During commodity bull runs, mining companies are exposed to inflationary cost pressures, capital cost overruns, equity dilution and misguided merger and acquisition (M&A) activity as bullish managements strives to expand near-term production to take advantage of high commodity prices.
Bearing this in mind, an alternative way to gain exposure to commodity prices – while being largely insulated from the issues associated with direct equity ownership – is through royalty streams. Royalties typically earn a percentage of turnover from the production of commodities, providing direct exposure to commodity prices without direct exposure to operating and other expenses, and so have a lower risk profile than mining equities. Royalty companies have historically outperformed mining equities, too.
Importantly, capital and exploration expenditures by operators often benefit a royalty holder by extending the life of mines, boosting production rates and progressing development assets towards production without cost to the royalty holder. Producing royalties also tends to deliver strong cash returns, which can be leveraged through relatively lower-cost debt and underpin dividends to shareholders of royalty companies.
In addition, royalties provide tangible benefits to investors as they are considered high-yielding investments, which rank senior in the capital structure. They are often secured and traded at attractive valuation multiples, while the scale and commodity diversity offered by a long-term royalty model inherently enhances value.
Building a valuable royalty stream
- Record first quarter royalty receipts of $3.6mn, up 63 per cent year on year
- Acquisition of silver royalties in Mexico
- 48 per cent like-for-like increase in gold offtakes portfolio quarterly revenue
- Mimbula copper mine ramping up production
First quarter results from Trident Royalties (TRR:49p) highlight the significant progress the commodity royalty group is making. In the first quarter this year, the group banked a 140 per cent gain on the $15.5mn sale of pre-production gold royalties to mining giant Franco-Nevada Corporation (CA:FNV), an eye-catching return on the $6.25mn investment made two years ago. It also highlights conservative portfolio valuations and management’s astute dealmaking.
At the end of April 2023, Trident had $37mn of cash available to invest, placing it in an enviable position amongst junior royalty peers to use a vendor’s preference for cash to acquire royalties on more favourable terms. The directors are doing just that, announcing the smart acquisition of a royalty over the La Preciosa Silver Project owned by Avino Silver & Gold Mines (TSX: ASM).
A deal with a silver lining
La Preciosa is one of the largest undeveloped primary silver resources in Mexico. Originally acquired by Coeur Mining (NYQ:CDE) in 2013 for C$350mn, it was subsequently sold to Avino in March 2022 for cash, shares and royalty assets.
Avino operates the Avino silver mine and plans to begin processing stockpiled material from La Preciosa at its mill in the second half of 2023, before commencing production from fresh ore in 2024. The plan is to ramp up annual silver production from La Preciosa to 3mn ounces by 2027, rising to 3.mn ounces in 2028.
At a silver price of $22 per ounce, joint house broker Tamesis Partners estimates that Trident will earn royalty receipts of $0.2mn in 2024, rising to $0.8mn in 2028 once Amino hits its 3.5mn ounce production run rate. The group can also expect the $8.75mn milestone payment to be made in the final quarter of 2024, meaning that Trident will recoup all its $7mn investment within 18 months and can use the milestone payment receipt to settle the $1mn deferred payment to Coeur. It will then have a free ride on the royalty.
It’s smart business. Using a discount rate of 8 per cent, analysts at Tamesis calculate that the acquired assets have a post-tax net present value (NPV) of $11mn and should generate a post-tax internal rate of return (IRR) of 21.7 per cent, materially above Trident’s cost of capital. It also adds another income stream to Trident’s strongly performing precious metal royalties.
In the first quarter of 2023, Trident’s gold offtake portfolio delivered 48 per cent higher quarterly like-for-like revenue of $1.9mn after adjusting for the April 2022 disposal of the group’s royalty interests in the Mercedes Gold-Silver Mine in Sonora, Mexico. That equates to a $30 per ounce NSR on the 62,335 ounces of gold deliveries under offtake contracts with the 1.6 per cent margin earned benefiting from a gold price trading just shy of all-time highs.
A copper-bottomed royalty investment
Trident’s copper royalty revenue from the Mimbula project in Zambia is ramping up, too, rising 50 per cent year on year to $0.75mn in the latest three-month trading period, adding both cash flow and diversification to the group’s revenue stream.
Acquired three years ago for $5mn, Trident earns a gross royalty revenue (GRR) of 1.25 per cent, decreasing to 0.3 per cent once $5mn has been paid, falling to 0.2 per cent once the royalty has been paid on 575,000 tonnes of copper. Including this next quarterly royalty payment of $0.75mn, Trident will have recouped its $5mn investment and retained a GRR on a project that has a mine life of 13 years and annual production of 56,000 tonnes.
Mimbula’s cash cost of $2,300 per tonne (exclusive of byproduct credits) is 70 per cent less than the current copper price of $7,520 per tonne, highlighting the gains to be made by both the operator and Trident.
Deep discount to fair valuation
Tamesis’ anticipated 50 per cent year-on-year ramp-up in Trident’s revenue to $13.5mn (2023) and $20.6mn (2024) underpins expectations of the group delivering net profits of $1.6mn and $3.6mn, respectively, and bumper cash flow generation, too. However, the undervaluation is best highlighted by the unwarranted 35 per cent share price discount to Tamesis’ unrisked net asset value (NAV) of $282.5mn (75.7p).
Half that valuation is accounted for by Trident’s royalty over the Thacker Pass lithium open mine project in Nevada, one of the largest known lithium deposits in North America. At the end of January 2023, the project’s operator, Lithium Americas (NYQ:LAC), entered a joint venture with motor giant General Motors (NYQ:GM) to develop the project, the latter making a $650mn equity investment which substantially de-risks Trident’s royalty.
Trident’s share price is well above my 37p entry point (Alpha Research: 'A lowly rated commodity and green energy inflation hedge’, 1 November 2021), but flat this year. That’s anomalous given that the group not only offers a smart play on growing demand for battery metals and the transition to electrification, but a hedge against inflation – precious metals account for 70 per cent of 2023 royalty receipt estimates. Buy.
■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com. The books are priced at £16.95 each plus postage and packaging (P&P) of £3.95 [UK], or both books can be purchased for the promotional price of £25 plus P&P of £5.75.
