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ASX investors can now enjoy mining’s royal(ty) treatment
By Tim Boreham - November 12, 2020
There’s a ‘something for nothing’ element with mining royalties: the holder takes none or little of the risk in extracting the commodity while enjoying a virtually assured income stream.Investors can sit back, relax and be treated like – well – royalty.
As an investment class, royalties have been poorly understood by Australian investors.
While plenty of resource companies hold royalties, Deterra is the first substantive pure-play royalty listing on the ASX.Earnings leverage without the operating risk.
Royalties are contracted agreements involving a one-off payment (or asset transfer) in return for a fixed revenue share of future production, typically a couple of percent.
While they’re not subject to the same operating risks and capital costs of the miners, royalty holders enjoy the earnings leverage by being able to acquire more rights without increasing their cost base.
For years, Iluka has held a 1.232% royalty over the Pilbara iron ore turf called Mining Area C (MAC), owned by BHP in joint venture with Itochu and Mitsui
.It’s been quite a little earner for Iluka, generating $929 million of income since mining started in 2003.In times of subdued mineral sand prices, the MAC royalty has generated more revenue for Iluka than its mainstay business.
But with BHP eyeing an expansion of the MAC area, the Iluka board decided that one plus one would equal more than two and opted for the demerger.
Iluka holders received one Deterra share for every Iluka share held.Deterra shares listed on 23 October and at last glance the company was valued at $2.1 billion, just a tad below the worth of Iluka, which retains a 20% stake in Deterra.
Deterra (MAC) generated $85.7 million of revenue for Iluka in calendar 2019 and earnings before interest tax and depreciation of $78.9 million. As we said, there are few costs involved and Deterra has a policy of distributing 100% of its net profit as dividends.
Broker Morgan Stanley assumes a yield of 5-6.5% when MAC is operating at full bore.
MAC’s saleable tonnes last were 55 million tonnes in a robust iron ore market. But BHP and its joint venture partners plan to ramp these tonnages up to 139Mt by 2023, although we caution that depends on China’s ongoing voracious appetite for the ferrous stuff.
International royalty holders
Even globally, comparisons to Deterra are hard to sniff out.The $42 billion market cap Canadian gold miner Franco Nevada has a swag of 374 royalties, including over oil and gas assets.The Canadian listed Wheaton Precious Metals and NASDAQ-listed Royal Gold Inc also hold meaningful royalties, while Xtierra Inc plans to sell its Mexican gold assets in favour of gold, silver and copper royalties.
According to the Deterra prospectus, companies with large and diversified royalty portfolios trade at higher multiples than the equivalent diversified miners: 24 times compared with six to eight times for the miners themselves.
Ash
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