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The fall of the paper money and low interest rate environment bring investors' focus towards precious metals where they search for the preservation of purchasing power together with dividend yield. This turns my attention towards the streaming and royalty companies and I select the largest gold royalty company Franco Nevada for detailed analysis and to evaluate how this company will fare in the near future.

Franco-Nevada (NYSE:FNV) is a royalty and streaming company. Royalties are taken off the top of production from mine operators. Streams are the right to purchase mine production at a low preset price. Royalty companies are the low-cost industry participants. In commodity businesses, the low-cost producers dominate the economic returns. Franco-Nevada is one of those giants that have little exposure to always increasing operating costs of the mines.

Before going any further, first let's compare the business model of Franco Nevada with Gold ETF (NYSEARCA:GLD) and operators of mines.

Peculiar Business Model

GOLD ETF

FNV

Operators

Dividend Yield

-0.4%

>1%

0-4%

Leverage to Gold Prices

1

>1

>1

Exploration and Expansion

0%

100%

100%

Exposure to Capital Cost

0%

0%

100%

Exposure to Operating Cost

0%

0%

100%

Exposure to Environmental Cost

0%

0%

100%

The above table clearly depicts the fact that FNV provides a lucrative dividend yield and more upside than the gold ETF, whereas at the same time it is providing limited exposure to the cost inflation.

Key Transaction Principles of FNV

Before going into any transaction, the management of FNV ensures that it is getting long-term optionality. Its key principles for any transaction are as follows:

  1. Exploration upside
  2. Long-term secure tenure
  3. Minimize potential for encroachments
  4. First dollar is last dollar
  5. Time is spent on future investments, not operations

Key Transaction Principles Lead to Big Wins

Gold Strike

Detour

Tasiast

Original Purchase Price <USD 3 Million

Original Purchase Price ~ USD 2 Million Loan

Book Value at IPO ~ USD 2 million loan

Royalties Paid to Date > USD 700 Million

Over 23 Moz M&I Resources

~15 MOZ M&I Resources

Expansion Expected

Expansion Expected

Optionality from large Land Positions

Diversity at its play

Franco Nevada has a well-diversified asset base that provides it a strong competitive advantage over its competitors. All of the FNV assets are located in politically stable countries, which is one of the strongest points of the company. These assets are operated by successful gold mining companies like Goldcorp Incorporation (NYSE:GG) and Barrick Gold Corporation (NYSE:ABX) etc. Following are the details of FNV's Gold assets:

USA

Australia

Canada

International

Goldstrike

Duketon

Detour

Tasiast

Gold Quarry

Henty

Sudbury (3 mines)

Palmarejo

Marigold

South Kalgoorlie

Golden Highway (3 mines)

Subika

Mesquite

Bronzewing

Musselwhite

Cerro San Pedro

Timmins West

Edikan

Hemlo

MWS

2012 at a Glance

USD Million

2010

2011

2012

Revenue

227.2

411.2

427

Operating Income

85.8

28

138.4

Net Income

62.7

-6.8

102.6

EBITDA

180

327.3

347.8

Working Capital

572.7

851.1

822.4

Long Term Debt

0

0

0

Shareholders' Equity

2,000

2,800

3,100

Cash Operating Margins

80.6%

82.1%

The year 2012 proved to be a good year for the company, registering new heights in the core earnings. Revenues of USD 427 million grew at a rate of 4% to set a new record for the company. The operating income of the company grew at a mind-boggling rate 394% to reach USD 138.4 million. The adjusted EBITDA of USD 347.8 million is also a new record for the company.

(click to enlarge)

One can see from the above pie charts. FNV 89% of revenues are derived from precious metals, importantly gold contributed 75% of the total revenue. Speaking geographically, 83% of the total revenues is derived from a politically stable region, North America.

2012 Actual Vs. Expected

2012 Guidance

2012 Actual

Revenues USD million

430-460

427

Gold Price (USD/oz)

1,700

1,669

Platinum Price (USD/oz)

1,700

1,552

Palladium Price (USD/oz)

750

645

WTI Oil Price (USD/BBL)

95

86

As one can see, production was largely in line with the expectations. Actual revenues would have been USD 440 - 445 at the guidance commodity price assumptions of the company. Though the company missed its own expectation, still results are quite handsome.

Lucrative Dividend Growth Rate

2009

2010

2011

2012

Dividend Paid USD Million

28.2

33.3

49.2

77.9

Dividend Per Share USD

0.28

0.29

0.32

0.54

The current annual dividend yield is 1.50% and is paid monthly at a rate of USD 0.06 per share. The new Franco-Nevada initiated the dividend six months after becoming public in May 2008, and has raised the dividend annually since then. The company has increased its dividend by 16.67% in 2009, 7.1% in 2010, 60% in 2011 and twice in 2012; by 25% and 20%. The board of directors intend to annually increase the dividend, keeping it at about 20% of the free cash flow. The company aims to maintain the dividend during cyclical downturns, which is a perk for investors.

Conclusion

The company currently has a total available capital of USD 1.4 billion, that can be used for further acquisitions of mines that may give company long-term optionality. The company is looking at more investment opportunities due to tight equity and project lending markets and commodity price volatility. For 2013, it is expected that the company will register oil and gas revenues of USD 55 to USD 65 million and will also get gold equivalent royalty and stream ounces of 215,000 to 235,000 AuEq.

Why to Invest in FNV

The following are the positive aspects of investing in FNV:

  1. Participation in world class discoveries
  2. Strong balance sheet position for future acquisitions
  3. Lucrative Dividend Yield - increase in each of the last five years
  4. Gives more upside potential that gold ETF at the same time minimizing inflationary cost risks that is inherent in mine operating companies
  5. Diversified and secure portfolio

Disclosure: I 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.

Source: Franco Nevada - Gold Investment That Works