The main difference between a streaming company and royalty company is
that a royalty is cash paid as a percentage of revenue, while a stream
involves the actual delivery of physical metal to the holder of the streaming
agreement. The finance model has also been called a volumetric production
payment transaction and originated in the oil and gas sector.
Advantages of the Streaming/Royalty Model
There are considerable advantages of a streaming/royalty business model
including:
1) Diversification-A streaming company has agreements with multiple
miners, thus spreading and mitigating any potential risk. The larger
companies have dozens of deals and multiple income streams.
2) Unlimited Upside Potential-Since the deals they secure are usually for
a percentage of the mine's production for life, the streaming company stands
to benefit immensely if new zones are discovered and actual production comes
in higher than originally forecasted. This occurs all of the time in the
industry, as drilling delineates new resources, either increasing annual
production or vastly extending the life of the mine.
3) Limited Downside Risk-While a miner may see profit margins squeezed as
the cost of production rises, the streaming company typically has a contract
for a percentage of the gold/silver production, thus eliminating the issue of
rising costs. Royalties are paid out of top-line revenue before any operating
expenses are accounted for. In addition, the contracts usually contain a
number of provisions protecting the streaming company in the event of fraud,
misrepresentation, etc. This is all on top of the considerable due diligence
that is exercised before entering into any streaming deal.
4) Favorable Tax Treatment-Streamers enjoy a favorable tax situation
courtesy of the Canadian government. As long as they reinvest their proceeds
or pay it out as dividends, they are gifted with a tax rate in the
neighborhood of 0-8%. That's a huge advantage when it comes to net profit
margin.
A few of the best-known streaming/royalty companies in the mining space
are Franco-Nevada
Corp. (FNV:TSX; FNV:NYSE), Silver Wheaton
Corp. (SLW:TSX; SLW:NYSE) and Royal Gold Inc.
(RGLD:NASDAQ; RGL:TSX). These stocks have all performed well during the
2016 bounce in commodity prices, offering leverage to the underlying move of
the metals. For example, while gold and silver are up around 20% year to
date, the three stocks mentioned above are up 45-55% in the same time period.
But I believe the best returns in the streaming/royalty sector will come
from junior streamers that have yet to be fully understood and appreciated by
the market.
AuRico Metals: The New Royalty Kid on the Block
One of my favorite among the small-cap streaming/royalty stocks is AuRico Metals
Inc. (AMI:TSX). I first recommended the stock in September 2015 around
$0.68, dubbing the company the "New Royalty Kid on the Block." The stock price is up
75% year to date in 2016, outpacing the gains of the larger and more popular
streaming stocks.
AuRico Metals was created in July 2015 as a spinout from the merger of
AuRico Gold and Alamos Gold. The company was created to hold AuRico's Kemess
project, a 1.5% net smelter return royalty (NSR) on the Young-Davidson mine,
and AuRico's Fosterville and Stawell royalties.
On Sept. 8, 2015, AuRico Metals announced the acquisition of Mineral
Streams Inc., a private company owning a 0.25% NSR royalty on the Williams
mine at Barrick Gold's Hemlo complex, a 0.5% NSR royalty on Wesdome Gold's
Eagle River mine, and a 1.5% NSR royalty on Barrick's David Bell property,
which also forms part of the Hemlo complex.
The really exciting part of AuRico's portfolio to me has always been the
upside potential of its partners' projects. Not only is its Young-Davidson
royalty quickly ramping up production, but reserves have increased by
double-digits at Fosterville, Hemlo, Eagle River and Stawell. The latest
increase to reserves at Fosterville was 34% and AuRico Metals has exposure to
this upside.
The royalty projects are expected to generate annual revenue of roughly $7
million ($7M) at $1,150/ounce ($1,150/oz) gold. And they offer revenue growth
potential well into the future, from both an increasing gold price and
increasing production. Even with zero production growth, their revenues are
projected to rocket nearly 50% higher to $10 million at $1,650/oz gold.
Not to be overlooked is the fact that AuRico is not solely a royalty
stock. The company also owns 100% of the Kemess underground gold-copper
project in British Columbia, Canada. In March of this year AuRico announced a
positive feasibility study with a base case after-tax NPV of CA$289M. This
moves up to CA$421M with copper prices at $3.00 per pound. The study outlines
the potential to produce 238,000 gold equivalent ounces per year at all-in
sustaining costs of $682/oz over the first five years.
So, we have a company generating $7M per year in royalty revenue and
sitting on a project with an after-tax NPV@5% of around CA$300M, yet its
market cap is under CA$150M. And to add to the upside potential, this company
is a likely takeover target for a larger streaming/royalty company.
This stock has been in the Gold Stock Bull model portfolio since September
of last year and is up over 55% since it was placed on the list. The stock is
up significantly in 2016 and recently reached overbought levels. I would be
inclined to wait for a dip below CA$0.95.
But short-term sentiment aside, I think AuRico Metals has a strong future
and will continue to outperform its peers. The company has a diversified
portfolio of royalties and can use these revenues to develop its low-risk,
low-cost project at Kemess with minimal shareholder dilution.
Applying the Streaming Model to Agriculture
The first company to apply this successful business model to agriculture
is Input
Capital Corp. (INP:TSX.V). The company flies under the radar of most
investors, but I think it will generate outsized returns over the next few
years.
Input Capital enters into canola streaming contracts with canola farmers
in Western Canada. Pursuant to the streaming contract, Input purchases a
fixed portion of the canola produced, at a fixed price, for the duration of
the term of the contract.
Input is a non-operating farming company with a portfolio of over 100
canola streams, all of which produce canola and revenue for Input in the year
the agreement is signed. Over the last four years, Input has invested $123.1M
via streaming contracts to strengthen farm balance sheets and enable improved
crop production. The company is focused on farmers with quality production
profiles, excellent upside yield potential, and strong management teams.
During the most recent quarter, Input signed 38 canola streaming contracts
for total up-front payments of $11M. Year-over-year, Input's streaming
revenue has increased by 173% on an increase in canola streaming volume of
160%.
The company has zero debt and uses existing cash on the balance sheet
along with cash flow from operations to fuel its rapid growth.
I like buying companies where insiders have skin in the game and the
interests of management are aligned with the interest of all shareholders.
Insiders own over 20% of the company and have a stated focus on strong
returns resulting in robust compounding of capital.
Speaking of management, Input Capital has a track record of building and
profitably exiting deals in the Canadian agriculture sector. It launched the
first farmland private equity fund in Canada in 2005 and raised $53M in
equity. In January 2014, it closed the sale of a 115,000 acre portfolio of
Saskatchewan farmland to the Canada Pension Plan Investment Board (CPPIB) for
$128M.
I believe that Input Capital is undervalued and is currently offering an
attractive entry point. This is due to the announcement of three these
canceled contracts in November of last year that caused the share price to
drop nearly 50%. Investor panicked out of their positions and I believe they
over-reacted.
On May 11, Input Capital announced that management expects via auctions
and land sales to completely recover all of the capital associated with the
largest streaming contract that was canceled. In fact, it expects to fully
recover all of the capital associated with all three terminated contracts.
I believe that the share price should return to previous levels following
these announcements. This implies upside of at least 50%. But considering how
fast the company is growing its streaming portfolio and revenues, the upside
potential is likely much higher.
Input may even be able to recover an amount exceeding the value of the
original contracts, per the contract security details. Furthermore, Input has
learned a hard lesson in this process and has now better diversified its
portfolio so that it is less concentrated/vulnerable:
Portfolio and counter-party risk continues to be reduced as a result of
improved process and underwriting procedures during due diligence and by
significantly reducing the average streaming contract size.
Another bullish development for Input is rising canola prices. After price
declines across the board over the past several years, food prices appear to
have bottomed and have started to head higher in 2016. The following chart
shows the strong rebound in canola prices over the past few months. While
prices can be very volatile, I expect a continuation of this upward trend
throughout 2016 and into 2017.
The technical chart for Input Capital shows the upward trajectory that was
in place since 2013 and the steep gap downwards that occurred in November of
2015. The price continued to slide to a low of $1.50, but has bounced back
towards $2.00 in the last week. The RSI became overbought, but I think the
upside potential remains enormous and I have a target price of $4.00.
At minimum, I think the share price should recover toward the previous
trend line and bring the price to around $3.60. But considering recent growth
in its portfolio, higher canola prices and strong financials, I expect the
share price to climb to at least $4.00 over the next 12-18 months. This
represents upside of greater than 100% from the current price!
Input Capital will release fiscal Q4/16 and year-end results after market
close on Tuesday, May 31, 2016. I expect strong results that will help to
propel the price higher. We already have a long position in the Gold Stock
Bull model portfolio, but may look to add to the position prior to the
release of these financials.
I have remained bullish on Input Capital through the recent turmoil. I
wrote the following to subscribers prior to the recent bounce:
The default on 3 streams was clearly a negative but the sell-off has
been substantially overdone. Input remains a strong buy during the dip with a
long-term view.
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markets in gold, silver, energy, rare earth metals and agriculture. Mr.
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consulted to Fortune 500 companies around the globe.
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