Duke Royalty [AIM:DUKE], the Guernsey-based provider of alternative capital, published its final results for the year ended 31st March 2022 today (8th September). Royalty finance is a well-established fundraising method in North America, with big companies like Franco-Nevada [NYSE:FNV], Osisko Gold [NYSE:OG], and Sandstorm [NYSE:SAND] being significant funders of mining finance; but a fairly new concept in the UK, with Duke Royalty being the only listed royalty finance company in the UK.
In the mining context, a royalty is the right to receive payment based on a percentage of the minerals or other products produced at a mine or of the revenues or profits generated from the sale of those commodities. Basically, a royalty finance company like Duke Royalty stumps up cash to a company up-front, in return for the right to take a financial share of what that company produces. It is often used when a company has no recourse to, or has exhausted traditional funding mechanisms like bank debt, capital markets debt, private or publicly-listed equity.
There is no obligation for the company raising the royalty to make royalty payments unless it is producing and generating revenue, unlike debt financing. The company also can avoid diluting its own public shareholders or have to work towards an ‘exit’ like it would have to do if it agreed a transaction with a private equity shop. The company can use the money for whatever it wants to, be that acquisitions, capital expenditure or project financing. However, the amount of capital it can raise from royalty is usually quite small, so if it needs to make a significant investment, it would have to look for other ways of raising capital and finance its investment either through those channels or with royalties as part of a total package.
Companies raising a royalty often find that it is cheaper to do so that through private equity, and they do not relinquish any control of the company to investors.
The royalty company in return gets ‘equity-like’ payments and can capture a company’s growth for a reasonably small capital outlay without having to involve itself in the operational side of the company. All it does is collect its money at the end of the month, month-on-month. The royalty holder is also protected from operational and production costs, as its returns are based on revenue. However, a royalty holder has less rights than investors holding shares or paper, and so should things go seriously south for the company it holds a royalty in, it will be difficult to recoup any of its investment.
Interestingly, given the AIM market is a significant source of capital for global mining companies, Duke Royalty does not provide finance to the mining sector. It also avoids oil & gas, biotech and start-ups and unlike some of the big American and Canadian royalty and streaming companies, which focus on one sector, or in many cases one commodity, Duke has a well-diversified portfolio across several industries and geographies. The company’s favoured sectors are Industrials, Healthcare, Technology, Leisure and Business Services.
The company’s chief executive, Neil Johnson spent his fledgling years in Canada in financial services and learned a lot about the royalty business in that market, then decided, along with former fund manager Charlie Cannon-Brookes, to bring the concept to the UK in 2014. Some of Duke Royalty’s clients include United Glass Group, one of the UK’s leading independent glass merchants and processors; Miriad Holdings the largest privately-owned recreational vehicle (caravans and motor homes) parts wholesale company in the UK; and Tristone Healthcare, a buy-and-build investment group focused on social care.
The company reported a 67% year-on-year increase on cash revenue to GBP18.4m, against GBP11m for FY21. Johnson attributed this to a strengthening of the underlying investment portfolio and increased deployments. Duke Royalty deployed over GBP75m of capital, adding five new royalty partners to the portfolio and completing a range of follow-on investments into existing royalty partners and completed exits from two investments with strong IRRs. Net income was also up, from GBP14m in 2021 to GBP20.4m.
The company raised GBP35m in capital through an oversubscribed placing which, together with additional capital from Duke’s senior credit provider, supported record deployments. Since the end of March, Duke Royalty raised another GBP20m through equity and paid a dividend of 0.70p per share for 1QFY23, representing an annualised dividend of 2.80p per share, a 24% increase over FY22 total dividend. Net debt for the group increased to GBP42.3m, from GBP15.5m the year before as Duke extended its facility with Pollen Street Capital in January 2022.
Duke Royalty usually offers royalty issuers between GBP5m and GBP20m with a fast turn-around (compared to banks, stock markets or private equity firms) of around seven to eight weeks. The royalty is repaid over 25 to 40 years, a bit like a mortgage and typical yields that Duke expected are in the 12% to 14% range for the capital it provided. Royalties rates are reviewed annually dependent on the issuer’s sales performance. The issuer has the option to buy back the royalty, with a 20% redemption premium.
Johnson said: “We are delighted to report significant growth across all our core KPIs for the 12 months to 31 March 2022. It is particularly pleasing that this positive performance has been achieved as we celebrate our fifth year since admission to AIM in 2017. Through all the highs and lows of the last five years, we have persevered through all the unexpected economic, political and public health shocks, to create Europe’s largest corporate royalty provider for long standing, profitable private businesses.”
Gary Greenwood, an analyst for Shore Cap, which has Duke Royalty under coverage said: “…headline numbers are generally in line or ahead of our expectations, and the company’s outlook is cautiously optimistic despite a more challenging economic environment.”
“While we have celebrated our growth in the face of the many macroeconomic headwinds over the last five years, the next five years will, undoubtedly, present their own challenges. With the majority of the western world now dealing with unusually high inflation and global supply chain issues, we take reassurance from the fact that not only Duke, but the wider royalty industry, has seen many economic cycles before,” said Johnson.
Higher free cashflow
“We believe we are in a strong position for growth and will prudently continue to make deployments to deliver higher free cash flow and increase free cash flow per share. As a company, our portfolio metrics are more robust than they have ever been, meaning Duke is well positioned to withstand headwinds better than ever,” he continued.
Greenwood did raise the point that: “so far Duke’s portfolio companies haven’t been able to pass cost inflation on to their customers in terms of higher prices, but it’s unclear how much longer this can continue, given the fact that even higher levels of inflation are expected.”
Greenwood also said that the fact that although Duke only had 13 partners, this in turn gave them access to 48 underlying businesses, which was a good diversification play. Overall, Shore Cap was positive on Duke and recommended investors should be on the lookout for future rights and liquidity issues to increase their shareholdings in the royalty company.
Duke Royalty opened trading today at 33p. By midmorning this had risen to 34.12p. The company offered a one-year return of -23.55% with a year-to-date return of -20.14%. Shares in the royalty business ranged from 29.3p to 48p and the company was capitalised at GBP136.3p.