired a 2% NSR in the Borborema project in Brazil for $21M. The royalty will decrease to 0.5% NSR after 725koz have been produced and that remaining 0.5% will be subject to a buyback of $2.5M after 2,250koz are produced or in 2050, whichever one comes first. The royalty includes pre-production payments of 1,000 oz per year until production starts, which is expected for 2025. This provides GROY with immediate cash flows.
Additionally, they provided financing to the operator for $10M in the form of a royalty-convertible gold-linked loan, which has coupon payments payable in gold of 440 oz per year. Gold Royalty can convert the gold-linked loan into an extra 0.5% NSR upon maturity. That 0.5% is subject to buyback under the same conditions as the 0.5% related to the royalty.
Royalty Generator Model
They have also developed a proprietary royalty generator model that has created 37 new royalties since the IPO in 2021 and keeps generating 2 or 3 new royalties per quarter at a minimal cost. The company stakes exploration claims around existing mines and then gives the property in exchange for option payments, a royalty and a commitment to work on the property. This way they “get paid to generate royalties” and they make sure that those properties are developed.
A Look at the Numbers
Revenues
The revenue for Gold Royalty comes from royalties and options. Currently, the revenue from options makes up an important part of total revenue, but as more assets enter production, the proportion of option revenue will decrease. They give options to other companies to buy some of their royalties in exchange for a payment. Essentially, they are selling puts on their properties to generate short-term revenues.
Gold Royalty expects to grow revenue organically by over 60% annually until 2026 as key assets start producing and gradually increase production. This projection only includes organic growth.
Costs and Operating Leverage
Costs are about $8M per year and right now they are making the company unprofitable. Nevertheless, almost 100% of these costs are fixed. Once royalties start to come in, the relative size of the costs will go down dramatically. David Garofalo (CEO) has said multiple times that they can run a business ten times this size with the same people. This translates into huge operational leverage in the short and medium term and it is the reason why they expect the company to reach profitability in 2024, in fact Q4 of 2023 was already FCF positive.
Financing
In connection with the Borborema acquisition, the company borrowed $40M via unsecured convertible debentures. They have a maturity of 5 years at a 10% interest rate, of which 7% is payable in cash and 3% in common shares at $1.90 per share. In addition to that, the lender can convert the loan into shares at maturity at a price of $1.75 per share. They also have a revolving credit facility with a maximum balance of $25M, of which $10M is drawn.
2024 Outlook
Gold Royalty recently published their FY 2023 results but much more importantly their revenue guidance for 2024. They expect to receive between 5,000 and 5,600 Gold Equivalent Ounces (GEOs), which then multiplied by the gold price gives the revenue in dollars. Considering that gold is trading above $2,200/oz, revenue for 2023 should be around $11.7M at mid-point guidance, doubling the revenue from 2023 thanks mainly to the start of production at Côte Gold. Canadian Malartic is also expected to significantly contribute to 2024 revenue with a further ramp-up of the underground part, the Odyssey Project, although it depends more on the production plans of the operator.
This means that it will be the first year in which the company produces positive FCF. They have stated that they want to keep growing the number of royalties, preferably with royalties that start paying off in the short term, and if possible, return capital to shareholders.
Risks
Despite the many advantages of the royalty model, GR faces some risks:
• Mining Risk: as the producing royalties are still few, operational mining risk still poses a threat to GROY’s revenues in the short to medium term. This risk will gradually fade as the pool of producing royalties gets more and more diversified.
• Gold Price: a bear market in gold can affect revenues negatively.
• Broken Contracts: should an operator challenge the royalty contract, the company would be forced to take legal action against the operator and incur in legal costs.
• NPI Contracts: the NPI royalties entitle the owner to a portion of the benefit of the underlying mine. If this mine becomes temporarily unprofitable, GR stops receiving royalties.
Competitors
There are two types of royalty companies, big ones (over $1B) and small ones (below $300M). Some of the big ones are:
Royal Gold is the most similar competitor to Gold Royalty in terms of the minerals covered by the royalties. It is a $7B company trading at 30x earnings and x16.5 free cash flow. It is much bigger in scale ($600M in revenue) but the business is very similar. There are few variations to the business model other than Royal Gold is a much more established company with more limited growth opportunities. In 2000 and 2001, Royal Gold received $6M and $12M respectively and its market cap was about $200M, a very similar situation to Gold Royalty now. Plus, Gold Royalty’s expected growth profile is very similar to what Royal Gold did in the 2000s. Since 2000, Royal Gold’s stock has returned 17.6% annually without accounting for dividends or dividend reinvestments. Other big royalty companies include Franco Nevada and Sandstorm Gold Royalties.
In the small space, there has been a consolidation and now only 4 companies remain. They are Gold Royalty, Metalla Royalty & Streaming, Vox Royalty Corp and Elemental Altus royalties. Out of all of them Gold Royalty holds the highest number of royalties and has the highest gold concentration, almost all of it in Tier 1 jurisdictions. They are the only royalty company with over 80% gold concentration (actually it is 97% gold) and the best company in terms of jurisdictions, with 87% in Tier 1 locations and the rest in South America. Among the small companies, none of them make a profit yet even though some of them have more than $12M in revenue. As previously mentioned, Gold Royalty should make a profit in 2024.
Valuation
The valuation in this industry is quite complicated. The price to Net Asset Value is typically used but there is a problem with it. The companies recognize net asset value, which is the value of the royalties, differently. Nevertheless, it is somewhat useful to assess the valuation of these companies.
Observing the valuation of the different companies in the royalty space we reach the conclusion that the P/NAV does not give the full picture. There are other factors that influence the valuation like the cash flow the company produces, the growth prospects, the size of the business, whether or not it pays a dividend and the quality of the company’s royalty portfolio. Most companies have royalties divided over several metals, not just gold, and that also plays a role in their valuation. The company with the most similar “mineral mix” is Royal Gold.
It is quite difficult to assign a numerical value to the fair price of Gold Royalty, but we can say that it is severely undervalued, especially given the future revenue growth and the operating leverage. For me personally, I think a target price for the stock is between $3 and $4, depending on how the gold price moves.
Overall Outlook
Gold Royalty Corp. operates in a very interesting industry with many good qualities. It should have impressive revenue and earnings growth in the next years without having to do much or spend any money. Risks are fairly limited, and they can benefit from exploration upside and gold price exposure. Plus, the company appears to be trading at a low valuation in comparison to its competitors.
Disclosure: I have a beneficial long position in the shares of one or more of the companies discussed in this article, either through stock ownership, options, or other derivatives. I wrote this article without external assistance, and it expresses my personal opinions. I was not compensated for this article, and I have no business relationship with any company whose stock is mentioned in this article.
