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Mining plays that dodge risk

Royalty/streaming companies offer exposure to mining growth, through exploration and commodity prices, but limit risk through diversification
May 30, 2019

Running mines is a tricky business. Lean times can come from grade challenges, labour issues, commodity price collapses or a government pulling the regulatory rug out from under a project, even if the company is capably run. Shareholders in Petra Diamonds (PDL), Acacia Mining (ACA) and Centamin (CEY) know this well. However, there are options available to those keen on the industry for its growth prospects, but who don't want the risk of backing a company for one project or one commodity.

Royalty companies have beaten many major mining companies in the past decade on returns. Canada-listed Franco-Nevada Corp (TSE:FNV) is the largest with a market capitalisation of C$18.7bn (£10.95bn). Its shares are up by around 225 per cent since May 2009, climbing consistently despite several lean periods for the industry. For comparison, fellow North American large cap Barrick Gold (TSE:ABX) has lost 69 per cent in value in the past 10 years. Newmont Mining (US:NEM) is down 29 per cent in that period, and Goldcorp was down 56 per cent from its April 2009 price on its last trading day.

Franco-Nevada’s smaller peers Wheaton Precious Metals (TSE:WPM) and Sandstorm Gold Royalties (TSE:SSL) have seen their share prices double and triple, respectively, in the past decade as well, far above gold-backed exchange traded fund SPDR Gold Shares, which climbed a quarter in the same period. Berenberg analyst Michael Stoner told us royalty and streaming companies give investors “many of the best bits of the mining sector with a slightly lower level of risk”.

 

The royal wave

Royalty companies came to prominence in North America during the most recent mining downturn, which ended in 2016 because they offered a financing option for developers looking for cash when banks and equity markets were largely closed to them. A typical deal entails a royalty/streaming company handing over a lump sum to a developer in exchange for a percentage of the metal produced (net smelter return, or NSR), or the right to buy the mine’s product at a certain price (a stream). As an example, in 2013 Franco-Nevada handed over $50m (£40m) for a variety of NSR royalties at Kirkland Lake Gold’s (Can:KL) Macassa operation in Ontario. It got $30m back in 2016 when Kirkland Lake bought back 1 per cent of one NSR royalty, and revenue from the smaller take in 2018 was $4.6m.  This is just one of many arrangements, with the royalty and streaming deals bringing in $653m in revenue last year at a cash cost of $105m, which saw $178m of cash and reinvestment plan dividends paid. The company has 34 full-time employees.

Frederick Bell, managing director at Elemental Royalties, runs a similar business – albeit at a different scale. The private company owns five royalties in Mexico, Chile, Kenya and Australia. For him, the sector offered the growth prospects of miners but with far more stability.  “With a royalty company, you get all the exposure to the exploration upside,” he said. “You get a lot of the downside protection, but you still get some of the upside through exploration success that actually gives you that alpha as opposed to a fund. We ended [last] year with more resources under our royalties on operating mines than we started with.”  

The London market is far behind the Canadians and Americans in this area, so the only listed option is Anglo Pacific (APF). Happily, it has performed strongly in recent years and has good near-term prospects through the Kestrel coal operation in Queensland. This is because of high prices and the fact Rio Tinto sold the underground coking coal mine in Queensland to EMR Capital and Adaro Energy last year, and the new owner decided to ramp up production in the area covered by Anglo Pacific’s royalty.

Even before this, its revenue from the project has climbed from £5m in the March quarter last year to £11.8m in the three months to 31 March 2019. Anglo Pacific’s dividend yield is 3.7 per cent, coming in ahead of Franco's. But the bigger company is trading on a forward earnings multiple of over 50, compared with Anglo Pacific’s 10. 

Mr Stoner (of Berenberg, which is the company's house broker) said there was a premium across the Atlantic for gold and silver exposure.  “A big part of [the PE difference] is the fact that a lot of those businesses are in the precious metals space, and North America often pays up premium ratings for precious metals exposure, and Anglo Pacific is more focused on base and bulk commodities,” he said. “The scale of those businesses is also quite different to Anglo Pacific. Anglo Pacific is currently on a growth path, whereas those businesses have already grown very significantly and now have annual royalty income that continues to fund further growth, whereas at the moment Anglo Pacific will fund growth in part out of royalty income but also through its debt capacity.”

Anglo Pacific chief executive Julian Treger told us last month he was cashed up and looking to add to the portfolio. "The [market] backdrop’s very favourable for a financier to the mining sector,” he said. "What we’ve seen in terms of the quality of our deal flow, many projects that are now at more advanced stages than we would have expected in the past, are still struggling to find finance, and we’ve seen that the cost of capital is going up. High-yield debt for development funds being in the mid-teens, even to 20 per cent now. All of that is a very favourable backdrop for us to deploy more capital."

 

Doing it all

The North American royalty companies mostly offer investment opportunities to precious-metal bulls, while Anglo Pacific has a mixed bag that should appeal to anyone bullish on steel – thanks to its coking coal, iron ore and vanadium holdings. Mr Stoner said he could see Anglo Pacific adding to its battery metal exposure. For investors very keen on backing that trend immediately, there is a commodity play on the TSX Venture exchange set up for that purpose. Cobalt 27 Capital (Can:KBLT) started as a vehicle for physical cobalt and nickel/cobalt royalties in June 2017, when the blue metal was worth $55,000 a tonne.

In the 12 months after the IPO, cobalt climbed to over $90,000/t, pushing Cobalt 27’s share price from C$9 (£5.27) at listing to over C$13 in May 2018, which shows how much growth was already priced in. But the pure-play cobalt exposure went from bull to bear point, with the metal now down to around a third of what it was priced at in May 2018. Management was able to then point to its royalty and streaming portfolio. This was part of the company from day one but this month Cobalt 27 completed a deal to buy a share in the Ramu nickel-cobalt operation in Papua New Guinea, which takes it into the world of real mining risks. London investors have a different energy material to bet on in a pure play vehicle in Cobalt 27-inspired Yellow Cake (YCA).

The uranium holding vehicle listed on London's Aim market in July last year, and holds 8.4m pounds of U3O8. Mr Stoner (of Berenberg – also the company's broker) said the company had a markedly different offering to a uranium miner. “It gives you very pure exposure to the spot price at a relatively depressed point in the uranium price cycle, with less of the operating risk,” he said. “The quirk of the uranium industry is that the miners are generally receiving long-term contract prices. As the contracts start to roll off, fall away, they will start to receive a greater mix of the spot price, which is lower than their long-term contracts, therefore for some of those miners we see a pricing headwind, whereas with Yellow Cake, with pure exposure to the spot price, we see clean exposure to the rising spot price without any of that long-term contract issue.”  

Yellow Cake has established a niche for uranium bulls, although Anglo Pacific could be another option if Berkeley Energia (BKY) manages to get the Salamanca project in Spain up and running – it holds a 1 per cent NSR royalty for the mine’s life.