Introduction

I own a dividend stock that benefits when metals like gold and silver do well: Caterpillar (CAT), the Illinois machinery giant. This decision was based – among many other reasons – on this quote:

In a gold rush, sell shovels.

– Unknown

In this article, I want to highlight another stock that may be of interest to investors looking for dividends in the gold mining industry. Royal gold (NASDAQ:RGLD). This Denver-based gold company is a light gold stream, which means it benefits from rising gold prices without having to bear all the risk involved in the gold mining process. On top of that it means investors benefit from rising gold prices, it also provides downside protection during periods of falling gold prices as well as a way to earn returns higher totals. This is in addition to a dividend yield, which benefits from regular increases.

Although there are countless ways to invest in gold (physical, gold ETFs, miners, junior miners and streamers), I think this is a great way to invest (indirectly) in this precious metal – especially for people looking to avoid high ETF expenses. ratios.

So, let’s look at the details!

Why streamers? And what is royal gold?

There are many ways to invest in gold. In fact, there are so many ways and philosophies that we could spend at least 10,000 words on the pros and cons of each method.

While there are some very good gold mining stocks out there, I think the low cost alternatives are the best long term investments. This includes physical gold (I don’t own any) for security reasons – especially in non-US dollar countries with less stable currencies – and gold streamers.

To use the United States World definition:

Royalty companies serve as specialized financiers who provide seed capital to help fund producers’ exploration and production projects. In return, they receive royalties on everything produced or rights to a “stream”. A stream is an agreed upon quantity of gold, silver or another precious metal at a fixed price below the market price.

The reasons why miners work with streamers is that borrowing terms usually lead to faster transactions. Additionally, streamers have expertise that they bring to the table as consultants.

This is how royal gold the dish:

We acquire and manage precious metal streams, royalties and similar interests. We seek to acquire existing stream and royalty interests or finance projects that are in production or in the development phase in exchange for stream or royalty interests. We do not engage in mining operations on the properties in which we hold stream and royalty interests and are not required to contribute capital costs, environmental costs or other operating costs on the properties .

As the price of gold always matters to streamers, operating margins tend to be cyclical. However, RGLD’s operating margins are well above the margins of large mining companies engaged in physical mining operations, as shown in the chart below. In addition, the company posts an adjusted EBITDA margin of 80%.

About a third of the company’s revenue is from royalties. Royalty fee are taxed as passive income and:

Generally structured as gross smelter return (“GSR”), net smelter return (“NSR”), net value return (“NVR”) or net profit interest (NPI). The difference is the amount of deductions allowed before the royalty calculation, ranging from zero deduction (“GSR”) to all costs (NPI).

Two-thirds of total revenues are flows, which:

Generally structured as the streaming company receiving a percentage of metal produced in exchange for an initial cash investment and an ongoing spot price per delivered ounce.

As of July 2022, the company had 185 properties in 12 countries. 73% of its revenue comes from gold assets, followed by copper, silver and others. In light of ongoing geopolitical unrest like war, it helps that the company has no exposure in Russia and limited exposure in countries that tend to be prone to social and political unrest.

In addition, after 2023, at least five other large mines will come into production, which will contribute enormously to revenues.

The dividend and relative performance

Thanks to its business model, the company generates high free cash flow in years when CapEx is low – which is only the case when large investments take place, and not on a regular basis.

For example, next year the company is expected to generate $455m in free cash flow, up from $347m in 2022E. This implies a return of 6.8% FCF for 2023.

This not only supports the company’s dividend, but also future increases.

The current dividend is $0.35 per share per quarter. That’s $1.40 per share per year. This implies a dividend yield of 1.4%. This return roughly matches the 1.5% return of the VanEck Gold Mining ETF (GDX).

It’s not an exciting yield, but it’s steadily increasing. Since 2000, the dividend has increased by 17% per year. However, I like to exclude the early years of the business. This may be biased, but at the time the company was far from mature and I doubt most current (retail) investors would have bought in the early years. Over the past 10 years, the average annual dividend growth has been 5.7%. However, the most recent rise announced in November 2021 was 16.7%, showing that rising gold prices do indeed end up benefiting cash flow to investors.

It is also helpful if the company has no positive net debt. This year, Royal Gold is expected to end up with $330 million in net cash, meaning it has more cash than gross debt on its balance sheet.

Currently, the company has $180 million in net cash, which is expected to increase due to the aforementioned increase in free cash flow, which eventually increases cash after dividends are paid. In addition, RGLD has approximately $1.0 billion of available credit on its credit facility, bringing total available liquidity to $1.2 billion.

Moreover, the company effectively outperforms its peers, thus ending up delivering what investors expect from good streaming companies.

Since December 2006, Royal Gold has returned (including dividends) 8.5% per annum. This roughly matches the performance of the S&P 500. However, the standard deviation was much higher at over 40%. The good news is that it beat the VanEck Gold Mining ETF by a mile, with this ETF costing investors 1.7% per year during this period, in addition to nearly 40% volatility. Additionally, this ETF has an expense ratio of over 0.50%. Royal Gold does not have an expense ratio as it is not an ETF.

The price of gold rose 6.5% over this period, using the SPDR Gold Shares ETF (GLD) as a benchmark. It also came with a much lower standard deviation, but no dividends.

Additionally, RGLD has beaten the GDX ETF in most years and on an annualized basis in all but the past three years.

That said, there’s another reason to love streamers.

Another reason to love streamers – Production costs

In a recent reportCME Group (CME) has highlighted an issue that – I believe – is underestimated: the supply of gold.

Although I have written extensively about the supply of metals in general, I have neglected precious metals. As CME Group shows, global gold production is down 7% since 2016.

Silver production is down 8.5% during this period.

As the company notes:

Mining supply appears to have a strong impact on precious metal prices over time. There appears to be a strong inverse relationship between the annual growth rate of the total quantity of gold supply (current year’s production divided by the cumulative supply of previous years) and the actual price of gold expressed in 2021 US dollars (Figure 5).

The good news is that gold mining is very profitable right now. With all-in sustaining costs of around $1,070, the “average” mining company earns $650 per ounce of gold.

While this is a good basis for a thesis that expects increased production, there are environmental and political reasons that prevent mines from increasing production.

Additionally, given the inflationary pressures, I think there is a strong case for asset-light streamers with growth potential who benefit from both high prices and higher future production.

This is where Royal Gold shines.

Evaluation

Royal Gold has an implied FCF yield of 5.2% in 2022 and 6.8% in 2023. While these numbers are subject to change based on fluctuations in the price of gold, they are on the high side. The current multi-year high is in the high 5% range.

The price/cash flow ratio is at 15.0x. That’s close to one of the lowest levels in years and significantly cheaper than other streaming peers according to Royal Gold.

Carry

There are many ways to invest in gold. For example, physical gold coins and bars, physical gold ETFs, miners, equipment producers and streaming companies.

Royal Gold, one of the biggest streamers in the world, is a low-asset company benefiting from high gold prices and a very large free cash flow used to reward investors with ever-increasing dividends – all over several gold price cycles.

The company looks like a much better investment than miners and physical gold, as it has shown superior returns and downside protection (compared to miners) due to a very healthy balance sheet and business model light in assets.

It also helps that the company should see higher volumes due to new projects in an industry that is not expected to ramp up production any time soon.

Also, the company is very well valued after going from around $150 per share to $100 per share.

I believe RGLD is now in the buy zone, which has provided a lot of support for the stock over the past 3 years.

Although RGLD is a solid dividend stock, I don’t consider the stock a must-have stock. The dividend yield is still low compared to basic materials and industrial peers. And the volatility is extremely high.

However, it is an excellent stock for investors specifically looking for long-term exposure to gold.

(Disagree? Let me know in the comments!