Can smaller players make the royalty model work...?
ROYALTY plays may have once been strictly the domain of larger companies, but smaller names are shifting gears to enter the space. Can the smaller players make the numbers work for their shareholders? In this interview with The Gold Report, Kwong-Mun Achong Low, an analyst with Jennings Capital, says why he believes they can.
The Gold Report: Kwong, investors have transferred billions of Dollars from fixed income mutual funds into equity funds during the past few months. The mainstream media is calling it the "great rotation." Do you expect that movement to result in higher bids for precious metals and mining equities?
Kwong-Mun Achong Low: There's some credence to it because some corporations have strengthening balance sheets and improving profits. Also, the Volatility Index (VIX) is at a five-year low and equities tend to outperform when volatility is low. I think that more capital will come back to equities and by extension some precious metals names will see benefits.
TGR: Will that capital reach all the way down to the junior mining equities?
Kwong-Mun Achong Low: Not all junior mining companies. Investors are very selective right now, looking for quality.
TGR: You're following a handful of development-stage stories with near-term cash flow and some relatively small-cap producers. What time frame does "near term" imply?
Kwong-Mun Achong Low: Mostly 6–12 months. I look for companies that are fully financed to get to production and cash flow.
TGR: Tell us more about what you look for in a company.
Kwong-Mun Achong Low: Company management first and foremost. Has it done this thing before and does it have the experience? Second would be the asset. It's best if there's scarcity value attached to the asset such as the highest grade, best production profiles for the capital expenditure (capex), and if it is close to infrastructure. Lastly would be political jurisdiction. My preferences would be for the tried and true regions like Ontario or Nevada.
After, I branch off into two categories: Who could be taken out and who could actually get into production on their own?
TGR: Newsletter writer John Kaiser recently said that as many as 500 junior mining companies could be forced off the TSX Venture Exchange this year. Do you believe that estimate is reasonable? Would that ultimately be healthy for the sector?
Kwong-Mun Achong Low: I think that it should be that many, but whether that will come to fruition is another story because it's in the exchange's best interests to keep as many companies listed as possible.
However, there definitely needs to be a purge. Investors are so jaded that they don't even want to hear anything when you call them with a good-quality name. There's too much noise out there. If the companies that should be leaving the market actually left, investors could put some faith and money into what was left.
TGR: There are lots of pretenders in the junior mining equity space that are frustrating investors. Some projects under development are going nowhere and everyone but the investors seem to know that. Who can investors trust?
Kwong-Mun Achong Low: It's a fair question for the times we're in. I can only speak for myself. I try to follow strict guidelines. Before I pick up coverage, a company has to pass the management, asset and jurisdiction tests that I mentioned earlier. It also has to make sense on a fundamental basis. Is it actually worth how much it's trading in the market? I do a fully financed model accounting for all the dilution and financings that a company has to do. I make sure it is still reasonable on a discounted cash flow basis.
TGR: Some companies have a sizable capex to reach production, but many don't have the cash to build a mine. Are these companies valued strictly on their potential as takeover targets?
Kwong-Mun Achong Low: That does factor in, but even though some don't have the cash to fully finance their capex, it's reasonable to consider other sources, like project debt, royalties and streams, and monetizing of non-core assets.
TGR: How does a junior explorer that's looking for precious metals deposits in the Yukon all of a sudden become a royalty play?
Kwong-Mun Achong Low: There's still some promise that the Yukon could get some mines into production—there are some success cases there—but it's not an easy operating environment. It's easier for investors to look at royalty companies over producers, especially given their outperformance by such a wide margin over the last few years.
TGR: Do you believe more companies will make the move into royalties?
Kwong-Mun Achong Low: I believe so. There are a number of junior royalty companies out there, but they have one-off assets or may not be in production for many years. I could see some consolidation in the space to gain some sort of critical mass.
TGR: What size is the sweet spot for projects right now?
Kwong-Mun Achong Low: I think anywhere from 100–300 Koz/year for gold with capex under $600M.
TGR: Thanks, Kwong, for your insights.
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