KGC - Royal Gold: Attractively Priced Here

• Gold stocks have been mercilessly hammered.
• Royal Gold, our favorite of the group, also pulled back sharply.
• We review the fundamentals today, including the recently announced acquisition.

Royal Gold, Inc. ( RGLD ) has been an exception to our usual disdain for precious metal mining companies. Unlike those that fall in the latter group, RGLD has had a good head on its shoulders by making sensible capital allocation decisions and not diluting its common equity. RGLD provides financing to mine operators and in return makes its living via Streams and Royalties. The two have been explained on the company website as follows:

Streams - A metal stream is a purchase agreement that provides, in exchange for an upfront deposit payment, the right to purchase all or a portion of one or more metals produced from a mine, at a price determined for the life of the transaction by the purchase agreement.

Royalties - A royalty is a non-operating interest in a mining project that provides the right to a percentage of revenue or metal produced from the project after deducting specified costs, if any.

Source: Royal Gold Website

When we last wrote on this company, we were bearish on the gold price in the short term. Although we liked RGLD, the price was still above our risk adjusted entry point then. This presented an excellent opportunity to write options on it and we suggested the $95 strike April 2022 cash secured puts.

Turns out outright purchase of the stock would have outperformed by a huge margin during this time frame.

Interestingly the price is back to where it was when we last visited this one. So if you kept writing $95 puts (following April with July for example), you would have outperformed the stock returns handily.

We had called this one an inflation hedge back in September. What's our game plan now?

Recent Events

RGLD's Q1-2022 was quite the sight. The company reported revenues of $162 million and operating cash flow of a shade over $101 million. Revenues, operating cash flow and earnings were all up double digits in percentage terms year over year. RGLD's showed that one did not need to take on too much debt to create great numbers. In fact, RGLD ended the quarter with a debt free balance sheet. The quarterly dividend was increased by a stunning 17% to 35 cents a share. The numbers were excellent all around.

The key one for us (and it was not the dividend increase which went up faster than inflation) was the production of the metals. Gold Equivalent Ounces were up 9% to 86,500. That statement sums up in a nutshell why we think RGLD is the best thing since sliced bread, at least within the Gold mining space. Most other struggle to keep production flat over time, whereas RGLD has consistently shown an ability to grow and use higher prices to its advantage.

Great Bear Royalties Corp ( GTBDF ) Buyout

Royal Gold did enter into a material transaction just two weeks ago and bought out a company at a 43% premium.

Royal Gold, Inc. (together with its subsidiaries, "Royal Gold" or the "Company," "we" or "our") announced today that its wholly owned subsidiary, International Royalty Corporation ("IRC"), has entered into a definitive agreement (the "Arrangement Agreement") with Great Bear Royalties Corp. ("GBR") to acquire (the "Acquisition") all of the issued and outstanding common shares of GBR for cash consideration of C$6.65 per common share (the "Acquisition Price") pursuant to a plan of arrangement under the provisions of the Business Corporations Act (British Columbia) and subject to the conditions set out in the Arrangement Agreement. The Acquisition Price represents a 43% premium over GBR's 20-day volume weighted average trading price on the TSXV up to and including July 8, and values GBR at approximately C$199.5 million on a fully diluted basis.

Source: Seeking Alpha

Great Bear's only real asset here is a 2% net smelter return royalty that covers all of the Great Bear Project in Ontario, owned and operated by Kinross Gold ( KGC ). This has potential for substantial ounces of Gold annually, but we are talking about many years out.

The premium may seem high in this market but we want to make three counterpoints. The first being that even after the premium, Great Bear is below its high price from 2021.

The second point here is that Royal Gold is one of the best allocators of capital and hence in most items, unless we can see a glaring fault, we tend to give them the benefit of the doubt. Finally, while the premium was high, the total amount is small in relation to Royal Gold. Even assuming that the entire premium of 43% was unjustified, it amounts to less than 2% of Royal Gold's market capitalization.

Outlook

We like Royal Gold here and time has compressed the valuation to a very attractive level.

As we said before, under 10X sales is where you want to aim your purchases. That number reflects market pessimism. We are putting a "buy" rating on this and 2-year target of $125.00. We tend to be conservative and we would look to target the $100 or $95 Cash Secured Puts. The $100 strikes for January 2023 offer a very attractive return profile for the income investor.

The best thing about options is that one can tailor the strike to the degree of bullishness or bearishness. More higher (aggressive) strikes would suit those who think the bottom is likely in and RGLD should move higher in the months ahead. While we think that is likely as well, in the market, we are hesitant to play anything without an options buffer.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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