>Royal Gold fights back after Barron’s sledging
By: Tim Wood
Posted: 2003/03/05 Wed 17:00 EST | © Mineweb 1997-2003
NEW YORK -- Having lost one third of its stock price to a Barron’s article sceptical of its valuation, Royal Gold [RGLD] has fought back, but the damage appears to be semi-permanent.
Much has been made of Barron’s reliance on an admitted short-seller for its information; a silly complaint since there is never an outcry when longs benefit from stock punts which are vastly more common in any and every context. Every informant has a vested interest, so full credit to Barron’s for disclosing that of its source.
What about Barron’s paltry valuation of anything from $4.50 to $9 for Royal? An immediate problem is that none of the top analysts cover Royal. Canadian outfits Canaccord and Griffiths McBurney & Partners used to cover it, but that was way back in 2001. After all [adopt cynical attitude], royalty companies do not generate a lot of investment banking business.
That leaves no comparable benchmarks to draw on, whilst the royalty business is vastly different to conventional mining. Its principal value is in offering a financing option that does not involve equity dilution, hedging or debt which invariably does more harm to resource investors than a royalty, especially in small companies.
In the case of Royal, the situation is more exaggerated since it the sole royalty pure-play left in North America following the departure of Franco-Nevada and Repadre, although the latter retains some of that flavour as a non-operator, but with an exploration portfolio that detracts. If you want a royalty company, you only have one option now and its name is Royal Gold.
As Jim Sinclair noted earlier this week, the only reliable way to value a business is to see what someone might pay to own all of it. In the case of Franco-Nevada, Newmont ended up paying 97 times annual 2001 sales. That would value Royal at $931 million at a gold price of $300 per ounce, or $1.5bn at $350 per ounce. Clearly that is unrealistic without Pierre Lassonde and Seymour Schulich in the driving seat, but it's an indication.
In the Repadre example, Iamgold [IAG] paid nearly 34 times 2001 sales. Unsurprisingly, Royal trades at about the same multiple at a similar gold price to when the Iamgold/Repadre deal closed. If you take the average gold price for the year-to-date, then Royal is currently trading at just 20 times the revenues such a gold price should generate in 2003 – which still ignores any potential growth. To trade at the Repadre multiple pre-merger, Royal’s price would need to be $21 at these gold prices.
Are sales an appropriate measure? Why not, in this industry they are a function of the commodity price rather than barter deals and the revenue round tripping games of the just-deceased Internet Age. If you prefer an earnings multiple, then Royal trades at a discount relative to many gold producers except for the waterlogged hedgers.
Barron’s missed that completely, just as it missed the option value that reserves and resources infuse to the overall price. It also missed management risk; there’s a lot less of it at Royal than if you buy a conventional operator.
Likewise, the publication was blindsided to the role a company like Royal plays in acting like a stock picking proxy for gold investors. The best returns are made through timely investments in advanced projects or those with large reserve growth potential. The average Joe is not particularly good at finding those or being able to participate at the right price, but when he invests in a royalty company, he is buying their expertise and can take refuge from the flood of information calling him to a decision.
In that vein, Royal has promised to double its revenues by mid-2004 and to ensure that it’s the right sort of growth in terms of increased free cash flow per share. Few companies promise that and so far Royal has not given cause to doubt it will achieve its goal.
Most of all, Royal represents the sort of raw leverage to gold that investors crave. While many companies have seen their betas fall quite quickly as gold has hit $350 per ounce, Royal remains highly geared all the way to $500 an ounce. The same applies on the way down, but we’re up, handsomely.
Is it expensive? Sure; relative to general equities it is expensive, but it is not a general equity suffering a general equity malaise. Is it perfect? Of course not, and one of America’s top mining investment brains cautioned Mineweb: “[Royal] would never have been a tag for [my firm] – there is no catalyst, nothing fundamentally flawed (or uniquely good) about the business.”
Ultimately, Barron’s and its source are proved wrong by the market’s decision not to take Royal down to the supposed value lines of $9 (about 15 times estimated 2003 sales) and $4.59 (8 x forward sales).
Don’t look in the rear-view mirror when valuing gold companies and don’t forget that all gold company investments require some suspension of logic and rationality – what else explains the fact that negative discount rates best predict gold stock prices?
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