EMX - EMX Royalty: Timok Dispute Continues To Weigh On Sentiment

2023-04-18 07:57:04 ET

Summary

• EMX Royalty has been one of the worst-performing royalty stocks this year, up just 9% year-to-date vs. a ~17% return for its royalty/streaming peers.
• This weak share price performance is despite underperformance in 2022, and I attribute this divergence to uncertainty surrounding its Timok royalty and negative news at Balya (first delays, now halted production).
• However, EMX appears confident in a favorable resolution at Timok, and while 2022/2023 weren't as strong as expected financially, I see these negative developments as largely priced in.
• So, with improved diversification, a growing royalty portfolio, and exploration success in its advanced portfolio, I would view any sharp pullbacks in EMX stock below US$1.92 as buying opportunities.

While several names in the precious metals space have started out the year with double-digit gains from a share-price performance standpoint, EMX Royalty ( EMX ) has been an unfortunate exception. While the stock was briefly up over 10% for the year following a disappointing 2022 return, the stock has underperformed its peer group by over 600 basis points, and significantly underperformed the mid-tier royalty/streaming group which includes Triple Flag ( TFPM ), Osisko Gold Royalties ( OR ), and Sandstorm Gold ( SAND ). This is undoubtedly disappointing for investors and I attribute the underperformance to continued uncertainty related to the royalty rate at Timok, which has overshadowed the rally in precious metals prices that has placed a relentless bid under some of its peers.

Let's look at the FY2022 results and recent developments below:

All figures are in United States Dollars unless otherwise noted.

FY2022 Results

EMX Royalty released its FY2022 results last month, reporting significant growth in annual revenue and other income and adjusted revenue and other income of $18.3 million and $25.4 million, respectively. This represented a 144% increase in revenue and other income vs. the year-ago period, and an ~130% increase in adjusted revenue and other income vs. $11.0 million in FY2021. EMX's significant improvement in its financial performance was related to an increase in its effective NSR interest at the Caserones Mine in Chile (~0.74% vs. ~0.42% which has since been increased to ~0.78%), and the start of production at Balya (Turkiye) and Gediktepe Oxides (Turkiye) with the latter being a massive contributor.

For those unfamiliar, the Gediktepe Mine with these assets, Lidya Madencilik operates Gediktepe and ESAN operates Balya, and while the former may not be that significant in scale, EMX holds a 10% gold royalty on the oxide portion of the deposit, translating to ~8,000 ounces of attributable gold production for the first two years, with an additional 2% NSR on sulfide material. In addition, the company holds an uncapped 4.0% NSR on the zinc-lead-silver property in northwest Turkiye, which is a solid contributor for EMX as well, and provides diversification vs. a revenue profile that relied solely on Leeville (Carlin Complex) and Caserones until recently. Finally, EMX saw a net settlement gain from a favorable ruling in a dispute between Barrick ( GOLD ) and Bullion Monarch Mining prior to EMX acquiring Bullion Monarch in 2012, with a $25.0 million settlement or $18.8 million after ~$6.2 million was paid in legal fees.

The significant increase in contribution from Caserones ($5.22 million) and initial contribution from Gediktepe ($3.71 million) and Balya ($0.28 million) helped EMX to finish the year with nearly $16.0 million in cash and an investment/loan portfolio valued at ~$14.6 million. However, the share price has barely budged despite this material revenue and income growth, which is understandably frustrating for shareholders. This can be attributed to additional disclosure in the company's year-end MD&A, which suggests that Balya likely won't be contributing much this year, and Timok doesn't appear as close to closing out its modified royalty agreement as communicated by management last year, with the most recent news being that an agreement is expected to be reached at some point this year.

Recent Developments & 2023 Outlook

While the declaration of production at Gediktepe and Balya North were positive developments for EMX, and the Bullion Monarch Mining win was certainly a positive surprise development, as was an investment in EMX by Franco-Nevada ( FNV ). Unfortunately, these positive developments were overshadowed by the major elephant in the room, the lack of a resolution on the 0.50% NSR royalty at the massive Timok (Cukaru Peki) copper-gold mine which is now in commercial production, with this dispute having been ongoing for over a year. The last major update from EMX was that it suspended its filing of a Notice of Arbitration to the operator in hopes to settle on a "mutually acceptable resolution".

Per discussions last year, EMX's management noted that it was confident this would be resolved before year-end, but the most recent MD&A stated that while " discussions have been amicable and productive ", minimal clarity was provided on the date that this might occur with the timeline given being " in 2023 ". This is certainly not the news that investors were looking for, and investors can't be overly pleased with the news from Balya either. For those that missed it, after what was already a delay in production at Balya North, the operator ESAN has suspended production in December with initial production levels being enriched with clay materials (impacting crushing/processing circuits) and reconciliation issues in the upper levels of the deposit.

Per the MD&A, ESAN is working to restart production in the latter portion of 2023 and work has continued on the main decline and additional underground development. However, the fact that two assets that were expected to contribute in 2023 will not likely contribute meaningfully is certainly a disappointment. On a positive note, though, metals prices have swung in EMX's favor, McEwen Mining ( MUX ) has begun mining at Gold Bar South where EMX holds a 1.0% NSR royalty, and this operation is much more desirable than where it's been mining previously with a lower strip ratio, better grades, and no expectations of carbonaceous material that impacted MUX's operations over the past year in its previous mining area.

In addition, the other major highlight of the year for EMX was that one of its partners, AbraSilver ( ABBRF ), continues to report exceptional intercepts (87 meters at ~360 grams per tonne silver-equivalent) from its new JAC discovery at its Diablillos Project in Argentina. EMX picked up a 2.0% NSR royalty on this asset when it acquired a royalty portfolio from SSR Mining ( SSRM ), and the new JAC Zone higher-grade than the main Oculto deposit and could result in increased production in the first five years with grades at JAC potentially being up to 60% higher grade than Oculto. In addition, with the total resource looking like it could grow to 300+ million silver-equivalent ounces by 2025, it's possible that AbraSilver could look at a higher throughput rate closer to 10,000 tonnes per day (7,000 tonnes per day contemplated previously).

Assuming a higher throughput rate of 8,500 to 9,500 tonnes per day and improved grades (~170 grams per tonne silver-equivalent), we could see average annual silver-equivalent production closer to 13.0 million ounces per annum over the mine life, and production in the first four years north of 14.0 million ounces per annum. This could translate to average annual revenue of ~$330 million at a $24.00/oz silver price, with EMX's 2.0% NSR being a significant contributor with attributable revenue of $6.5+ million per annum in the earlier years of the mine life. Plus, given the improved economics with JAC, I would expect AbraSilver to have an easier time financing the project. So, while investors may have to wait until 2027 to see first pour at Diablillos, this is certainly an exciting development for both companies.

That said, while the long-term picture is improving with Cukaru Peki having a massive first year of commercial production per Zijin's Annual Report and positive developments across the portfolio, the market often focuses on the short-term, as do investors which is entirely fair when the sector is trending higher and a name like EMX is being left behind. And while the strong performance at Cukari Peki and positive drill results out of Diablillos are encouraging, the real key will be settling the Timok dispute in a timely manner to improve sentiment in the stock. Based on the year-end MD&A comments, I would be surprised if it was settled before June, so it's possible that EMX's underperformance could persist a little longer.

Valuation

Based on ~126 million fully diluted shares and a share price of US$2.10, EMX Royalty trades at a market cap of ~$265 million. This is one of the lowest market caps within the junior royalty/streaming space, yet EMX Royalty should generate significantly more revenue & other income than its peers this year with a full year of contribution from Gediktepe Oxides, additional contribution from Caserones and Leeville, plus higher metals prices. Assuming a copper price of ~$9,000/tonne and an average realized gold price of $1,900/oz, its three main royalties should generate revenue of ~$25.0 million alone, leaving EMX trading at less than 10.0x sales, a significant discount to its junior royalty/streaming peer group.

As noted in past updates, EMX is not a pure-play royalty/streaming company and incurs significant costs related to its royalty generation business, which could impact the stock's ability to trade at a similar multiple relative to that of its peers. In addition, only one of its producing royalties (Leeville) is in a top-10 ranked mining jurisdiction and some of its producing royalties have limited disclosure because of being operated by private companies (Lidya Madencilik, ESAN). Still, even if we use a steep discount to its peer group of just 12.0x revenue & other income and assume EMX generates $25.0 million in revenue/other income this year, EMX's fair value comes in at $300 million [US$2.40].

However, it's important to note that this excludes Balya (a minor contributor and could be restarted by year-end) and it also excludes Cukaru Peki (Timok), which is a massive copper-gold project in Serbia. According to Zijin Mining ( ZIJMF ), the asset produced ~111,000 tonnes of copper and ~150,000 ounces of gold last year, and based on 2023 estimates (~120,000 tonnes of copper and ~164,000 ounces of gold), Cukaru Peki could generate revenue of $1.40 billion this year. Even if we assume EMX's 0.50% NSR ends up being reduced to 0.35% to evade a potential lengthy arbitration process, this would translate to annual attributable revenue of $5.0 million per annum, which doesn't factor in gold remaining at spot levels above $1,950/oz.

Once resolved and assuming a favorable resolution (0.35% or better), EMX could generate upwards of $30 million in annual revenue from its producing royalties while Gediktepe Oxides is in production near peak levels, translating to a fair value of $360 million [US$2.85] even at a multiple of 12.0 on revenue and attributable income. Finally, it's important to note that these figures ignore stage-gate payments at several properties, with some examples including $7.0 million in 2025 from Diablillos, and $2.5 million and $3.5 million in Q4 2023 and Q4 2024, respectively, from Berenguela. In addition, EMX will receive $4.0 million in deferred milestone payments this year in Gediktepe, expected in Q2 2023.

With several other royalties that could be key contributors in the future, like Parks-Slayer (1.5% NSR), Diablillos (2.0% NSR), Berenguela (1.0% - 1.25% NSR), Kaukua (2.0% NSR, but with buyback right), and Yenipazar (6.0% - 10.0% NPI), there's certainly room for EMX's portfolio to mature substantially, with the potential for Diablillos to offset the lower revenue following the transition from oxide to sulfide production at Gediktepe later this decade. So, with EMX remaining undervalued at just ~10.0x forward revenue & other income even without Cukaru Peki, Diablillos and several other assets contributing, there's certainly room for an upside re-rating if the company does finally start getting some good news at its producing assets.

Summary

EMX Royalty had a solid year in 2022 with the ~$18.8 million gain (net of legal fees) from the Bullion Monarch Mining/Barrick dispute, a $3.0 million milestone payment from Parks-Salyer, and a material increase in revenue and income from Gediktepe and an increased royalty rate at Caserones. Unfortunately, this was overshadowed by the Timok royalty dispute that has yet to be fully resolved, and the negative news that Balya North production has been suspended temporarily. These are undoubtedly negative developments and while we should see a resolution, it's certainly put a dent in sentiment for the stock, with investors having to potentially wait another before Timok contributes meaningfully and uncertainty around the royalty rate remaining in place.

That said, EMX saw positive developments across its development portfolio at Diablillos, the increase in copper and gold prices has improved the outlook for FY2023 cash generation, and McEwen Mining ( MUX ) is better capitalized, suggesting it might drill more aggressively than previously when it's had limited cash on hand, which might add lead to reserve growth at Gold Bar South. So, while the short-term outlook may remain cloudy, I continue to see a bright future for EMX Royalty, though the key to this investment thesis is a favorable ruling on its Timok royalty. To summarize, I see EMX as one of the more attractively valued names in the royalty space, and I would view any pullbacks below US$1.92 as buying opportunities.

For further details see: