FNV - EMX Royalty: The Timok Problem Solved

2023-09-13 10:42:19 ET

Summary

• EMX Royalty and Zijin Mining have reached a compromise in the Timok royalty dispute, reducing the royalty rate from 0.5% to 0.3625%.
• EMX will receive a total of $6.68 million in royalty payments from Zijin, for the H2 2021 - H1 2023 period.
• EMX is attractively valued compared to its peers.
• The relations with Franco-Nevada keep on tightening, Franco-Nevada emerges as a potential acquirer.

EMX Royalty ( EMX ) is a precious metals R&S company with an attractive valuation compared to the industry standards, a large asset portfolio, one of the biggest in the industry, and good growth prospects. However, over the last 20 months, its share price has been negatively affected by a dispute with Zijin Mining ( OTCPK:ZIJMF ), regarding one of its key assets, the Timok (Cukaru Peki) royalty.

Fortunately, the problem has been finally solved. On September 5 , EMX announced the solution for the Timok royalty dispute. EMX and Zijin Mining agreed to reduce the 0.5% royalty to 0.3625%. The royalty covers the Brestovac exploration permit area, as well as a part of the Jasikovo-Durlan Potak exploration license located to the northwest (map below). What is important, the Brestovac area includes the Cukaru Peki copper-gold deposits (the Upper, as well as the Lower Zone). The Upper zone is being mined, while the Lower Zone is in the development stage right now.

Under the revised royalty agreement, EMX will receive $1.59 million for the July-December 2021 production, $3.2 million for the 2022 production, and $1.89 million for the H1 2023 production. It means $6.68 million in total. Starting in Q3 2023, EMX will be receiving the royalty payments from Zijin on a quarterly basis.

Zijin Mining acquired the Timok property several years ago by acquiring Nevsun Resources. The problems with the royalty held by EMX started in late 2021 , as the mine commissioning was underway, and the royalty payments were about to start. EMX announced that Zijin declared a reduction of the 0.5% NSR royalty on the Timok copper-gold mine to 0.125%. Although the royalty agreement contained a provision for the reduction of the royalty rate under certain conditions, EMX believed that these conditions hadn't been met, and therefore, it initiated the arbitration process. However, surprisingly, only a month later , EMX decided to suspend the arbitration. Since then, the negotiations have been ongoing, but EMX hasn't provided any specific news. Until recently.

The final agreement looks like a compromise. The original royalty was as high as 0.5%, Zijin wanted to reduce it to 0.125%, after more than 18 months of negotiations, it was reduced to 0.3625%. Yes, at first glance, it looks like EMX just gave up a lot of money. However, given that the management decided to suspend the arbitration pretty quickly, it is possible to assume that Zijin's claim to reduce the royalty wasn't completely unfounded. The arbitration would take time and money, and the result would be uncertain. This way, the royalty was reduced, but it remains EMX's key asset, given the size and quality of the Upper and Lower Zone deposits.

Last year, EMX generated revenues of $18.3 million. The Timok royalty in its current reduced form would add $3.2 million, or 17.5%. This is a non-negligible contribution. And the contributions should last for years to come. Unfortunately, there is not much information provided by Zijin Mining. Its webpage only states that Timok (the Cukaru Peki mine) should be producing 201.5 million lb copper, and 80,645 toz gold per year. It means that according to the revised royalty agreement. EMX should be entitled to 730,438 lb copper and 292 toz gold per year. At the current metal prices of $3.7/lb copper, and $1,920/toz gold, the royalty should generate around $3.26 million per year.

However, Zijin also mentions a potential peak output of 297.6 million lb copper and 196,120 toz gold. This would entitle EMX to 1,078,800 lb copper and 711 toz gold, valued approximately at $5.36 million. It is not clear when the peak year could occur. Nevsun's old mine plan envisioned peak production in 2023, the second year of full production. The royalty for H1 2023 ($1.89 million) indicates that the overall 2023 royalty could be around $3.8 million. It is better than the $3.2 million received for 2022, however, it doesn't approach the abovementioned promised peak values.

Even less clear is the current status of the Lower Zone. It has lower grades, but it is much larger and contains much more copper and gold than the Upper Zone. According to the resource estimate released by Nevsun in June 2018 , the Lower Zone had inferred resources of 31.45 billion lb copper and 9.566 million toz gold. Zijin mentions 40.9 billion lb copper and 12.38 million toz gold (table below), however, it doesn't provide more detailed information regarding the categorization.

The current shape of the plans for the Lower Zone mine is even more unclear. The current market value of the metals contained in the Lower Zone is approximately $175 billion. If Zijin manages to extract only 1/3 of the metals, we are still talking about approximately $58 billion, of which, around $210 million should be attributable to EMX. Assuming that the production will last for 30 years, EMX should be receiving around $7 million per year on average. Which is even better than the cash flows generated by the Upper Zone. During the first year of the Lower Zone operations, the Upper Zone should be still in production. It means that for several years, the overall cash flows generated by the Timok royalty should be higher than $10 million.

EMX has over 100 exploration projects and more than 160 Overview listed on its webpage. But only six of them, including Timok (Cukaru Peki), are in production, and 11 more are in more advanced development stages. It means, that although the future potential is really huge, it will take long years before the majority of the properties get into production. If ever. This is why the Timok royalty, which should be generating decent cash flows for at least three decades, is so important for EMX, even in its reduced form.

EMX ended Q2 with cash of $19.5 million. With the accrued payments from Zijin, the cash balance should improve to more than $26 million. At the same time, the net debt should decline to less than $17 million. At the current market capitalization of slightly over $200 million, given the large asset portfolio, and its ability to generate revenues of around $16 million per year (annualized H1 2023 revenues plus annualized H1 2023 Timok payments), EMX is attractively valued, especially compared to other small-to-mid-sized precious metals R&S companies.

EMX's TTM revenues (including the deferred payments from the Timok royalty) amount to $18 million, which leads to a price-to-revenues ratio of 11.11. As of the end of August , the average TTM price-to-revenues ratio for 16 precious metals R&S companies stood at 22.8, with a median value of 14.7. EMX is positioned well below both numbers. Moreover, EMX holds one of the biggest portfolios in the industry, which provides a significant long-term growth potential.

Of course, there are also risks. The company has cash reserves, the indebtedness is not too high, and with the Timok royalty finally generating cash flows, the financial risks should be only limited. However, the development projects may encounter some delays, which, obviously, may affect EMX's growth prospects negatively. An example is the Yenipazar project acquired back in 2021 , as a part of the SSR Mining portfolio. It was one of the most advanced projects in the portfolio, believed to get into production relatively soon. However, two years later, it seems like no or only a little progress was reached on the project. Another potential problem may emerge with some of the mine operators, as could be seen in the case of Zijin Mining and its successful effort to reduce the Timok royalty. The uncertainty surrounding this event weighed on EMX's share price for more than 18 months. Fortunately, this kind of dispute is relatively rare.

Conclusion

Although the announcement of the dispute resolution elevated EMX's share price slightly, it remains around 25% below the December 2021 levels. The RSI stands at 60 which leaves enough space for further growth. Moreover, the 10-day moving average seems to be primed to cross the 50-day one to the upside. If the positive momentum continues, the resistance in the $2.2 area should be tested soon. If it is broken, the next stop should be around $2.5.

And there is also one wild card at play. Only on August 1 , EMX closed an acquisition agreement for new royalties with Franco-Nevada ( FNV ). Under this agreement, the acquisitions of new royalties sourced by EMX will be funded 55% by Franco-Nevada and 45% by EMX, but their ownership will be split between the two companies on a 50/50 basis. The agreement is valid for 3 years, or until $10 million is invested by both parties. This will enable EMX to acquire more royalties, to save some money, and it also boosts EMX's reputation, as Franco-Nevada is a heavyweight in the industry. Franco-Nevada in fact invented the precious metals streaming industry and it is the largest precious metals R&S company by far, with a market capitalization of nearly $27 billion. At the same time, Franco-Nevada is EMX's shareholder. It means that Franco-Nevada emerges as a potential acquirer of EMX Royalty.

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