Gold might look reassuring, yet that’s just before its price bounces to a level that makes everyone nervous. The metal doesn’t send an earnings warning. It simply falls, leaving investors to decide whether their supposed safe haven needs a seat belt.
The latest pullback is another reminder that owning gold and owning a gold business are different decisions. Bullion provides price exposure. A mining company must also dig, process, maintain equipment and pay people before shareholders see a dollar.
A royalty company offers another route. It can receive a share of mine revenue without operating the mine itself, which changes where rising gold prices and rising costs show up. So let’s consider one on the TSX today.
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Let someone else run the mine
A royalty is generally a contractual claim on part of a mine’s revenue or production. A stream typically involves an upfront investment in exchange for future metal purchases at an agreed price.
Neither makes mining risk disappear. If the operator produces less, delays a project or shuts down, the royalty owner can receive less money. The attraction is that it usually doesn’t pay the mine’s day-to-day operating bill directly.
OR Royalties (TSX: OR) gives Canadian investors that exposure. Its interests include a cornerstone royalty at the Canadian Malartic complex, tying future receipts to both gold prices and the mine’s long production life. That’s a more useful starting point than assuming every gold stock behaves like a gold bar.
A raise with a small starting cheque
There’s more than just the price to consider as well. OR increased its quarterly dividend from US$0.055 to US$0.065 in May, a rise of 18.2%. The percentage increase is substantial. The cash yield is much smaller. Investors should put both figures on the table before mentally spending the income.
That cash is supported by cash flow. OR generated US$83.2 million of operating cash flow in the second quarter, up from US$51.4 million a year earlier. Its adjusted earnings of US$0.32 a share covered the US$0.065 quarterly dividend about five times.
That leaves capacity for reinvestment and obligations, although operating cash flow still has to support acquisitions and financing. For Canadian dividend investors, coverage is more useful than the increase alone.
The growth opportunity comes from additional production at existing interests and carefully priced new deals. Paying too much for a royalty during a strong gold market can weaken returns even when the underlying mine performs.
The operator still holds the shovel
The main risks are a weaker gold price and disappointing production from partner mines. Concentration in a major asset also means a problem at that operation can outweigh success elsewhere.
I’d consider OR for a modest precious-metals allocation, particularly for investors who prefer royalty economics to running mines. I wouldn’t choose it to generate a large retirement paycheque.
An eligible Tax-Free Savings Account (TFSA) can shelter Canadian tax on gains and dividends, subject to available room. Keep the position diversified because a tax shelter doesn’t repair a mine interruption.
Bottom line
OR’s dividend increase is encouraging because recent earnings support it. The larger opportunity is letting well-bought royalty interests deliver cash for years, giving today’s small payment room to become more useful.
