Royalty companies are a good way to get low-risk exposure to the gold sector while retaining most of the upside. In essence, a "pure" royalty provides the royalty owner with a share of the production without having to take on the cost of building the mine and ongoing capital requirements.  The cost of the royalty is known upfront.

Franco-Nevada (FNV, NY, 44.17) is the largest gold royalty company, and in my mind, the best. It has a super strong balance sheet, top management, and well diversified asset base in politically safe jurisdictions, with plenty of upside from royalties on undeveloped properties.

Royal Gold (RGLD, Nasdaq, 52.71) is the second largest. It carries some debt and has a less diversified asset base; until recently, three royalties were responsible for over half of net asset value and revenue. Having said that, I think it’s a great company with, arguably more short-term upside in a strong market than Franco.

Osisko Gold Royalties (OR, Toronto, 14.86)(OKSKF) is the new kid on the block, formed as a result of the takeover of Osisko Mining Corp. 18 months ago. A  royalty on Osisko’s Malartic Mine was created as part of a friendly takeover of the company, and Osisko Gold Royalties was launched. The company has the goal of building a portfolio of royalties from its foundation of two of the best gold royalties in the world.  These are attractive royalties (5% net smelter return in one case) on two low-cost, long-life mines in Quebec, one of the safest jurisdictions in the world.

But it is pursuing a different approach from the two largest royalty companies, Franco-Nevada and Royal Gold.  It is challenging to buy significant royalties at attractive prices when competing against these two well-financed behemoths. So Osisko is going about building a royalty company a different way, both by generating royalties through its own exploration programs, and by investing in juniors seeking to create royalties from them. 

More risk, more time and more potential

This is a longer-term approach than buying a paying royalty, but one that, though a little more risky, will pay off in the long run with arguably potentially more upside.

A current example is the four-way merger underway revolving around Oban Mines, an Osisko-backed exploration company. Osisko will invest $18 million for an additional 18% interest (approximately) in the combined entity, and a right to acquire a 1% NSR on all properties held by the company.  The shareholding could also be converted to a royalty at a later stage. Through Oban and other juniors, Osisko has exposure to some of Canada’s most active exploration camps.

The two mines on which Osisko has existing royalties are Canadian Malartic and Eleonore. Malartic, one of Canada’s largest mines, was brought into production by Sean Roosen (CEO of Osisko Gold Royalties) and the former Osisko Mining in 2001 just six years after the first drill hole.  It was subsequently taken over by Agnico and Yamana jointly and Osisko Royalties created).

Eleonore, the Virginia discovery in Northern Quebec, was sold to Goldcorp (GG) in 2006 and began production at the end of last year. It reached commercial production in April this year with an official mining opening just last month. Osisko will start to receive royalty income from this mine in the third quarter (after its advance royalty has been offset). Revenue from these two royalties is expected to grow from $54 million dollars next year (when Eleonore is fully paying) to $69 million by 2018 (even at today’s gold price).

Strong balance sheet for future growth

The company has a strong balance sheet with $320 million in cash, as well as credit lines putting it in a strong position for an acquisition. During the course of this year, Osisko has invested nearly $100 million into Labrador Iron Ore Royalty (LIFZF); that generated $1.6 million in the latest quarter. Roosen, Osisko’s CEO, has said that, though the focus is precious metals, it would invest outside the gold sector in long-life mines with solid cash flow and this investment fits that profile.  Franco and Royal also have some royalties from non-gold assets, including about 10% from oil in the case of the former.

This investment in iron ore has, however, caused some concern. Another concern is that its controlling interests in some juniors could put the company in a position where it needs to pony up more cash. Lastly, Sean Roosen clearly has a more aggressive style than, say, Virginia’s Andre Gaumond or Franco’s David Harquail. (“You can forgive but you don’t forget,” Roosen famously said in relation to Goldcorp, which initiated a failed hostile offer for Osisko Mining.) However, notwithstanding an at-times combative front, Roosen is well regarded in the Canadian mining sector as a mine finder and builder.

Solid position with strong upside, and a good price to buy

All in all, Osisko has a solid balance sheet, two powerful main assets, strong management, and a goal to create more revenue-generating royalties.  Its approach is more long term and a little more risky than buying royalties but also one that has greater potential.  With the drop in the gold price, the share price has fallen (from over $18) into attractive territory; we see it as a strong buy for long-term patient investors.