Annual Letter to Shareholders and Outlook

May 11, 2015

To the Shareholders of Abitibi Royalties Inc.

This letter from your president is intended to be more than an annual update. The purpose is to outline our game plan for Abitibi Royalties and how we see it evolving. It is designed to provide better insight into our thinking and how we intend to run the business.


Share Performance


Last year started the process of creating the ‘Best Gold Company’.  Why is this our goal? Well, there is no sense getting up in the morning and competing if you don’t have a clear goal that pushes you.

Having watched and been employed in this industry since the ripe old age of 5 (not a misprint), there are only a handful of companies that have achieved this status in my mind (American Barrick 1985-1992, Goldcorp 1995-2005 and Franco-Nevada for most of its history).

I define the Best Gold Company as the one that achieves the best share performance - period.  These companies approach the industry from a different angle. They are shareholder friendly and for the three examples above, the founders squeezed every ounce of value from their company’s single most important asset (Barrick: Goldstrike, Goldcorp: Red Lake, Franco-Nevada: Goldstrike royalty)

Ultimately it is not just about market capitalization or how much gold a company produces. It is about BUILDING VALUE ON A PER SHARE BASIS, creating capital gains for the company’s owners, which is we, the shareholders.

In 2014, we started the year trading at Cdn$0.35 per share (market capitalization Cdn$3 million). We ended the year at Cdn$2.60 per share (market capitalization Cdn$27 million) for a gain, if you held, of 642%. As of this letter, May 11th 2015, the price has increased to Cdn$3.65 per share (market capitalization Cdn$40 million) for a total gain of 943% over 16.5 months.

This placed us as one of the best performing gold companies in 2014. In comparison, gold was up 7% and the GDX (Market Vectors Gold Mining Index) was down 8% (all returns in Canadian dollars). Our one-year performance might be luck or due to our small size.  Both are possible and it will be extremely difficult to generate a similar return in future years. As Warren Buffett says “trees don’t grow to the sky”.  Our share performance appreciation may slow, but the objective is to make smart decisions and outperform our peers in order to build the Best Gold Company.


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Operational Review


Most annual letters focus on the previous fiscal year. I will also need to cover the start of 2015 in order to provide a full picture.

  • Two significant events occurred early in 2014 that caused our world to shift:  
  1. Goldcorp’s hostile bid for Osisko Mining Corp., which owned the Canadian Malartic mine, where Abitibi Royalties owns a 2% net smelter royalty (NSR) on a small portion of the mine known as Gouldie and its 30% free carried interest on the Malartic CHL project that adjoins the mine. Goldcorp’s interest seemed to shine a renewed light on this part of the world!
  2. Soon after Goldcorp’s bid, Odyssey North was discovered on Malartic CHL. The “discovery” hole returned good grades over a wide intersection (April 2014), demonstrating good potential to make additional discoveries on the Malartic CHL project. When there is a new discovery next to the largest producing gold mine in Canada, it tends to get noticed.
  • Additional exploration results from Odyssey North were released in October 2014 and February 2015. The results continued to expand the discovery. Drilling also encountered numerous high-grade intercepts around Odyssey North.
  • In February of this year the Company announced a transaction that we described as transformational. In exchange for transferring our 30% free carried interest, we received Cdn$35 million in Agnico Eagle and Yamana Gold shares (Cdn$17.5 million from each company) and a new 3% NSR on Malartic CHL. In this one deal, we were able to limit our downside and protect significant upside. We would do extremely well if Abitibi Royalties did one deal a year similar to this.


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Going Forward – Building our Business


What’s next for our Company? Before getting into these details, I think it is important to outline some of our key principals, many of which appear to be shared by Warren Buffett:

  1. Owning a single wonderful business has made a lot of great fortunes. If you understand that business, you don’t need to own many of them. It could be a coincidence but our Best Gold Company examples all had one great asset. We believe there is potential for our 3% NSR on Malartic CHL (now part of the Canadian Malartic mine) to reach this status, with a stream of reoccurring cash flows over many years.
  2. The best business is when it’s barely managed at all, still makes a lot of money. Royalties fit this mold. Having to reinvent the wheel every few years to stay relevant doesn’t hold a lot of appeal.
  3. To quote a song by Justin Bieber, “The grass ain’t always greener on the other side, it is greener where you water it”. I figured when you have 73 million followers, there is probably something business-wise you are doing right. Growing organically is the preferred route.
  4. Share structures are like pizza. The goal should be to put as much cheese on the fewest possible slices!


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Agnico Eagle and Yamana Gold Shares


Since announcing the transaction for the Malartic CHL project and receiving Cdn$35 million in shares of Agnico Eagle and Yamana Gold, some shareholders have worried that we will trade as a holding company or directly put, trade at a discount to our net asset value. I don’t believe this will happen for reasons described below, but if it did, it could then represent an attractive buying opportunity for investors. 

Here is why I don't believe Abitibi Royalties will trade as a holding company:

  1. The shares we received in Agnico Eagle and Yamana Gold represent a tiny percentage of their float and could be easily liquidated in a few days and converted into cash.  Our selling would have limited impact on their share price.
  2. The shares should be viewed as another royalty within our portfolio (and a valuable royalty at that!). Let me explain.

First, Agnico Eagle and Yamana Gold pay dividends. The ultimate amount we receive varies based on the U.S. and Canadian dollar exchange rate. At a USD:CDN exchange rate of 1.25 our annual dividends total approximately Cdn$415,000.

Second, we have the option of generating sizable cash flow from our Agnico Eagle and Yamana Gold shares from issuing call options.  This would provide immediate cash flow that would help us grow our business organically. If we were forced to sell these shares, it would be at a much higher price than they are currently trading.

I happen to think we received the Yamana Gold shares at a good price. They have taken their write downs, cut their dividend, completed an equity financing, announced plans to breathe new life into their troubled assets and the shares are trading near a 10 year low. There could be more downside, but Yamana Gold is not likely going anywhere. It is a solid company, with some really terrific mines and very capable and highly motivated people.


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Our Royalties on the Canadian Malartic Mine


Canadian Malartic retained its position as the largest gold mine in Canada during 2014. This is a mine that will be a large producer of gold for many years to come. We are happy to own royalties on it and wished we owned more! Canadian Malartic fits our description of a “world class royalty”. First, it is a large mine with a long life, forecasted to produce 600,000 ounces of gold annually. Second, two established companies operate it with substantial financial resources behind them. Lastly, there is good exploration potential and I believe much of it is on Malartic CHL, where we own a 3% NSR. All are key ingredients for a valuable royalty.

We are anticipating our first royalty income from Canadian Malartic in 2015. This is expected to come from our 2% NSR on a portion of the Gouldie Zone. Initial cash flows are not expected to be large, but it will mark an important milestone in our history. Cold hard cash! Abitibi Royalties gets paid 60 days after each quarter when production comes from this portion of the mine. For once, we hope, “the cheque is in the mail” may have special meaning.

Agnico Eagle and Yamana Gold will continue to permit the Barnat Extension and the Jeffrey Zone for production. Our 3% NSR covers a portion of the Barnat Extension and all of Jeffrey. The operators have disclosed that they expect to receive approval in late 2016. I think Agnico Eagle and Yamana Gold are terrific operators and we are happy to own a royalty on portions of their mine, but shareholders should not be surprised if this deadline comes and goes without approval. Permits are typically dependent on many external and variable factors. I have little doubt that the permit will be approved, since the Barnat Extension and Jeffrey are just part of a much larger permitting effort at the mine. Not only is Canadian Malartic the largest producing gold mine in Canada, but it is a huge driver of economic activity in this part of Quebec. Permitting tends to take longer than you think, even when you have two operators with great track records.

The greatest leverage within our royalty portfolio comes from the 3% NSR we own on the Odyssey North discovery and the surrounding exploration targets.  Odyssey North is the most important discovery to date at the Canadian Malartic mine where we own a royalty.  Drilling resumed on April 1st, 2015 for the first time in approximately a year.  Exploration drilling is at an early stage, but the gold grades, intercept lengths and strike (length)/vertical extent of the mineralization have all been encouraging.    

Agnico Eagle and Yamana Gold are planning to spend an initial Cdn$3.5 million between April and December to complete a total of 25,500 metres of drilling around Odyssey North. As mentioned, we put up no money, but are entitled to 3% of any future revenue. All you need is one royalty on a great discovery to make shareholders a lot of money. It should be noted that Agnico Eagle operates three other mines in the area (LaRonde, Lapa and Goldex) that could have positive implications for our royalties due to the established infrastructure. Between these three mines owned by Agnico Eagle and their partnership with Yamana Gold at Canadian Malartic, total production is approximately one million ounces of gold per year. It is a good region to own a royalty.


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Royalty Acquisitions


A few shareholders have asked, “Are you planning to acquire additional royalties”.  We should make it clear that it is our intention to acquire additional royalties. It is a fabulous business to be in!  However, selling our Agnico Eagle and Yamana Gold shares, paying the tax and then acquiring the first royalty that comes our way is probably a very quick way to a lower share price. There are not many things I will guarantee in life, but if we sold the shares and spent the money foolishly, there won’t be a lineup of investment banks looking to give us another Cdn$35 million! This, I am willing to guarantee.   

The next logical question concerns the location of the royalties we would look to acquire and the type of commodity. Our preference is North America (including Mexico) and gold will continue to be our focus, with other metals/commodities playing a lesser role. A guiding rule will be to keep 80% of the Company in gold and in North America. This should allow us to obtain the premium valuation that is typically placed on gold royalty companies.

There are two points in the life cycle of a mine where we will be most active. First, early stage prospects with good geology, known mineralization and most importantly, near a producing mine. These are low cost entry points that have tremendous optionality on potential ounces in the ground and future cash flow. Once acquired, we are no longer obligated to put up any of the cost for exploration or development and a lot of the required infrastructure is already built (mills, crushers etc.). Every time the operator drills a hole, we get another free lottery ticket. We look forward to building a large portfolio of these types of royalties over the coming years. I suspect a certain percentage of them will become very successful.

We will also look at “world class” royalties.  These are royalties in production, with a long mine life and considerable exploration potential.  It may seem obvious, but it’s exploration that gives a royalty its zip. Anyone with an Excel spreadsheet can discount the future cash flows and come up with a value.  Now admittedly, there are not many world class royalties kicking around and even less for sale. Patience is required. Abitibi Royalties is not like Franco-Nevada or Royal Gold. We will have to pick our spots and find creative methods to compete.    

You may have noticed there was no mention of metal streams. I don’t believe there has traditionally been enough optionality. For a large company like Franco-Nevada they may or may not make sense, since they need a place to invest their excess cash. They also need size and metals streaming can provide that. For a company the size of Abitibi Royalties, we will stick with royalties from net smelter returns. Becoming successful like Franco-Nevada and figuring out how to invest a mountain of cash is not a problem we currently face! Hopefully soon.

We will also stay away from acquiring royalties on feasibility or development staged assets.  When the operational risks are high and the operators are financially weak, things tend to turn out badly. I think the royalty industry is a lot like the junk bond market. Investors are reaching in order to generate returns like the ‘good old days’. The problem is risk and the amount one has to take in order to generate those returns. Companies have been paying top dollar for royalties on risky projects. All it takes is for one project to fail for the return to become negative. Rule number 1.  Don’t lose money. Rule number 2. Don’t forget rule number 1. 


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Gold Prices


I won’t spend a lot of time talking about our predications for the gold price. There are far more intelligent people that can give you greater insight.   Pierre Lassonde, Chairman of Franco-Nevada, or Rob McEwen, Chief Owner and Chairman of McEwen Mining, have done a lot more work on this subject.  Google either of them and type in “gold” and you will come up with a lot of interesting commentary.  

I do feel the need to touch on this topic though, no matter how brief. A few years ago a CEO of a multi million-ounce producer was on TV and stated that neither he nor the company would provide their views on the gold price. I didn’t feel this was right. When your top line depends on the gold price, its anticipated future direction should influence how you run the business and this needs be communicated to shareholders.

In January, there was a quote from yours truly in the Toronto Star that stated, “Gold’s in a down cycle, and it’s competing against a strong U.S. dollar that is higher against every major world currency. It is also losing interest due to lower oil prices, the expectation we could see lower inflation. I expect both themes to continue into 2015, along with the potential for U.S. rate hikes”.  The price of gold was US$1,200 per ounce to start the year and we are basically flat one-third of the way through 2015.

As an industry, I believe that we are closer to the bottom than the top. This may not provide a lot of comfort.I believe the gold sector started to bottom about a year ago and the industry is now treading water. For most companies, I think there is more treading to do before gold and share prices go up. Hopefully I am wrong.


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Long Term Vision


What does the Best Gold Company look like? For me it would look something like this:

  1. Share structure: It has a small number of shares outstanding. Investors who purchase shares become partners in the business.  They are also treated like partners.
  2. Per share value: The company generates meaningful cash flow on a per share basis.
  3. Physical gold: The company takes a portion of its royalty income in gold bullion, which would continue to grow each quarter. This should also defer tax.
  4. Share buybacks: The share count goes down, not up.  Few if any mining companies follow this strategy. We aim to be different.
  5. Exploration: Provides exposure to exciting discoveries.
  6. Growing the business: Continually builds its royalty portfolio through cash flow or other creative means.

All of this will not happen overnight but let us set the stage.


Ian Ball
President and Director

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