Franco-Nevada: Building Up a Royalty War Chest

Newmont (NEM) mining did investors a huge favor by spinning off what is now Franco-Nevada (FNNVF.PK), a royalty company focused mainly on gold, with additional interests in Oil & Gas, Platinum, and Base metals. While Royal Gold (RGLD) garners more investor and media attention, Franco-Nevada has more upside potential, especially given the current valuations. Franco failed to take part (at least to a meaningful degree) in the $150 rally in gold over the past two months, while Royal Gold is sitting close to its 52-week high, sporting a rather rich valuation. Part of the reason may be due to the fact it only trades on the TSX or Pink Sheets, but Franco-Nevada is and looks like it will continue to be a superior free cash flow machine.

Don't get me wrong, Royal Gold is a great company as well, but it lacks depth in its royalty portfolio as well as depth in its soon-to-come online, medium and long term royalty pipeline (relatively speaking). Franco made a gutsy, albeit brilliant, investment in Coeur d’Alene’s (CDE) Palmarejo mine (as Coeur d’Alene was flirting with bankruptcy not that long ago, going on to be an amazing turnaround story for 2009).

What I think gives Franco the upper hand is its more or less recent spree of acquisitions, and more importantly, the 750 million available to fund additional growth (600 million in cash and short term investments + 150 million undrawn debt facility). It was not until today that I realized Franco made not one but two acquisitions recently. Not only does Franco have great leverage to the price of gold, but as key flagship streams ramp up production and/or come online over the short, medium and long term, its war chest will transform it into an enormous free cash flow generator. Franco’s Oil & Gas royalties (which account for 12-15% of income) also offer investors some exposure to oil & gas (which should rise past its 2008 highs as inflation sets in).

Current Flagship Royalties:

• Goldstrike
• Palmarejo
• Gold Quarry
• Stillwater
• Marigold
• Robinson
• Oil & Gas, others
  

Near Term Growth Pipeline – 2010 – 2011:

• Holt
  
• Holloway
• Hollister
• Hemlo
  
• Tasiast - 30% increase in reserves and updated production not included
• Palmarejo – Expected to add 25 million in 2010 and 30-40 in 2011
  

2012+ Pipeline:

• Hemlo – 2nd royalty
• Detour
• Others - Includes several of what may prove to be flagship streams from the likes of Great Basin Gold (GBG), Kirkland Lake Gold (KGILF.PK) and others
• 131+ exploration interests In gold royalties

Envelope Back Pros and Cons:

Revenue	2009	2010	2011	2012	2013
Gold	$110,000	$160,000	$190,000	$225,000	$300,000
Oil & Gas	$30,000	$50,000	$60,000	$70,000	$80,000
Others	$9,000	$10,000	$10,000	$10,000	$10,000
Total	$149,000	$220,000	$260,000	$305,000	$390,000
FCF	$104,300	$150,400	$182,000	$213,500	$273,000
Gold Price Assumption	$940	$1,050	$1,150	$1,250	$1,400
Oil Price	$55	$85	$110	$135	$150

Not only does Franco-Nevada have a diversified royalty portfolio, but it will continue to become increasingly diversified with excellent growth in attributable gold production. It also has several potential catalysts with its exploration interests and the high likelihood of multiple value-adding acquisitions. Take advantage of the stigma that plagues many Pink Sheet stocks before Franco debuts on another major stock exchange. Some other notable attributes worth mentioning:

• $5.50/share in net cash (or 20% of the current market cap)
• 33% year/year increase in dividends paid
• Royalty revenue from gold will increase to 80-85% of total revenue with Oil and Gas accounting for almost all the rest
• Over 300 royalty interests in total

Author's Disclosure: Long FNNVF.PK, RGLD, CDE

Comments

[MILESCFA:]

RGLD is creeping up; however, the great thing for me is it does so slowly. You can sell 2+ mn straddles on it and collect a LOT in time premium! (Sh Don't tell anybody though)

Nov 16 08:52 AM

[Hyperinflation:]

I have only one concern about Royal Gold, which is the potential hurdles they may face at Andacallo as its account for approx 25% of their NAV going forward. I'm sure it will be resolved, but any news regarding this stream could bring some volatility back into Royal Gold.


On Nov 16 08:52 AM MILESCFA wrote:

> RGLD is creeping up; however, the great thing for me is it does so
> slowly. You can sell 2+ mn straddles on it and collect a LOT in time
> premium! (Sh Don't tell anybody though)

Nov 16 09:04 AM

[dlweld:]

Good article! I'm sure you know, but readers might not, that Franco Nevada has warrents available on the Toronto Stock exchange. One is the right to buy the stock for $32 CDN until Mar 13 2012 (2 yrs 4 mo) and the other is the right to buy at $75 CDN until Jun 16 2017 (8 yrs 6mo). The stock right now is about $30, and the first warrent is 5.90 (all time value). If the stock gets to $45 (up 40%) anytime in the next 2 years the warrent will have a base value of $13 and probably some time value too. Seems like a dead cert double as a minimum and maybe a lot more. Any thoughts on this? Long FNV.wt and SLW.wt.b

Nov 16 08:01 PM

[Hyperinflation:]

Yeh I am long the 2012 warrants as well as the common stock for franco nevada. I split it about 75% CS and 25% Warrants. As Franco increased their dividend 33%, I expect that to happen again in the coming year due to weakning of the USD, Strength in Gold, Oil and given the fact they already have a very ample cash balance. As for Silver Wheaton, I initiated the majority of my position from last Nov- Jan, making it unnecessary to increase what is already my largest holding. But that is a great strategy if you got into at higher prices or are looking to get in it now. I have been fairly active with warrants in First Majestic, ECU Silver, Great Basin Gold and others.
-Cheers


On Nov 16 08:01 PM dlweld wrote:

> Good article! I'm sure you know, but readers might not, that Franco
> Nevada has warrents available on the Toronto Stock exchange. One
> is the right to buy the stock for $32 CDN until Mar 13 2012 (2 yrs
> 4 mo) and the other is the right to buy at $75 CDN until Jun 16 2017
> (8 yrs 6mo). The stock right now is about $30, and the first warrent
> is 5.90 (all time value). If the stock gets to $45 (up 40%) anytime
> in the next 2 years the warrent will have a base value of $13 and
> probably some time value too. Seems like a dead cert double as a
> minimum and maybe a lot more. Any thoughts on this? Long FNV.wt and
> SLW.wt.b

Nov 16 10:04 PM