And Now For Something Different: Royalties

This story features DETERRA ROYALTIES LIMITED, and other companies. For more info SHARE ANALYSIS: DRR

The benefits of royalties and where to access them via the ASX.

By Tim Boreham, Editor, The New Criterion

Royalty – as in the Windsor variety – has endured more than a few reputational hits of late. The same can be said for royalties, which are not a gaggle of surviving monarchies but the right to a revenue cut of a producing asset.

While royalties are well-known in North America – notably in the oil and gas and precious metals sectors – the concept tends to draw a blank with investors here in Australia.

Similarly, local miners are unfamiliar with the use of royalties as a funding source – an adjunct to better-understood debt and equity.

In essence, the sector is more on the outer than Harry and Megan.

That’s a pity, because royalty payments are usually revenue based and tend to increase in inflationary times, without the holder being subject to rising input costs or the requirement to commit more capital.

In the non-resources sphere, entertainment royalties are equally foreign to us at a time when more mega artists have sold off their portfolio rights (including Bruce Springsteen and Bob Dylan).

Australians’ aversion to royalties – and, we suspect, royalty post The Queen’s demise – makes the $2.5bn market-cap Deterra Royalties ((DRR)) an ASX unicorn.

The stock is as close as we get to Canada’s $60bn market cap Franco Nevada, the global leader in precious metal royalties.

A spin-off from mineral sands miner Iluka Resources ((ILU)) , Deterra holds one key asset: the right to a 1.232% revenue share from BHP’s Mining Area C (MAC) iron-ore project in the Pilbara.

Not surprisingly, Deterra chief Julian Andrews is on a mission to spruik the benefit of royalty flows to both investors and as a corporate funding source.

“Royalties don’t have the best reputation in Australia,” he told the Melbourne Mining Club recently, adding that they are well understood and widely used in the global oil and gas sector.

Deterra’s mandate includes developing new projects in exchange for royalty streams.

“There are strong overseas examples of royalties being used to fund a project that otherwise would not be built,” Andrews says.

“We are talking to the market and the industry about how royalties can be used more efficiently to fund a project.”

Meanwhile, the MAC project is the gift that keeps giving: when a current extension to the south flank is completed, the long-life project will account for roughly 8% of seaborne iron ore.

In the half year to December 2023, MAC generated revenue of $119m for Deterra, $79m of which trickled to the bottom line.

Deterra distributed a full-franked dividend of 14.89 cents per share – a payout ratio of 100%.

Andrews says royalty funding better aligns investors with the ebbs and flows of the commodity cycle and corporate performance.

In other words, if a project output slows temporarily, the return to royalty holders does as well. Unlike bankers or equity holders, they are not baying for blood and this equates to superior returns over time.

 “We get paid when the mine is producing and we don’t get paid when it isn’t … we have a qualitatively different interest in the project.”

As with MAC, royalty holders participate in the growth of an asset without having to contribute additional capital.

Another benefit is that given the revenue is over the life of a mine, royalty-based projects tend to be valued on a net present value basis, rather than a discounted market value.

While Deterra is kicking tyres on new royalty deals, some things are off limits. Given a royalty agreement in essence is a bit of paper, sovereign risk is crucial and thus the company is unlikely to invest in African or South East Asian projects.

“We’re focused on more developed mining jurisdictions, somewhere we would be happy to take our family for a holiday.”

Commodity-wise coal is off limits – thermal or metallurgical – while the precious metals sector is well served already. “We have a relatively small team and need to focus our attention on where we have relatively high chance of success,” Andrews says.

He dubs royalty funding as “another quiver in the arrow for CFOs”: not the funding be-all-and-end all, but an adjunct to debt and equity that sits in the middle of the capital hierarchy.

Andrews reports a decent flow of royalty opportunities, often involving parties that have acquired them by “happenstance” (such as tenement holders vending an asset).

In 2020 BHP spin-off South32 ((S32)) sold a portfolio of gold royalties to Canada’s Elemental Altus Royalties Corp for US$55m in cash and scrip.

In 2022 South32 followed up with a US$200m base metal royalty sale.

Both results were better than expected, but sometimes deals can end up in more trouble than Prince Andrew’s spin doctor. For instance, South32 is in dispute with IGO Ltd ((IGO)) over $122m of alleged unpaid royalties pertaining to the Tropicana gold mine (now owned by Regis Resources ((RRL)) and Anglo gold).

In the microcaps space, the $12m market cap High Peak Royalties ((HPR)) has a swag of oil and gas royalties here and in the US, with counterparties including Santos, Origin Energy and Shell Australia.

High Peak pocketed gross revenue of $301,000 in the December 2023 quarter, for net income of $125,000.

For a broader exposure, Betashares Global Royalties ETF ((ROYL))  provides a one-stop exposure to global companies that earn a substantial portion of their revenue from royalty income.

Tracking the Solactive Global Royalties Index, the fund’s biggest exposures are Canada’s Wheaton Precious Metals Corp (12% of the portfolio), Universal Music Group NV (11%) and Royalty Pharma PLC (10%).

The fund has gained 8% since inception, but has declined -3.5% over the last 12 months.

“Royalty companies generally display attractive fundamental characteristics such as strong and recurring cash flow, high gross margins, strong debt servicing and high return on capital,” Betashares says.

Indeed: they’re a right-royal opportunity for investors seeking something a little bit different.

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