Royalty Sector Review: Abitibi (ATBYF) Shares Rally.

abitibi

Summary

To my astonishment, the streaming/royalty sector has outperformed the classic miners this year up to date.

The biggest winner was Abitibi – this year the company’s revenue should grow substantially on the Canadian Malartic royalty.

Investors were also heavily betting on Metalla, an emerging growth story.

As a result, most plays have gone out of slight undervaluation. According to my discounted cash flow valuation model, only two picks are undervalued today.

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Introduction

Here is the fourth edition of Simple Digressions’ review of the streaming/royalty sector. Since the beginning of 2019, the STREAM index has delivered a profit of 9.7%, beating the broad precious metals mining sector represented by GDX (a return of 6.4%):

Chart 1

Source: Simple Digressions

Note: The Stream index, replicating the price action of five big streaming/royalty plays (Wheaton Precious Metals (NYSE:WPM), Royal Gold (NASDAQ:RGLD), Franco-Nevada (NYSE:FNV), Osisko Gold (NYSE:OR) and Sandstorm (NYSEMKT:SAND)) was created by the author.

As for individual stocks, the best performing play was Abitibi (OTC:ATBYF), returning as much as 45.4%. The last in the rank is Maverix (OTC:MACIF) (a loss of 4.3%):

Chart 2

Source: Simple Digressions

Now, as usual, let me look at two valuation measures.

Valuation

In my opinion, the streaming/royalty sector is considered less risky than classic miners. Keeping this thesis in mind, I have calculated the equity value of the following streaming/royalty companies: Franco–Nevada, Wheaton, Royal Gold, Sandstorm Gold, Osisko Gold Royalties, Metalla Royalty and Streaming (OTCQX:MTAFF) and Maverix Metals. Then, using these figures and current share prices, I have identified the undervalued and overvalued picks. Here is my methodology:

  • Firstly, I calculate the annual (the last four quarters, starting from Q4 2017) cash flow from operations excluding working capital issues.
  • Then, I divide the annual cash flow by a discount rate of 5%. If my basic assumption (a streaming/royalty sector is less risky than classic miners) is correct, a discount rate of 5% seems reasonable. Additionally, I presume that, contrary to classic miners, the life of each company under my survey is unlimited.
  • As a result, I arrive at the core value of the streaming/royalty business; in other words, the value of this business is equal to the time value of money generated by the portfolio of streaming/royalty assets held by each company.
  • Then I calculate the equity value of each company using the following formula: equity value = core value of the streaming/royalty business + cash less debt (as at the end of Q3 2018).
  • Finally, I calculate the ratio defined as current market capitalization/equity value; if this ratio is higher than 1.0, a company is overvalued; on the other hand, if the ratio is lower than 1.0, it means undervaluation.

The sector

Applying the above-discussed methodology to most of royalty/streaming plays, I have arrived at these results:

Chart 3

Source: Simple Digressions

Well, it looks like the recent rally has brought many plays into the overvaluation zone – as the chart shows, only two picks are undervalued today (Maverix and Wheaton). What is more, I am pretty surprised to see Wheaton among the undervalued plays. To remind my readers, last year the company settled its long-term legal dispute with the Canadian tax office but Wheaton share prices, despite a pretty nice rally (9.1% this year up to date), are still undervalued.

Price/Book Value

Now, another valuation measure. The chart below shows a Price/Book Value multiple calculated for 10 streaming/royalty plays. To remind my readers, the Price/Book Value multiple discloses how Mr. Market values the assets held by each streaming/royalty play:

Chart 4

Source: Simple Digressions

Since my previous survey there has been one change – now Metalla shares are trading at a P/BV multiple of 3.0 (instead of a 2.6, as disclosed in my previous report). I guess investors perceive Metalla as a growth story – as the chart below shows, since 4Q 2017, the company has increased the book value of its royalty/streaming portfolio from C$18.5M to C$39.5M:

Chart 4

Source: Simple Digressions

What is more, this month Metalla acquired another royalty (I discuss this transaction below), increasing the book value of its portfolio to C$44.8M, roughly.

Latest developments

Now let me discuss the latest events reported by a few streaming/royalty plays.

Sandstorm

In January 2019, Sandstorm purchased a 0.9% NSR royalty on precious metals produced from the Fruta del Norte project owned by Lundin Gold (OTCPK:FTMNF). I have made a few calculations using the data disclosed in the technical report for Fruta del Norte and arrived at an after-tax net present value (NPV) of this royalty of $23.4M, well below the total consideration paid ($32.8M). To calculate NPV, I have applied the current prices of gold and silver ($1,300 per and $15.5 per ounce, respectively). Well, it looks like the company is betting on higher metal prices or the extended life of the mine (or both factors).

Metalla

In February 2019, Metalla acquired a 1% NSR royalty on Atlantic Gold’s Fifteen Mile Stream project in Nova Scotia, Canada. Currently, the Fifteen Mile Stream project (which is a part of the Moose River mining complex) is at a development stage and, according to Atlantic Gold (OTCPK:SPVEF), it should commence mining operations in 2021:

Graph 1

Source: Atlantic Gold

Keeping in mind that Metalla paid $4M for this royalty and an undiscounted pre-tax cash flow to be delivered by Fifteen Mile Stream between 2021 and 2026 stands at $5.1M (assuming a gold price of $1,300 per ounce and total production of 391 thousand ounces of gold), this deal looks like a long-term bet on gold prices. Quite risky, in my opinion.

Franco-Nevada

On February 7, 2019, Franco-Nevada released the revised production guidance for 2018. According to this release, last year the company produced 445–450 thousand ounces of gold equivalent. It means that Franco has not met its initial guidance of 460–490 thousand ounces. What is more, in 2018, the company recorded the first drop in production since 2013:

Chart 6

Source: Simple Digressions

Altius

Since the beginning of January 2019, Altius (OTCPK:ATUSF) has purchased two new royalties:

  1. In February, it purchased a 3% GRR (gross revenue royalty) on a number of wind energy development projects owned by Tri Global Energy (TGE). According to the company, over the next three years, it will invest $30M in TGE, further diversifying the current royalty portfolio.
  2. In January, the company purchased a 2% NSR royalty on the Curipamba copper-gold-zinc project owned by Adventus Zinc (OTCQX:ADVZF), paying $10M. To remind my readers, Altius holds a 21% stake in Adventus.

I am particularly impressed by the first acquisition. According to the company:

This is an important step in executing our strategy to ultimately replace our Alberta electrical coal royalties, which are being phased out by 2030 as a result of government policy changes

Royal Gold

Royal Gold has just released its 4Q 2018 results (the company’s fiscal year ends each June 30). As the chart below shows (the panel on the left), in 2016, the company’s stream/royalty portfolio reached a kind of a plateau (the red rectangle):

Chart 7

Source: Simple Digressions

As a result, since 2017, Royal Gold’s cash flow from operations has stabilized at around $270M a year. Well, Royal Gold looks like an oasis of calm…

Ely Gold

In January 2019, Ely Gold (OTCQB:ELYGFentered into an option agreement with Integra Resources, an exploration company developing its Delamar gold project in Idaho, U.S.A. I guess it is a typical deal for Ely where it options its property to an exploration company in exchange for option payments. Then, if an explorer finally exercises its option, Ely retains a royalty on this property.

As for the option agreement with Integra – the leased War Eagle Property is located 9 kilometers from Delamar. Under the option agreement, Integra will pay Ely $200 thousand in four annual installments. In the case Integra exercises its option, Ely will retain a 1% NSR royalty on War Eagle.

Abitibi Royalties

On January 16, 2019, Abitibi announced the commencement of production in the area covered by the company’s 3% NSR royalty at the Canadian Malartic mine. I guess it is a milestone event for Abiti. As a result, this year, we should see a substantial increase in Abitibi revenue. The market reaction to this announcement was very violent, sending Abitibi shares 45.4% higher this year up to date.

Summary

I am a bit surprised to see the outstanding performance of the streaming/royalty sector this year. The sector has outperformed the classic mining stocks by 3.3 percentage points. To remind my readers, in the past, the streaming/royalty plays outperformed classic miners during bear markets and consolidation phases in the gold cycle. This time it looks like we have a strong leg up in precious metals so we should see the classic miners outperforming the sector, which is not the case. Hence, I am a bit surprised (maybe I am wrong and the precious metals market is not in a classic bull stage?).

As discussed at the beginning of this article, this year, the big winners are Abitibi (a 3% NSR royalty on Canadian Malartic is now a productive asset), Metalla (a growth play) and Sandstorm (another growth play).

I am also surprised to see pretty poor performance of Wheaton shares – despite winning a lawsuit with the Canadian Tax Office, the company’s shares are up only 9.1% this year up to date.

Final note

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Disclosure: I am/we are long CEF, GDX, KL, SAND, ARREF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.