Adrian Day - Thu, Nov 15, 2018

Royalty Companies Move Ahead, Justifying Their Premiums

Adrian DayMoney manager Adrian Day reviews royalty companies and also updates exciting news at other companies in his portfolio.

Mining pit

Franco-Nevada Corp. (FNV, NY, 64.89) had a strong quarter, with gold streams from two large copper mines (Antapaccay and Candelaria) better than expected with strong oil and gas revenues (which represent somewhat over 10% of revenues, and growing). As always, some assets perform better than expected, while some has softer quarters. There were no particular significant shortfalls in the recent period. Franco said it was on track to meet its annual guidance. This is a benefit from having nearly 40 minerals assets generating revenue, none representing more than 15% of the total.

Its next large asset, Cobre Panama, is expected to start production in the first quarter of next year, though sales (and Franco's revenue) may come a little later. There is a somewhat complicated challenge to the way the mine concession was granted, though owner First Quantum expects that to be resolved in the near term, and it should not affect the mine start-up. Meanwhile Franco has made its final contribution under its agreement.

The balance sheet remains strong, with $77 million in cash and no debt, and a $1.1 billion undrawn credit facility. In the current environment, oil and gas revenues are expected to increase in relative as well as absolute terms, perhaps exceeding 20% next year, before Cobre Panama is producing at full capacity.

Franco-Nevada is a core holding for us, with best-in-class management, business model, assets and balance sheet. If you do not own, we would buy here, but otherwise look for prices closer to the recent floor around $62.

Low production at key assets hurts revenue

Royal Gold Inc. (RGLD, Nasdaq, 73.69) saw royalty and stream revenue down, largely because of lower production at Mt. Milligan and lower grades at Peñasquito. The former have been well advertised to the market. Milligan's operator, Centerra, has faced a water supply issue all year, but it just hit the last quarter's revenues. The company has applied for permits to gain access to alternative water sources. It is currently operating on temporary permits, and if not made permanent, mine will not move back up to full capacity until the snow melt next spring.

Royal also took losses on fair value on investments, notably Rubicon, in the quarter. On the positive side, the company saw lower G&A, while the balance sheet remains strong, though not as strong as Franco, with net debt of $238 million, down from the previous quarter, and an unused $1 billion credit facility.

Though its valuations are in line with other major royalty companies, it needs Milligan to come back to full production, representing as it does, over 25% of its NAV and revenues. If this happens, Royal—down from over $90 in July—could recover strongly.

A different approach to royalty generation

Osisko Gold Royalties Ltd. (OR, NY, 7.39) reported royalty revenue in line with estimates. Canadian Malartic Mine, on which Osisko holds its largest royalty, is on track to achieve guidance, while Éléonore continues its long ramp up, with sustained mining of around 400,000 ounces annually is expected by the end of the year.

There has been some activity in the portfolio this past quarter. As expected, Pretium exercised its right to repurchase the royalty on its Brucejack mine; Osisko retains, for now, the offtake agreement on the same mine. Osisko also renegotiated its stream with Stornoway Diamond, paying $21.6 million to expand the stream to the entire production on slightly different terms. It also acquired an attractive stream on Falco's Horne project. Falco is one of Osisko's "incubator" companies. This novel approach provides Osisko with opportunities to more early stage projects, though makes it somewhat more risky than its larger peers.

Osisko has a good balance sheet with $137 million in cash, a portfolio of investments valued at about $365 million, and $100 million drawn on its credit facility (with another $350 million available). It is trading at a discount to the other large royalty companies, particularly on a price-to-NAV (under 1x compared to well over 2x for Royal and Franco). However, given that its junior portfolio represents 16% of its NAV and that it is a smaller, less diversified company, some of this discount is justified. However, the current level is overdone; down from $9.50 in July and almost $12 at the beginning of the year, Osisko is a buy at this level.

Creating your own royalties

Altius Minerals Corp. (ALS, Toronto, 13.22) reported strong results, on the back of higher iron ore and potash revenues offsetting lower base metals and thermal coal. There were some peculiarities, mostly positive, in recent results: the resumption of Labrador Iron Ore Royalty distributions after a work stoppage; mine sequencing at Sheerness coal; the settlement of litigation and resumption of royalty payments at Voisey's Bay; and Nutrien closing one operation on which Altius does not hold a royalty and shifting to Saskatchewen mines on which it does. All in all, Altius said it remains on track for annual revenue of between $64 million and $69 million this year. Again, this is a benefit of having exposure to different resources.

On an annual basis, copper accounts for about 44% of revenues, coal 24%, and potash 13%, with iron ore and nickel accounting for most of the remainder. Though total revenues would remain fairly stable (from existing producers) for the next five years, by 2022 the potash revenues will have more than doubled, while copper will have declined to around 33%, due to the closing of one large mine, and the start of another (Gunnison, in Arizona, which will start this year and still be a small contributor, around $1 million by 2022, though rising to $7 million by 2026).

Altius has made additional royalty investments, increasing its stake in Labrador Iron Ore Royalty and the new Lithium Royalty company. It has also spun out a new diamond company, currently private, with DeBeers Canada as a leading investor. Following drilling this winter, the company plans to go public. As is its game plan, Altius will retain a significant share ownership as well as a royalty on any future revenues.

Equities and royalties in multiple juniors

The balance sheet is strong, with $84 million in net debt and $100 million available on an unused credit facility. It also holds a portfolio of junior equities valued at around $68 million. The appreciation in this portfolio was due largely to a 15% interest in Evrim (which is also on our list of current holdings). It has bought back some of its own shares this past quarter. Alderon Iron Ore announced an updated feasibility study on its Kami project, showing strong economics on the high-quality product; though Altius sold down some of its share-holding, it remains a 3% royalty. Altius also exchanged a 50% interest in various exploration interests in the James Bay area for an equity interest in Midland.

Altius is a core holding for us, though the share price tends to be volatile. It has risen from lows under $12 in August and early September to nearly $14 earlier this month, before the recent drop. We would wait to buy for prices closer to the mid-$12 level, depending of course on whether you already own or not.

New option generates cash and potential

Lara Exploration Ltd. (LRA, Toronto, 0.55) signed an option agreement with Capstone Mining on its Planalto Copper project in northern Brazil. The project returned very high-grade drill results over the past 12 months. Under the agreement, Capstone will make payments to Lara (US$150,000 immediately and $200,000 following receipt of a drill permit) as well as exploration commitments of $5 million over three years to earn 49%. At that point, Capstone can earn another 2% (for majority ownership) upon payment of $400,000 to Lara.

The agreement is a good one, seeing fairly aggressive exploration of a high-potential project as well as providing ongoing revenue to Lara.

Lara has other key assets, including a high-potential zinc project, Puitico in Peru; a 2% royalty on a new coper mine, Maravaia (formerly Curionopolis); and an interest in a lawsuit on its Libertade project.

The company has about C$2 million in cash and marketable securities, and has a history of making progress throughout the bear market at a low spend rate. It has various payments coming in, including on Maravia, where its partner must pay Lara $1 million if it is not in production this month (which it won't be). Lara has already granted one extension.

It also has several other properties, mostly in Brazil and Peru, with drilling under options and joint ventures. Lara has been very active in recent years, has multiple properties being worked and two high-potential assets, as well as Planalto. Management has proven itself most adept at doing attractive deals even in a down market and without excessive dilution. (Indeed, Lara is one of the juniors with minimal dilution over the past decade.) At this level, it's a very strong buy. Indeed, we will add another tranche of Lara to our list at C$0.55.

Waiting and wishing and hoping

Evrim Resources Corp. (EVM, Toronto, 1.50) is currently drilling on its 100%-owned Cuale project in Mexico. Evrim has planned a minimum of 3,000 meters comprising 10 to 15 drill holes, with the first holes testing the depth of the high-grade mineralization found in trenching at La Gloria. Drilling is also planned for four step-out areas identified by geophysics. Results will likely be released by the company in two batches, with the first round of results expected potentially by month end.

Being paid to take part in a scavenger hunt

Though Cuale is the focus of the company and the market at present, Evrim is not standing still on other fronts. Last week, it announced a very attractive exploration alliance in the western U.S. with Yamana. Under the agreement, Evrim has free access to Yamana's extensive dataset (obtained from work conducted over 30 years by Meridian and FMC). Yamana is funding the exercise with an initial $1 million. Yamana has the right to enter into an option agreement on any project unearthed by Evrim on predetermined terms (including payments to Evrim, initially of $150,000 and subsequent three years of $100,000 annually; and a royalty to Evrim). At the end of a three-year alliance, both companies have equal access to the database and are free to pursue any projects independently.

This is a superb opportunity for Evrim on very attractive terms which provide it with cash and a royalty on properties that Yamana wants, and opportunity for multiple projects it is free to deal to other companies if Yamana declines.

Drilling is also underway on a very prospective property Cerro Cascaron, optioned to a junior, Harvest Gold, and First Majestic is undertaking an infill drilling program on Ermitaño (on which Evrim holds a royalty) to upgrade the resource to indicated.

How good will the drill results be?

Results from Cuale could move the stock price significantly in either direction. Certainly, disappointing results—which we do not expect—could see the stock price fall back to levels before the initial trench results set the market aflame. Results which confirm the grade and show it extending to depth could see the stock price jump meaningfully. We are holding. Our next move will depend on the results when released and the market's reaction.

The fat lady is preparing to sing

Nevsun Resources Ltd. (NSU, NY, 4.48) continues to inch up as the acquisition by Zijin draws closer. In Canada, at C$5.90, the shares are just 10 cents below the tender price. Given we are not expecting another competing bid for the company—nor, on the other hand, do we see much risk of the acquisition not completing—this is a small discount for 50 days. Given the weakness in the Canadian dollar over the past month and a half, the U.S. price has not moved so much.

If taxes are an issue, you might wait and tender your shares, and if the proceeds are received next year (and you are a cash-basis taxpayer), potentially postpone your tax bill a year. (Note: we are not tax accountants; ask your accountant.) Now that the Lundin offer has expired, there is also the possibility that Nevsun and Zijin bring forward the closing date, which would make the tax consideration moot. Zijin has already received two of the three approvals from China (as well as the Canadian approval, which was fully expected).

If taxes are not an issue, a Canadian might sell, while a U.S. holder might wait in anticipation of a stronger Canadian dollar in coming weeks offering a better opportunity to sell. But we are only talking about pennies here. Much depends on whether you have alternative uses for the funds.

A potential new discovery is worth watching

Midland Exploration Inc. (MD, Toronto, 0.94 x 1.05) released very promising high-grade results from a new project in James Bay, with copper, gold, molybdenum and silver showings. The property, called Mythrill, is a new discovery in an underexplored area, though one with excellent infrastructure (a road and electricity). The second set of results on the heels of the initial release extended the strike length of mineralization to 2 km (from 700 meters); it remains open in all directions. The high-grade boulders suggest strong mineralization.

This is very early, with the assays mostly from grab samples and some channel samplings. It is not known yet if the mineralization is continuous. Although the company plans to conduct an IP survey and fly an electromagnetic survey, probably by Christmas, with snow falling, there will likely be little work on the ground and no drilling until spring. The company aims to generate drill targets from its work over the winter.

Midland is well funded, with $11 million cash and no debt. Moreover, in Quebec, there is a rebate of 38 cents for every hard dollar spend on exploration in the province.

The stock price jumped on the news, following both releases, from under 80 cents to over $1.20 before falling back. Given the likely lack of exciting news over the winter, the short-lived gains was not a surprise and the stock will likely further drift back in coming months, giving us an opportunity to more up more shares.

Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."

Disclosure:
1) Adrian Day: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: Evrim, Nevsun, Lara Exploration, Franco-Nevada, Royal Gold, Midland Exploration, Osisko Gold Royalties and Altius. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Evrim, Nevsun, Lara Exploration, Franco-Nevada, Royal Gold, Midland Exploration, Osisko Gold Royalties and Altius. I determined which companies would be included in this article based on my research and understanding of the sector.
2) The following companies mentioned in this article are billboard sponsors of Streetwise Reports: Pretium Resources. Click below for important disclosures about sponsor fees. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
3) Statements and opinions expressed are the opinions of the author and not of Streetwise Reports or its officers. The author is wholly responsible for the validity of the statements. The author was not paid by Streetwise Reports for this article. Streetwise Reports was not paid by the author to publish or syndicate this article. Streetwise Reports requires contributing authors to disclose any shareholdings in, or economic relationships with, companies that they write about. Streetwise Reports relies upon the authors to accurately provide this information and Streetwise Reports has no means of verifying its accuracy.
4) This article does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer. This article is not a solicitation for investment. Streetwise Reports does not render general or specific investment advice and the information on Streetwise Reports should not be considered a recommendation to buy or sell any security. Streetwise Reports does not endorse or recommend the business, products, services or securities of any company mentioned on Streetwise Reports.
5) From time to time, Streetwise Reports and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their immediate families are prohibited from making purchases and/or sales of those securities in the open market or otherwise from the time of the interview or the decision to write an article until three business days after the publication of the interview or article. The foregoing prohibition does not apply to articles that in substance only restate previously published company releases. As of the date of this article, officers and/or employees of Streetwise Reports (including members of their household) own securities of Evrim, Nevsun, Lara Exploration, Franco-Nevada and Royal Gold, Midland Exploration, Osisko Gold Royalties and Altius, companies mentioned in this article.

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