Investors watching gold prices might want to buy into this hard asset. There are a few different ways to do that, but one of the most attractive is with a dividend-paying stock called Royal Gold(NASDAQ: RGLD).
It isn't a miner; it is a streaming company. And it has a host of ways to win when gold prices rise. Here's what you need to know.
Royal Gold buys gold on the cheap
As already noted, Royal Gold is a streaming and royalty company. That means that it provides cash up front to miners in exchange for the right to buy gold, silver, and other precious metals at reduced rates in the future.
Miners normally use the cash to pay for new mines or the expansion of existing assets. Sometimes that cash will be used to strengthen balance sheets, too. Either way, it gives the miner access to vital capital without the need to sell shares or issue debt. That's a big win in a capital-intensive industry like mining.
Image source: Getty Images.
Royal Gold wins, too, because it gets to buy precious metals at reduced rates. Normally the price is set as a percentage of the current spot rate. In this way, it is guaranteed a profit when it turns around and sells the metal on the open market.
The company's revenue and earnings will rise and fall along with commodity prices, of course, but the reduced rate keeps margins high throughout the cycle.
Royal Gold's 22 years of annual dividend increases are a testament to the strength and reliability of its business model. The 1.3% dividend yield isn't huge, but if you are a dividend investor focused on dividend consistency and would like to add gold exposure for diversification purposes, this is a stock you should probably be looking at.
It has multiple ways to win
The best use of Royal Gold's profits is probably investing in new streaming and royalty deals. That makes sense because it effectively grows the company's business and, thus, its dividend-paying ability.
However, mines are big, complex projects that take years to build. And as you might expect, some mines have better prospects than others. So Royal Gold has to be selective and, at the same time, it doesn't exactly know when deals are going to come along. But when they do, it is more than happy to invest, even if that means adding leverage to its balance sheet.
To that end, the company has a $1 billion credit facility. That gives management the flexibility to act when a good deal shows up. That debt, obviously, comes with costs, notably interest expenses and reduced leeway to act on future deals.
But as noted, deals can be lumpy, so there will be long stretches of time when nothing is happening on the deal front. In those times, excess cash is simply used to pay down the credit facility.
So even when Royal Gold isn't "doing anything," it still is working to the benefit of shareholders by preparing for future deals. When precious metals prices are high, like they are today, it can more rapidly reduce leverage.
For example, in the third quarter, Royal Gold paid down an additional $75 million on its credit facility, leaving it with a balance of $325 million. That means it has around $675 million free for the next deal it inks.
And the company's interest expenses drop as it trims the balance -- not as good as a new streaming deal, but still a nice win for the company and its investors.
A reliable dividend stock in a volatile sector
Precious metals are volatile commodities, but that can actually be a net benefit from a diversification perspective for your portfolio. It makes sense for investors to have modest exposure to gold and silver in their asset mix.
For dividend-focused investors, however, the list of options isn't huge. But Royal Gold is a solid choice, offering a resilient business and a growing dividend. No, the current yield won't excite you, but if the goal is diversification, then the yield is just a bonus from a company that will fit logically into your income-oriented portfolio.
Should you invest $1,000 in Royal Gold right now?
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
