Nolan Watson – Master of the Gold Cycle

Kerry: Welcome, and you are listening to the Financial Survival Network. I’m Kerry Lutz, and today is September 14th, 2018. Well, we’ve been dealing with a lot of mining companies, brought you a lot of CEOs, and talked about what makes them tick. Got a really interesting company that we haven’t talked with before and I think you’re going to be really impressed by it. The name of the company is Sandstorm Gold Royalties and the CEO is Nolan Watson. And Nolan, thanks so much for coming on the show.

Nolan: Well, thanks for having me.

Kerry: So, you started Sandstorm in 2009, before that you were with Silver Wheaton. By your own admission, you’re a finance person, a numbers guy. As a numbers person, how did you get into mining? How did that happen?

Nolan: My background is predominantly in finance, international finance. I’m a CPA and CFA and have been in the mining industry my whole career in Vancouver. It is an inappropriate industry to be in because it’s a heavily capital-intensive industry. Most mining companies require lots of capital to get up and running and being involved in finance, that’s one of the key critical success factors of mining companies can they raise that money and hence my interest in it.

Kerry: Right. Obviously, Canada resource-based economy and that really opens up.opportunities. So, you kind, of saw this royalty based company up close and personal when you were with Silver Wheaton when you were there from the beginning, and obviously something about it appealed to you.

Nolan: Yeah, it’s a fantastic business model that really is one that successfully takes out a lot of the risks that you inherently get in mining, like increases in operating costs, and if there’s a flood or a fire or an earthquake the mining company starts losing money trying to fix things, that royalty company or streaming company does not. We just collect checks from mines all around the world, and some months we get more checks than others, but we’re always getting checks, we’re always cash flow positive, and it’s a fantastic business model that I fell in love with.

Kerry: And basically, you get all of the benefits of mining without the burdens, without the risks.

Nolan: Mining companies, and gold mining companies in particular, are notorious for producing gold but not producing free cash flow, and the royalty companies, we are basically just free cash flow generating machines. That’s all we do is just generate free cash flow and go out there and sometimes we grow and acquire other royalties so that we can generate more free cash flow.

Kerry: All right. And right now at last count, you have 189 royalties that the company’s involved in?

Nolan: Absolutely, we’ve got contracts all across the world. We are in North America, South America, Africa, Europe, Asia. We’ve got royalties on a number of producing assets, development assets, exploration assets, we’re discovering the whole spectrum around the world.

Kerry: Remarkable. And 189 companies, that’s pretty hard to keep track of, so, it sounds like one of your main functions, the company’s, is just figuring out what’s going on at all of these projects all over the world?

Nolan: Yes, it’s actually not as hard as one would think. We’ve got a couple of employees who are 100% dedicated to just tracking the progress and communicating with the partners, finding out what they’re doing, what drilling they’re doing, what exploration, figuring out how many ounces of gold they found during the year, tracking production, figuring out how much gold they produced, doing the calculations about how much we’re owed and making sure that matches up to the checks. And we’re able to run a company that’s got about a $900 million market cap Canadian with only about 22 employees and about 2 of them are solely dedicated to just tracking them.

Kerry: That’s remarkable. And obviously, at certain times the royalty model is better than others when the price of gold is kicking around the $1200 the ounce, there’s obviously more opportunities, a lot of companies are knocking on your door.

Nolan: Yeah, it’s one of the benefits of the model is that when the gold price is very high and royalty companies are making lots of money and the mining companies are also making lots of money, we get to slow down our deal flow. We don’t really acquire that much when the gold price is high and we just build up a war chest of cash and then when the gold price is low, we deploy all of that capital and sometimes we even borrow money on revolving lines of credit and go and acquire things. Right now Sandstorm is debt free, we don’t have any debt, but we do have large lines of credit we can draw on if we find amazing acquisitions, and we just build up the royalty portfolio so that when the gold price goes up again, our investors profit.

Kerry: Which makes a lot of sense. And so the criteria for a project, I assume you have people actively out there looking for you, but then Sandstorm’s known in the industry, so you’ve got people just submitting deals to you all the time. What do you look for in a deal before you’ll commit funds to it?

Nolan: We’re looking for lots of different things. So, we look at probably 40 to 50 different criteria, the majority of them are technical. So, we’re trying to make sure that the asset is in the hands of a partner who knows how to operate it properly and knows how to manage the political risk and knows how to manage local risks, that the resource is good, that it is continuous, that the grades are high, that risks are low. Generally speaking, we spent a lot of time identifying as many risks as we can and flushing those out and understanding them, and trying to avoid situations where there are risks. And then we spent a lot of time looking at the exploration upside, that’s where we really feel like we make the significant amount of our returns to investors is getting the exploration upside story right.

Because when you buy a royalty, you buy it for the entire life of the project, and so if they’ve got a million ounces of gold on the day that you acquire that royalty and the mine produces eight million ounces before it shuts down, you got the other seven million for free. And that’s really how we generate a lot of return for shareholders. In fact, our portfolio right now, we’re two years running where the number of gold ounces found for free to Sandstorm and the shareholders on our projects significantly exceeded the number of gold ounces mined. So, our investors received, say, $50 million a year U.S. of free cash flow, and there were more emphasis on the books before counting acquisitions just because of the exploration upside. And then we obviously added even more ounces than that through the acquisitions that we made.

Kerry: Right. So, pretty much the reserves are very conservatively estimated and often the production goes way past what the estimates were?

Nolan: Yeah, if you’re thinking about an underground mine, in particular, you’ve got these narrow winding veins throughout the earth, your reserves are only the ounces that you can show are proven and probable and demonstrate economic viability. So, what a mine does is typically just drills up the minimum number of ounces required to prove that they’ve got an economic mine there. They go and build the mine and then as they tunnel down and start mining, they send out additional exploration drills, and they start continuing the exploration to add ounces to those reserves. It’s a lot cheaper to do that drilling from underground than it is to do it from the surface. So, the mines really start to add ounces once they’re up and running, and so we try to buy our royalties before that point that we get all of that exploration upside for free.

Kerry: So, that’s a kicker that usually turns out well. I see literally you’re all over the world, Africa, Asia, Australia, North America, South America, are there particular places where you won’t go?

Nolan: There are a number of countries that we won’t go to and that we just deem too politically risky at any one point in time and those places change from time to time as politicians changed. But it would be countries like Venezuela, China, Russia, a whole host of other countries, too many to name, but that those are the types of country we won’t invest in right now.

Kerry: So, automatically you see a deal there it just goes to the side, thanks but no thanks. So, you’re debt free right now, is there an advantage to being debt free or is it better to have some debt on the books, even a small amount?

Nolan: Well, the vast majority of royalty companies do have debt on their balance sheet that they prefer to try to make acquisitions with that and to minimize dilution, and we are the same. We have had that in the past, we’ve repaid all of that debt now, and we still have a revolving line of credit, it’s $150 million U.S. And we’re looking at actually increasing that with our banks, and the plan is to go out and acquire things with that line of credit over the next few years.

Kerry: It makes a lot of sense. And so, as far as looking ahead, obviously productions going up the next several years, you know, looking at the website looks like it’s going to go up substantially, isn’t it?

Nolan: Yeah, right now we’re looking this year to be around 60,000 ounces of gold equivalent production, so that would be $70 to $80 million of revenue and that translates to about $60 million of free cash flow. We should be substantially more than doubling that over the next four years based solely on the things that we already bought and paid for. So, we think that those 60,000 ounces a year will go up to over 140,000 ounces a year within the next 4 years. And so sometimes I joke that, you know, Sandstorm has…because we have the best growth profile of any royalty company in the world right now, or any material royalty company anyway in the world, that sometimes the best thing that we could do is just sit on our hands and do nothing for four years and watch our production more than double, our cash flow more than double, and our share price go up without doing anything. But of course, we’re not going to do nothing, we’re going to continue to grow the company.

Kerry: Which is what it’s all about. And, so you’ve been buying shares back, correct?

Nolan: Yeah, right now gold is a little bit out of favor and everyone’s investing in the next sexy tech thing and pot stocks in Canada and cryptocurrencies, and gold has kind of been forgotten and is traded down to around $1200 an ounce, and a lot of gold stocks had been hit at the same time. Because we have lots of free cash flow, cash is coming in the door every single day, and we have the ability to buy back our own stock when we want to, so we’ve been doing that here over the last year.

Kerry: Right. So, earnings per share are going to go up. One thing I noticed on your income statement, you’ve got a lot of depletion and a lot of non-cash expenditures that flow through, is that a result of the structure of the company and the way you participate in the mine?

Nolan: So, let’s say you go in and invest, say, $50 million buying a royalty, what we do is we typically deplete that entire $50 million on our balance sheet over something that resembles the reserves. And so, let’s say it was a 7-year mine life originally, but it’s going to go for 40 years as they continue to explore and find more underground, we’ll deplete that full $50 million fairly quickly. And then so earnings on that individual stream will be low for the first few years while you’re taking that depletion hit, and then earnings go up dramatically when you produce your depletion rate because they found more ounces of gold and there’s been more exploration upside, you’re now getting those free ounces that I was talking about before.

Kerry: Right. So, really with Sandstorm, you can’t look at the net profit because the depletion is effectively front-end loaded and you’re going to recover your costs before you realize a profit effectively on the investment.

Nolan: Exactly. That’s the way that the analysts value us, and institutional investors, they basically take a look at our free cash flow generating capacity. They basically say, “Okay, if management wasn’t there and they weren’t making any more acquisitions and the portfolio just sat there, how much free cash flow would it generate over the next 30 years? What is the present value of that today?” And that’s how they value us.

Kerry: Right. So, strictly on cash flow because the depletion is going to pretty much wipe out the net profit anyway. So, you’ve got a large operating loss carryforward, so when the company pays taxes, it’s going to be quite a ways from now, isn’t it?

Nolan: Yeah, it’ll be a few years off still before we start paying material income taxes. We do pay income taxes in some of the local countries. So, we’ve got some deals, let’s say, for example, in Burkina Faso where the deal is done in Burkina Faso, we’re paying taxes in Burkina Faso right now, and same in Argentina and so on and so forth. And so we’re paying those taxes now in Canada. Like you said, because of that depletion, we do have some loss carryforwards, and eventually, those will get eaten through as the mines start maturing and we start mining some of that exploration upside. I think all things being equal and gold price not going down, earnings should go up dramatically because of that effect.

Kerry: Right, after-tax earnings. But if you keep on adding royalties, you can put that day off, the taxpaying day off for quite a while, can’t you?

Nolan: Every time you buy a royalty in Canada, you get to deplete it, even if it’s not in production right now. So, you go and buy a royalty that the mine is going to start up in the next four years, you can deplete it down against your current income, so that’s true.

Kerry: And what’s your average investment in a mine approximately? I’m sure it’s all over.

Nolan: There’s no average, that’s one thing I’ve learned over the years. You can have deals in the hundreds of millions of dollars and you can have deals in the thousands of dollars. We don’t necessarily think one is better than the other, what we like the most are deals that get us really high IRRs and ones where we think that it’s going to be substantially better than and more valuable than what we paid for it. And some of the best deals that we’ve done over the years have been been small deals that turned out to be highly valuable.

Kerry: Interesting. And give us an example of a couple of the best deals you’ve done.

Nolan: An example of a really small one that we did, we invested, I want to say, around a million dollars into a company buying a combination of a 2% NSR and their equity, and it’s a company called Erdine [SP]. And we ended up selling the equity a year-and-a-half later for $4 million. And the royalty right now, we could probably sell for $10 million if we wanted to. So from a million to $15 million and in a couple of years, and we’ve had a few like that.

Kerry: That’s pretty good. So, if all the other ones are just pretty decent performers and then you get some home runs, some grand slams, it can really up the earnings substantially.

Nolan: Exactly.

Kerry: So, the outlook is good. If gold goes up, you’re going to benefit and if it stays at the same price or goes down a little bit, you’re still going to benefit because probably more companies are going to come to you. What’s the state of financing for these mining companies now? How hard is it for them to get cash? To get funding to actually complete a project?

Nolan: Well, that’s one of the benefits of having a down market is when equity investors don’t want to invest in gold we step in and we get incredible deals because there are no other alternatives. I mean, I literally had a CEO sitting in my boardroom not too long ago and he asked if we would buy some equity in his company and I said, “Well, if you sell me…” he had three properties… “You sell me three royalties, I’ll pay you a dollar each. So, I’ll pay you $3, and then I’ll buy some equity,” and you know, on the spot, he said sure. So, we got three royalties for free and I have a feeling there’ll be worth millions and millions of dollars.

It just really, really is that bad in the mining industry right now. So, I believe that when prices are low it’s the perfect time for us to invest our capital. I believe when prices are low it’s the best time to buy the equity of royalty companies and mining stocks. I just bought $200,000 a couple of weeks ago of Sandstorm stock because I think it’s trading at an incredibly low valuation based on what I think it’s inherently worth, based on the future free cash flow generating capacity. And now is the time for us to be investing.

Kerry: Yeah, it’s a great business model, and it just reminds me of that movie “Trading Places” where Eddie Murphy says, “You mean if somebody buys and…he buys, you earn a commission and he sells, you earn a commission?” And they said, “Yeah, that’s right, and regardless of what he makes.” And it just reminds me of that, kind of, situation there. So, obviously, you’ve got major plans for it and you’ve got easy access to capital. If rates are going up, what kind of effect is that going to have as far as Sandstorm is concerned?

Nolan: Yes, I think it’s already has had the effect, which is when rates go up, gold prices go down, and the rates going up has caused the gold prices to go down. And we’re benefiting from that because we’re getting incredibly good deals and it doesn’t really affect us right now. As I said, we don’t have any debt, so we’re not paying any interest. What it does is make our competition more expensive because sometimes when we’re looking to buy royalties from a mining company, one of the competitors that we have is debt. They could go and borrow money instead of selling a royalty to Sandstorm for Sandstorm’s money. And as interest rates are going up, the debt rates are getting more expensive and so it makes us more competitive and that helps us as well.

So, it really does help us grow our business when interest rates are high and going up and we’re benefiting from that right now. The downside is that our share price is incredibly low because gold prices are low, but that’s just the reality of the situation. And I think we all know that the situation is not going to last forever. We’re in, basically, the longest bull market ever. I think it doesn’t have that many legs left. And when it turns around and central banks have to start easing, gold price is gonna rip through the roof and so will our stock price.

Kerry: It is interesting that your stock is really not understood on your business model, the profits are just increasing, that you’re not so much a gold company as, I guess you would say, a cash flowing gold company, you got cash flow no matter what. The market doesn’t really get what Sandstorm does.

Nolan: Yeah, it takes a while to get known. And sometimes, unfortunately, it takes a while for investors to actually care about a sector to get them to want to invest in it. And right now no one wants to invest in the gold sector, nobody really cares about it, but that’s okay with me. I’m a big believer that you make your money when you buy, not when you sell and when things are down and out that’s when you buy, that’s why I’ve been doing it that way.

Kerry: And it’s worked extremely well. So you need to find out more about Sandstorm, and just go over to www.sandstormgold.com, that’s www.sandstormgold.com. You trade on the New York Stock Exchange, American under S-A-N-D is simple to remember, and the TSX: SSL. Nolan, it sounds like it’s going to be smooth sailing ahead. Of course, there’s always challenges, but if you’re at the bottom of the market now, who knows where you’ll be once gold comes back into favor and the market, you know, become sexy once again?

Nolan: Absolutely. I’m looking forward to it.

Kerry: As are we. Well, thanks so much for coming on, thanks for your sponsoring the show, and we wish you the best of luck.