It's been a rollercoaster ride of a year for investors in the precious metals sector, with the Gold Juniors Index (GDXJ) briefly sporting a 20% as it entered April, before cascading through a violent bear market. This bear move has been so severe that it left the GDXJ sitting at a (-) 80% annualized return from its April highs, on par with what we saw in September 2018 before the index made a major low (that likely wouldn't have been undercut if not for the COVID-19 Crash in March 2020).  During these periods, patient investors are presented with the opportunity to purchase explorers, developers, and producers at massive discounts to fair value. However, it's not often that the much lower-risk royalty/streaming companies with infinitely superior business models find themselves on similar sale racks. Instead, their corrections are typically limited to 30-40%, and rarely exceed 50%. Fortunately for investors that didn't chase the stock at much higher prices, there is one royalty/streaming company sitting on the 50% off rack, or 58% from its 2020 highs.  Let's take a closer look below:

(Source: TC2000.com)

Sandstorm Gold Royalties

Sandstorm Gold Royalties (SAND/SSL) has had a very busy year in 2022, completing two major acquisitions with a transaction value north of $1.0 billion (Nomad/Basecore) that added over 20 new royalties/streams to its portfolio. The company also shifted to a more pure-play royalty/streaming model with the sale of its 30% interest in Hod Maden, which was converted into a 20% gold stream at a price equal to 50% of the spot gold price and a 2.0% NSR royalty. While these deals have certainly added meaningful growth in Sandstorm's production profile, which other royalty/streaming companies have also accomplished through acquisitions and new deals over the past 12 months (Gold Royalty Corp, Royal Gold, Franco Nevada), investors seem to have overlooked the other positives that have dramatically changed the company.

Following these deals, Sandstorm not only significantly increases its number of producing assets from 29 to 39 and its total royalties from 230 to 250, but it has leap-frogged all of its peers to become the sector's most diversified royalty/streaming company. This is a differentiation that cannot be overstated, given that the three most attractive points of the royalty/streaming model are the fact that its inflation-resistant, it's protected from violent metals bear markets due to the margin profile (pay up-front only, receive deliveries over mine life with no need to continue committing capital each year), and it's unparalleled diversification. The problem is that even if a royalty/streaming company has 30+ producing royalties and enjoys sales of more than 150,000 GEOs per annum, but the top 5 make up close to 70% of net asset value [NAV], that company is much less protected from a single-asset risk, and is actually in a similar position to a major producer (10+ mines) from a diversification standpoint, even if it checks the former two boxes. 

(Source: Company Presentation)

In Sandstorm's case, its recent transaction has left it with just 39% of NAV tied to its top-5 assets and barely 55% of NAV tied to its top-10 assets. This is much more attractive than Triple Flag, which has 67% of its NAV tied to its top-5 assets and over 80% of its NAV in its top assets. I believe this shift from a messier hybrid model pre-2022 with a Hod Maden interest to a pure-play combined with industry-leading diversification should lead to a premium valuation relative to peers. However, following a surprise financing that caught investors by surprise ($92 million at US$5.10), the stock has actually seen significant multiple compression and has found itself trading at a producer-like P/NAV multiple. Let's take a closer look below:

(Source: Company News Release)

Recent Financing

Sandstorm announced an $80 million bought-deal financing last month (upsized to US$92 million), and the deal caught many investors (including myself) by surprise, especially given that I had already initiated a position in the below US$5.80. Not surprisingly, the deal got significant air-time from detractors, and understandably, many investors were frustrated with the news, given that dilution is never ideal. Some investors noted that the whole point of owning royalty/streaming companies is to avoid significant share dilution, others pointed out that Franco Nevada (FNV) would never do something so preposterous, and some pointed out that it makes zero sense to be buying back shares above US$6.00 only to sell them at US$5.10. These are certainly fair points, and there's no question that Sandstorm clearly bit off a little more than it could chew by doing two major acquisitions in a rising-rate environment, which suddenly turned into a rising-rate and falling commodity-price environment, further impacting its short-term cash flow.  

However, this was not a case where Sandstorm massively overpaid in the upper portion of a cycle and had to do write-downs and/or dilute shareholders to compensate for the heavier debt burden. Instead, this was a case of Sandstorm acquiring at very favorable prices in a period of extreme pessimism and getting a very solid price for Nomad/Basecore.  In fact, I think this was a brilliant move for the company that transformed its portfolio, providing the potential for a significant re-rating once new assets start to come online (Greenstone, Platreef, Robertson, and Hod Maden). Plus, I think it's important to make the following points:

1. Sandstorm’s surprising bought deal financing has received considerable airtime and grievance from investors, but it’s actually quite insignificant. In fact, I would argue that the deal has received more attention than the 70% plus dilution from Marathon (MOZ) and Argonaut (AR), which were much worse and absolutely inexcusable, leading to irreparable dilution. So, while no dilution is welcome, I don’t see ~7% share dilution as that meaningful to the investment thesis.

2. Although Sandstorm bought back shares at much higher prices than it diluted, the company shouldn’t be judged for not having a crystal ball. Given the inflationary environment, buying back shares below US$6.50 made sense previously, with most believing that gold and silver would respond much more favorably to the macro backdrop, which they briefly did (2020). Sandstorm also didn’t likely think it would have the opportunity to buy an established royalty/streaming company with growth to up to 50,000 GEOs per annum for less than 1.0x P/NAV when it was buying back shares over a year ago, so it didn’t have a more accretive use for its cash. Given the ability to look into the future with the hindsight knowledge that gold would be below $1,700/oz with 8.0% inflation, the company might have been more patient with buybacks.

3. Finally, while it’s true that Franco Nevada would likely never do a bought deal today for 5% plus share dilution, comparing Franco Nevada today to Sandstorm today is an apples-to-oranges comparison. The reason is that Franco Nevada's scale and considerable cash flow generation plus available liquidity allows it to grow without dilution outside of its occasional ATM use. However, when Franco Nevada was a much smaller royalty/streaming company, it regularly did financings, and many had warrants attached. In fact, Franco Nevada saw heavy dilution in its high-growth phase, going from 90 million shares in Q1 2008 to 146 million shares by the end of 2012, translating to 60% share dilution. An example of some of these transactions is below: 

February 22, 2008 - Franco-Nevada Corporation (TSX:FNV) (“Franco-Nevada”) announced today that it has entered into an agreement with a syndicate of underwriters led by BMO Capital Markets and UBS Securities Canada Inc., under which the underwriters have agreed to buy 10,000,000 units (the “Units”), from Franco-Nevada, and sell to the public at a price of C$23.25 per Unit, representing an aggregate amount ofC$232,500,000. Each Unit consists of one Common Share and ½ of one Common Share Purchase Warrant (the “Warrant”). Each whole Warrant entitles the holder to purchase one Common Share at a price of C$32.00 on or before the date, which is four years following the closing of the offering. In addition, the underwriters will also have an option exercisable for a period of 30 days after the closing of the offering, to purchase up to an additional 1,500,000 Units.

May 27, 2009 - Franco-Nevada Corporation (the “Company”) announces that it has entered into an agreement with a syndicate of underwriters, co-led by BMO Capital Markets, GMP Securities L.P., and CIBC World Markets Inc. which have agreed to purchase, on a bought deal basis, 10.0 million Units of the Company at a price of $32.20 per Unit for aggregate gross proceeds of $322 million. Each Unit will be comprised of one Common Share and one-half of one common share purchase warrant (“Warrant”) of the Company. The underwriters will also have the option, exercisable in whole or in part at any time up to 30 days after the closing of the offering, to purchase up to an additional 1.5 million Units. In the event that the option is exercised in its entirety, the aggregate gross proceeds of the offering will be $370.3 million.

Nov. 22, 2011) - Franco-Nevada Corporation (the "Company") (NYSE:FNV) (TSX:FNV) is pleased to announce that it has entered into an agreement with a syndicate of underwriters, led by BMO Capital Markets, which has agreed to purchase, on a bought deal basis, 8,000,000 common shares ("Offered Shares") of the Company at a price of C$42.50 per share, for aggregate gross proceeds of C$340,000,000 (the "Offering"). The underwriters will also have the option, exercisable in whole or in part at any time for a period of 30 days following the closing of the Offering, to purchase up to an additional 1,200,000 common shares to cover over-allotments, if any. In the event that the option is exercised in its entirety, the aggregate gross proceeds of the offering will be C$391,000,000.

To summarize, I certainly would have preferred not to see the dilution, but I am willing to give Sandstorm a pass here if this is the last of the dilution, and I believe it's opened up an incredible opportunity to accumulate the stock. 

The Opportunity

Based on ~299 million fully-diluted shares (year-end 2023 estimates) and a share price of US$4.80, Sandstorm has found itself trading at a market cap of $1.44 billion. This is an insane valuation for a company capable of generating $190 million in cash flow in FY2025 at conservative metals price assumptions of $1,725/oz gold, $20.00/oz silver, and $3.60/lb copper. Even based on historical cash flow multiples, which were depressed due to Sandstorm's non-pure play royalty model, the company traded at a historical multiple (15-year average) of 19.0x cash flow. Based on this figure which doesn't incorporate an expansion in its multiple due to its superior business model and scale today and estimated FY2025 cash flow of $190 million, this translates to a fair value for Sandstorm (2-year price target) of $3.61 billion. If we divide this figure by 299 million, we arrive at a fair value for the stock of US$12.05.

(Source: FASTGraphs.com)

From a P/NAV standpoint, Sandstorm's estimated net asset value comes in at $1.82 billion, and I see a fair multiple for the stock being 1.65x P/NAV today. This is based on its industry-leading diversification, precious metals focus (88% of 2025 revenue is from gold/silver), and its differentiator as having royalties/streams on some of the lowest-cost mines. After multiplying its estimated NAV by 1.65x and dividing by 299 million shares, Sandstorm's fair value comes in at US$10.05. So, regardless of how you look at the company, Sandstorm looks to have more than 100% upside to fair value (2-year target price), and this is based on three conservative assumptions:

1. no further growth in its portfolio through new acquisitions and no additional share repurchases

2. no improvements in metals prices from conservative assumptions of $1,725/oz gold, $20.00/oz silver, and $3.60/lb copper

3. no multiple expansion related to being the most diversified and highest-growth royalty/streaming company in the sector

Understandably, some investors in the precious metals space might not be interested in a 100% upside to fair value to a 2-year target price when some developers and explorers could triple in a very short period if the gold price heads back above $2,000/oz. However, I believe portfolio construction to be important, especially if one chooses to have a high weighting to an extremely volatile sector like the precious metals space. While one may get better bang for their buck in explorers/developers, and some allocation to the best developers like Osisko Mining (OSK) is justified, a portfolio with mostly explorers/developers has the opportunity to lead to significant drawdowns. Some investors might believe that weighing each name smaller makes sense with a shot-gun approach, but I believe a shot-gun approach doesn't fix the issue. This is because it can lead to owning many lower-quality names (your 11th-best developer idea probably isn't even worth owning since there are only a handful of high-quality names). Plus, given that the sector tends to trade like a school of fish, you're in a similar and sinking boat in a bear market whether you have 30% of your portfolio across four juniors or 30% of your portfolio spread across 15 juniors.

As discussed earlier, royalty/streaming names typically have lower beta and are much lower risk, and they tend to outperform in bull and bear markets for precious metals. For this reason, allocating to precious metals royalty/streaming companies can help smooth out portfolio volatility and significantly reduce risk in the precious metals portion of one's portfolio. The problem for most (myself included) is that it's hard to justify owning these stocks at a 50% premium to net asset value when developers can be purchased for 0.30x P/NAV and producers can be purchased for less than 0.80x P/NAV, with the latter, also having diversified business models (even if not inflation-resistant). However, today we have Sandstorm trading at a producer-like valuation at less than 0.80x P/NAV, which would be the equivalent of buying Royal Gold (RGLD) at US$60.00 per share. So, if there was ever a time to add royalty exposure to one's portfolio, I believe the time is now, and Sandstorm is an excellent fit. To summarize, I see the stock as a steal below US$5.00, and I plan to accumulate and increase my position if we see further weakness.

Disclosure: I am long SSL, OSK

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing. This article is provided for informational purposes only, and is not intended to be investment advice of any kind, and the author is not sponsored by any company discussed in the article, nor has he ever been compensated by any company discussed in the article. Given the volatility in the precious metals sector, position sizing is critical, so when buying small-cap precious metals stocks, position sizes should be limited to 5% or less of one's portfolio.