Compass, episode 12

Our previous episode: https://www.cruxinvestor.com/posts/gold-shines-while-traditional-safe-havens-falter-7015

Recording date: 23rd April 2025

Mining royalty companies are emerging as an attractive investment option for those seeking commodity exposure with reduced operational risk. Recent market developments, particularly the acquisition of Orogen Royalties' tier one royalty on the Silicon deposit by Triple Flag, have highlighted the value proposition of these unique business models.

Unlike traditional mining operations, royalty companies operate on a fundamentally different model. They hold the right to a percentage of revenue, typically 1-2% of the net smelter return, providing commodity price exposure without the corresponding operational costs or risks. This business model originated in the oil and gas industry but has been successfully applied to mining, particularly in gold where returns are straightforward to calculate.

The key advantage of royalty companies lies in their risk profile. As Samuel Pelaez, President & CEO at Olive Resource Capital explains, these companies have "no exposure to the cost portions or the risk that's attributable to cost overruns and margin compression." Their sole exposure is to commodity prices and production success. Additionally, most royalty agreements include rights to exploration upside, covering new discoveries within the area of interest.

This capital-light business model allows companies like Franco Nevada to operate with minimal staff while commanding a market capitalization of C$46 billion. Once due diligence is complete and royalties are secured, the business essentially involves waiting for royalty checks to arrive.

Royalty companies typically trade at premium valuations of 10-20 times revenue compared to traditional mining companies. This reflects their lower risk profile and appeal to generalist investors seeking gold exposure without the complexity of evaluating individual mining projects.

"Tier one royalties" – those on large-scale assets in good jurisdictions – are particularly valuable but rarely held by small public companies. The recent acquisition of Orogen's royalty on AngloGold Ashanti's Silicon-Merlin project (with approximately 16 million ounces of gold resource) by Triple Flag valued it at approximately 15-16 times projected annual revenue.

When evaluating royalty companies, investors should focus on royalties that are either currently cash-flowing or have a clear path to production. As Derek Macpherson, Executive Chair at Olive Resource Capital notes, "A royalty that isn't producing cash flow or doesn't have a clear path to production is worth zero."

As gold prices remain strong, royalty companies continue to offer an appealing way to gain leveraged exposure to precious metals without taking on the full range of risks associated with mining operations.

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290. Ed Gein's House of Horrors