Commodity investing through a mining royalty
17 October 2018
Mining royalties offer a range of advantages over direct investment, not least the they receive Gross Revenue Royalty, says Julian Treger, CEO Anglo Pacific Group
When most people think about royalties, they think about music royalties, but there are many other options for clients to consider and they are growing in popularity. They are a unique investment that provides a stable, low risk regular income and they range from healthcare, entertainment and also in the mining industry.
What is a Mining Royalty?
A royalty is a right to receive payment, based on a percentage of the minerals or other products produced at a mine, or of the revenues or profits generated from the sale of those minerals or other products at a mine.
Royalty financing for mining companies is an alternative way for both mining companies to fund the upfront capital expense of projects as well as for the royalty holders themselves to gain a return from its initial investment through revenue generated from the project once in operation. A royalty investor typically provides upfront capital in exchange for a percentage of the future revenues or cash flows from the sales of the mined product.
With the large upfront capital associated with mining projects, royalties offer companies an avenue of funding which is only repaid once the project in question has started to produce cashflow. In turn, the royalty holder traditionally receives a Gross Revenue Royalty (GRR), meaning a percentage of revenue before costs of the project are taken into consideration.
This is a key benefit for the royalty holder as it maintains a stream of cash return without being exposed to the capital and operational costs of a mining project which can often erode the margin of an investment.
Why are Mining Royalties a good investment?
Investment in mining royalties offer a particularly unique and attractive asset class as mining royalty companies can pay a significant yield, made possible through both the income generated and their relatively low G&A and operating costs.
Mining royalty companies keep their overall costs low as they do not need the large operational teams that would be associated with a traditional mining company as well as being able to run the business from one location.
Investment in mining royalties also offers exposure to a range of commodities while also being protected from the cost of inflation which often blights the typically cyclical mining industry. With the dollarized nature of the global mining industry, currency exposure is not such an issue compared to other sectors, with income from mining royalties usually paid in US dollars. As well as an attractive yield, mining royalty companies can also provide significant growth through reinvesting in other royalties.
Where to invest?
Royalty companies in the mining sector are common place in the US and Canada where in particular, gold and silver royalty companies such as Franco-Nevada Corp and Wheaton Precious Metals Corporation offer a yield from the royalty earnings while offering growth through further investment in royalties on mines.
While the investment proposition is attractive with a significant yield and more protection than owning gold directly, exposure to only one commodity could still be seen as being a risky and concentrated investment proposition.
When looking to invest in a mining royalty, it is important to choose one that offers diversified exposure to mining royalties and has an evolving portfolio. A typical diversified portfolio would contain a range of royalties over coal, uranium, iron ore, vanadium (used in the production of lithium batteries) and gold. The diversified composition of a portfolio means that investors are not exposed to one particular commodity and ensure that dividend payments are protected. There needs to be a clear focus on commodity exposure, being very careful when taking into account the jurisdictions of the royalties held and concentrating on countries with minimal political risk.
One example of an individual high earning royalty is the Kestrel thermal coal mine in Western Australia. While coal has been under certain scrutiny from environmental groups, it still makes up a significant source of power generation for many countries, especially emerging markets. This solid demand and decreasing supply has meant that coal prices have more than doubled in the past two years, which in turn has meant that income from the Kestrel royalty has been particularly strong. To add to a strong coal price, the operatorship of the mine was recently sold by mining giant Rio Tinto, to an Indonesian conglomerate which has showed its intent to double production at the mine, adding further to future profitability.
A recent focus for us has been on commodities which go towards the manufacture of electric vehicles. Consultancy Wood Mackenzie estimates battery demand for transportation is set to rise by almost forty times by 2040, so with the demand for battery metals which go into producing them also increasing, investment in royalties which have the potential to increase income through the underlying commodity is an attractive proposition. The Maracás Menchen Vanadium mine in Brazil is a great example of this.
While royalties are not new to the mining industry, with the tightening of liquidity in the market, royalties offer a key source of financing to project owners and opportunities for royalty companies to grow their portfolios. This means that it is also of growing interest to those investors that wish to gain exposure to the sector in an innovative way but with the protection of a risk reward profile that is balanced and diversified.
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