I was exploring the mining industry looking for significantly undervalued assets given the entire sector has been out of favor, and I stumbled into Sandstorm (SAND). As a brief summary for those who don’t follow the stock, the company has a unique business model in that the company itself does not own or operate any mines. Rather the company finances advanced stage development projects/operating mines that need CAPEX and in return for giving upfront financing/cash, Sandstorm receives the right to purchase, at a fixed price per ounce or at a fixed percentage of the spot price, a percentage of a mine’s gold, silver, or other production for the life of the mine.
This right to purchase the mine’s output is called a “stream” and as a form of capital has certain advantages from providing straight-up debt or equity. It basically has all the upside of an increase in commodity prices while having the protection of commodity price decreases by having a low contract purchase price. In other words, Sandstorm will not lose money as long as the price of gold (or whichever commodity) falls below the contracted price. Sandstorm also has protection from operational risks such as higher production cost vs. initial estimate as the company gets a percentage of revenue and not profit.
In some ways, investing in the company is similar to buying into a mutual fund of junior miners. Instead of directly paying the management fee of % of AUM, you are paying the $6 million of G&A to actually run the company. It’s also a lot easier to value Sandstorm than a mutual fund as we just need to examine the company’s cash flow and assets (as opposed to a mutual fund where we need to have a valuation of each and every stock in the portfolio). Sandstorm has the advantage of having possibly a better portfolio than the average mining mutual fund because of its focus on making investments in the mine itself (i.e., the focus on getting good cash flow deals) vs. a mutual fund which may need to benchmark against a certain market index. Having cash flow also means that Sandstorm can continuously compound the returns of streams to get even more deals.
Setting up for the future
A streaming model works best when companies like Sandstorm are able to get a streaming deal that is favorable to them. This happens when the access to capital is tight and mining companies do not have a lot of alternatives when it comes to financing options. In this type of environment, mining firms would have to accept relatively expensive financing from companies like Sandstorm. Currently, the smaller less established mining firms are having trouble raising capital in the equity markets. This represents a massive opportunity for Sandstorm in order to get the best deals possible.
As such, while seven or eight years ago the vast majority of mining deals used to be capital markets transactions, today alternative financing deals are increasingly the best option for cash-strapped miners. In fact, around half of the billion dollars of mining deals Fieldfisher conducted last year came from alternative sources.
Source: Alternative financing for the mining industry: what are the options?
In terms of valuation, Sandstorm as a streaming company is pretty straightforward to value as it’s all about the cash flow. The company is projecting $140 million in operating cash flow in 2023 assuming a price of gold of 1500/oz. At 190 million diluted shares outstanding and taking out the $6 million of G&A expense, this gives us a cash flow per share of about 0.70 per share. At a conservative 12 P/CF this translates to a share price of 8.4, which is 20% higher than the close of 6.9.
This assumes two things, though: 1) that there aren’t any operational delays and 2) gold prices hit $1500 by 2023. The first scenario is somewhat mitigated given the diversified nature of the firm’s portfolio. In the case of the second scenario, at prices running the same exercise above but assuming a price of $1000, puts the company at operating cash flow of $93 million, which translated to a cash flow per share of 0.49 at a P/CF of 12 would put us at a share price of 5.5. So I think this share price range of 5.5 to 6.9 represents a decent floor for the company’s valuation given its producing and developmental assets.
A key component of that cash flow forecast is the Hod Maden gold-copper project, which is located in Turkey. Based on the 3Q 2019 report, the project economics are quite promising as the preliminary feasibility study envisions a conventional underground mine and processing facility producing copper-gold concentrates with a cost of $374/oz. There are an estimated Proven and Probable Mineral Reserves of 2.6 million ounces of gold and 284.4 million pounds of copper being mined over an 11-year mine life (9.12 million tons at 8.9 grams per ton gold and 1.4% copper or 11.9 grams per ton gold equivalent). The company hopes to get this asset producing by Q4 2022. Hod Maden is considered by the company to be an anchor asset that is expected to increase the company’s attributable gold equivalent ounces to over 140,000 in 2023.
Source: Sandstorm 2019 Investor Presentation
The company doesn’t break down its cash flow forecast by development project, however, seeing the big-jump in cash flow from 2022 to 2023 can lead us to infer that this project is expected to generate $45 million in cash per year. Depending on how you feel about the political situation in Turkey, this cash flow may be at risk.
Running the same exercise with gold prices between $1000 and $1500, and a P/CF of 12 but removing the cash bump of Hod Maden would give us a share price range of about $3.6 to $5.6.
Turkey is still a democratic country though that only a few years ago almost joined the EU. Furthermore, Sandstorm has a strong partner in Lidya which is part of a large Turkish conglomerate called Çalik Holding which has a strong relationship with the Turkish government.
In order to hit my worst-case scenario price of $3.6, the price of gold would have to fall to $1000 and Hod Maden scrapped, both of which happening I think is unlikely. Given the circumstances on a projected cash flow basis, Sandstorm is fairly valued to undervalued.
There are certain possible scenarios that will allow Sandstorm to surprise on the upside. The first is that the company currently has low leverage ratios. Once it has steady cash flow by 2023, the company can start thinking about taking on debt to finance even more deals which would lead to more cash flow. As of 3Q 2019, the company has Total Liabilities of $51 million against Total Assets of $608 million which indicates a lot more room to “juice” their returns. Another possible upside for the company is if gold rallies above the price of $1500. At $2000, the company estimates this will add about $55 million or about 0.3 cash flow per share.
The final possible kicker is that the company has a massive exploration portfolio of about 150 possible streams, about half of which are projects located in Canada or the US. Having a portfolio of mines in the exploration stage means that the company isn’t overly exposed to a single project. Assuming you have the necessary expertise and experience, it is true that you can replicate the effects of having a mining portfolio focused on exploration by buying stocks of junior miners. However, given that the cash flow of the producing mines is already worth $3.6–6.9 per share, you are basically getting this potential upside for a discount at the current share price of $6.9. I like the business model of the company and while I don’t think the company is cheap, it is definitely something to consider when building a long-term portfolio. Sandstorm is a buy for me.
Source: Sandstorm 2019 Investor Presentation
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SAND over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.