What Could Impede This Gold Company?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Royal Gold (NASDAQ: RGLD) has been showing solid numbers in terms of profit margins and revenues growth: as of the third quarter of 2012, the company's revenues rose by 21% and its operating earnings by 27.6%. The company's operating margin was 61%. These impressive numbers were noticed as shares of the company rose by 20.66% during last year. Nevertheless, this rally might reach a halt in 2013. Let's examine what could impede the progress of this company.

Some gold producers’ stocks, unlike Royal Gold, have declined during 2012: shares of Goldcorp (NYSE: GG) fell by nearly 20%; shares of Barrick Gold (NYSE: ABX) plunged by 29%. The major linking factor between Royal Gold and these gold producers is their dependency on the developments in the price of gold. Besides this factor, the similarities end: Royal Gold's business operation relies on royalty contracts with gold producers while Barrick and Goldcorp operate gold and silver mines. The uncertainty these gold mine companies face seem to be higher than the uncertainty Royal Gold faces. So let's turn to the price of gold. 

Will Gold Resume its Rally?

The price of gold remained nearly unchanged during January. The main uncertainty will be whether the demand for gold will rise. In India, one of the leading countries in importing gold, the import tax on gold was recently raised. This news is likely to curb the demand for gold in this country. But the physical demand of gold wasn't the prime driving force for the spike in gold prices in recent years; it was its demand as an investment. On this front, the steps taken by the Federal Reserve to implement QE1 and QE2 in 2008-2011, along with the sharp fall in the long term interest rates (the drop in rates is related to the Fed's asset purchase plans) contributed to the spike on gold prices.

The Fed's recent QE3 program, which consist of purchasing $45 billion a month of long term securities and $40 billion a month of mortgage backed securities, hasn't, for now, pressured up gold prices. In the recent FOMC meeting the Fed stated it will keep this asset purchase program until the labor and housing markets will substantially improve. For now, this plan doesn't seem to affect the markets as the long term interest rates don't fall and the U.S inflation is currently bellow the inflation target of the Fed.

This could mean that the actions taken by the Fed have a diminishing effect on the money market so that the potential rise in demand for gold as a safe haven isn't likely to rise in the near future. In such a case, Royal Gold and other gold companies such as Barrick and Goldcorp are likely to suffer from the stagnation in the price of gold: This could curb the growth in revenues and earnings of these companies. So that most of the potential rise in revenues for Royal Gold will come from its growth business activity by signing on additional royalty contracts. For that let's examine the company's cash flow situation to see if it could impede the company's growth in business activity. 

Cash Flow

In order to finance the company's activities, it has issued during 2012 both stocks and debt: during the past year (until September 2012) the company issued nearly $270 million in stocks and $130 million in loans. Royal Gold needed these funds since its free cash flow remained negative during last year. In the first nine months of 2012 the free cash flow was ($107) million. But most of this deficit was due to its investment activities.

Despite the rise in debt, the company's debt to equity ratio remains relatively low at 0.16. This means Royal Gold's leverage is still low with room to grow, if needed. In comparison, some companies in the gold market have a higher debt to equity ratio: Barrick's debt to equity ratio is at 0.55. This ratio, however, has declined from its level at 0.6 back in September 2011. Other gold companies have a much lower debt to equity ratio: Yamana Gold (NYSE: AUY) has a ratio of 0.1; Goldcorp's ratio reached 0.03. So at least in terms of leverage, Royal Gold is in the middle among gold companies. Despite Royal Gold's negative free cash flow, it continues to provide with its investors with dividend.

Dividend

The company's dividend yield remains relatively low compared to gold related companies such as Barrick, Goldcorp or Yamana. Royal Gold provides an annual dividend yield of 1.08%. In comparison, Goldcorp offers a dividend yield of 1.68%; Barrick gives a yearly dividend yield of 2.48%; Yamana offers a dividend yield of nearly 1.56%. The low yield of Royal Gold is despite the higher profit margin or revenues growth compared to leading gold companies. At the same, the hit that shares of Barrick and Goldcorp endured during 2012, as listed above, had a silver lining for new investors as it raised the yields of these companies. 

The Bottom Line

If the price of gold won't start to pick up in the near future, Royal Gold's growth will mainly revolve around its business development. The cash flow might pose a threat – especially if the price of gold will drop and lower the company's cash flow from operating activity – but for now it seems well under control. The company is still capable to generate high profit margins. Along with its low leverage, the company could continue to grow it business.

For further reading:

Gold and Silver Outlook for February 2013

 Gold and Silver Yearly Outlook For 2013 

Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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