What are metal royalties and streams?
Metal royalty and streaming companies fund mines for exchange of money or precious metal. Mines often have trouble getting funding through traditional routes such as banks because of the high costs and unpredictable revenue. This is why they borrow funds from royalty and streaming companies. This is also beneficial for royalty and streaming companies as they get exposure to wide margins without taking on the risk of running a mine.
Quick Summary Points
- Metal royalty and streaming companies provide funds for mines in exchange for future payoffs.
- Royalty companies receive a fixed percentage of revenue generated by a mine while streaming companies receive physical metals.
- The benefit of these companies is larger margins, less exposure to risks, and diversification while still being in the mining industry.
Overview of a metal royalty company
A metal royalty company will give a mining company a loan and then receive a percentage of the revenue generated by the mine. Generally, the royalty is small, around 1% to 3 %. For example, Franco Nevada can give Kirkland gold $400 million in loans and in exchange, they get 3% of royalties on a mine. If Kirkland Gold’s mine produces 200,000 ounces of gold, then Franco Nevada will get 3% of the revenue generated from the 200,000 ounces. With an assumption that the gold spot price is $1,200, that means the mine made $240,000,000 million. With a 3% royalty, Franco Nevada will receive $7,200,000.
Overview of Streaming companies
A streaming company also provides a large sum of money to a mining company to get a percentage of interest in a particular mine. For example, the streaming company Franco Nevada might give a $600 million loan to the mining company Newmont Goldcorp. Newmont Goldcorp will use the loan to develop Mine A. In exchange, Franco Nevada will receive 7% of interest on Mine A until 200,000 ounces of gold has been delivered and then 2% after.
If Mine A produces 200,000 ounces of gold in a year, then Franco Nevada will receive 14,000 ounces of gold per year for roughly 14 years. However, Franco Nevada will not get the 14,000 ounces for free. When the deal is created, streaming companies will also set up an amount relative to spot price to purchase the gold. Thus, if the deal was 50% of the spot price, then Franco Nevada will get a discount and receive large margins. If the spot price is $1,200 per ounce, then Franco Nevada will pay Newmont Goldcorp $600 per ounce. With 14,000 ounces per year, Franco Nevada will make a revenue of $16.8 million and a profit of $8.4 million after purchase expense.
Benefits of investing in royalties and streams?
A royalty and streaming company has several advantages such as diversification, wide margins, and lower risk. Since these companies invest in many mines at once, if one fails, they will still receive revenue from other ones. They can also diversify the risk by investing in mines in different stages. Instead of only investing in mines in the production stage, these companies also have stakes in mines that are developing. By having multiple, some a much as 200, mines in stages of development, royalty and streaming companies will be less impacted if a few of these mines are not able to generate revenue.
Wide margins are another benefit that sets royalty and streaming companies apart from mining ones. A mining company sell the metals at the spot price or futures price and profit is created depending on the cost of operating the mines. However, a streaming company get to buy the metal at reduced prices which guarantee a wide margin. The reduced prices are significant enough that the margin will stay very profitable even if the spot price falls. A royalty company also has a large margin as they receive a percentage of revenue without having to pay the high costs of operating mines.
Another benefit is lower risk compared to pure mining companies. This is because royalty and streaming companies do not actually operate or take on the risk of mines. Mines are inherently complicated and prone to delays. This includes geologic conditions leading to disasters, work stoppage, growing labour costs. All of which delays the flow of gold and increases costs. As royalty and streaming companies are not exposed, they do not have to invest extra capital to operate the mines. Profit margins are also not affected as overhead costs remain low.
Risks of investing in royalties and streams
Even with the benefits of higher margins and consistent earnings, there are still risks with investing in royalties and streams. One of the main risks relates to the structure of the business. To invest in mines, royalties and streams need a large amount of capital. The two ways to get the capital is through stocks or debt. Companies that want a debt-free balance sheet will raise money through stock issues. This leads to dilution of ownership stake for existing shareholders. If the investment leads to a successful mine, the investors will be rewarded with higher earnings.
A company can also get funding through debt and they will be responsible for the principal and interest payments. If the mine is profitable, then the cash flow will reduce debt over time. If not, then the company won’t be able to pay back the interest and principal expense.
To a lesser extent, spot prices and mine production still impact royalty and streaming companies. If the spot prices fall, royalty companies will receive less revenue and streaming companies will have to sell metals at a lower price. In a case of mine delays, both companies will be impacted by a delay of gold flow.
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