This Gold Company Is Preparing for a New Growth Phase

Precious metals streaming and royalty company Royal Gold, Inc. (NASDAQ: RGLD) used the commodity downturn to materially increase its production of gold and silver. The increased production, coupled with improving gold prices, led to a massive 56% increase in cash flow between fiscal 2016 and 2017. But higher gold prices have changed the opportunity set and led Royal Gold to focus on preparing for a new growth phase.

What you need to know about Royal Gold

Royal Gold provides mining companies with cash up front for the right to buy gold and silver at contractually reduced rates in the future. Gold miners use the cash to shore up their finances or to fund growth and expansion projects. Royal Gold effectively provides miners access to capital outside of the traditional bank and financial markets, which sometimes aren’t the cheapest or easiest places to find funding (particularly during commodity downturns).

Image source: Getty Images.

Royal Gold, in return, locks in low prices for gold and silver. This generally leads to wide margins in good years and bad, and has helped the company deliver 17 years worth of annual dividend increases to shareholders. That’s an incredible record when you consider the often volatile price of the precious metals that underpin its business.

But Royal Gold is more like a specialty finance company than anything else, funding streaming deals by issuing stock or debt. Royal Gold’s preference is to use leverage. At the end of fiscal 2017, the company’s long-term debt was $586 million — an 87% increase over its debt load two years earlier. Roughly $250 million of that was drawn from its recently upsized $1 billion revolving credit facility, with the rest made up of convertible bonds.

No big deals

During the commodity downturn, Royal Gold was able to find large streaming deals for operating mines that immediately added to cash flow. That’s why cash flow growth was so impressive in fiscal 2017. The lingering benefit from the streaming deals inked during the downturn could lead to another 20% cash flow jump in fiscal 2018, as well. However, now that commodity prices have largely recovered, Royal Gold isn’t inking deals like it once was because miners simply aren’t as desperate for cash.

The company’s projected cash flow growth in fiscal 2018 shows that it still has worthwhile growth potential as previous mine investments play out. But Royal Gold isn’t resting on its past successes — it is preparing now for the next phase of its long-term growth, which will inherently require expanding its portfolio and, thus, spending more money. This is why management is using its cash flow growth to solidify its finances so it has the financial leeway to spend when new opportunities finally do arise.

Royal Gold is trimming its debt load. Image source: Royal Gold, Inc.

To put some numbers on that, between March 2017 and March 2018 the streaming company reduced its total debt by $270 million. At the end of its fiscal third quarter, long-term debt stood at $422 million, a nearly 30% drop in just three quarters. The bulk of its efforts have been to pay down its revolving credit facility, as it plans to tap that facility to pay off its convertible bond, which comes due in mid-2019.

The real upshot of all of this, however, is that Royal Gold now has around $1 billion in liquidity (including cash balances) that it can put to work on streaming deals. And that figure will only increase as it continues to pay down its debts. To put it simply, Royal Gold is building up a solid war chest in preparation for the next round of growth spending. This is exactly what investors should want to see, since it means that management is taking a conservative approach to create a stronger overall business for the future.

More going on than you might think

When you look at the huge cash flow growth taking shape at Royal Gold, the miserly 4% dividend hikes in 2017 and 2018 might seem shockingly low. However, there are two issues at play. First, management is taking a cautious approach to an often volatile industry — it doesn’t want to overpromise and then be forced to cut the dividend. But second, and perhaps more hidden, is the fact that it has chosen to use its increasing cash flow to pay down debt so it can take advantage of growth opportunities in the future. If you are looking for a precious metals stock, a deep dive at Royal Gold seems well worth the effort as it prepares today for its next growth phase.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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