Seeking Alpha

Franco-Nevada: Stick With The Leaders

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About: Franco-Nevada Corporation (FNV)
by: Taylor Dart
Summary

Franco-Nevada is one of the few gold stocks sitting at all-time highs, despite the Gold Miners Index more than 50% below its all-time highs.

The company continues to see positive earnings revisions, with FY-2020 earnings pegged at $1.88 currently.

I see the stock as a hold and would view any 10% corrections as buying opportunities.

With the Gold Miners Index (NYSEARCA:GDX) selling off since early September, investors have got their first opportunity to pick up quality names on sale since the uptrend started. Fortunately, in an industry that's riddled with landmines, it's much easier to spot the quality than in other sectors. The two main metrics I look for when assessing quality is earnings per share growth and a strong trend. The one stand-out in both of these categories among the major gold producers is Franco-Nevada (NYSE:FNV). Not only is it one of only five gold companies with earnings per share at 8-year highs, but it's also one of the few gold companies hanging out at all-time highs. Based on Franco-Nevada's exceptional earnings growth and the robust technical picture, I believe that any 10% corrections in the stock are buying opportunities. I recently went long the stock at prices ranging from $90.25-91.20 and continue to hold as it's one of my favorite names in the space.

(Source: CIBC Investors Edge Account)

In a sector where 90% of sector constituents are below all-time highs, it pays to keep a close eye on the names that are somehow managing to make new all-time highs. The most notable name to achieve this was Kirkland Lake Gold (NYSE:KL) in 2016, after it began a massive run. A more recent name was Atlantic Gold (OTCPK:SPVEF) before it was bought out almost immediately after. All-time highs are attractive as everyone is at a profit, and everyone is making money. When everyone is making money, there is no one but weak hands left to sell, and no supply of shares overhead. This allows for clean trends and much less volatility and is one of the criteria I closely watch when entering new positions. While it would be naive to expect Franco-Nevada to return 500% in four years as Kirkland Lake Gold did after its all-time high, the setup is undoubtedly bullish. Franco-Nevada put in its new all-time high in June at over $85.00 per share and is since digesting this move nicely.

(Source: TC2000.com)

(Source: TC2000.com)

(Source: TC2000.com)

We'll get back to the technicals later, first, let's take a look at the fundamentals first:

Looking at the below chart of annual EPS for Franco-Nevada, we can see that EPS is at multi-year highs and expected to make another new high in FY-2020. FY-2019 earnings estimates are currently sitting at $1.56, up from $1.40 just eight weeks ago. FY-2020 earnings estimates are presently pegged at $1.88, up from $1.66 only eight weeks ago. This is extremely impressive as there are very few gold stocks putting up multi-year highs in EPS with gold still 30% below its all-time highs. This rarity can be attributed to the company's industry-leading gross margins above 80%, and the company's tight share structure. While Franco-Nevada has seen their shares outstanding grow less than 50% since 2011, many other names in the space have diluted heavily due to acquisitions. For example, Barrick Gold (GOLD) has seen its shares outstanding grow over 200% since 2011. Meanwhile, Agnico Eagle (AEM) has seen their share count also grow by nearly 200% in this period. This dilution is inevitable for major gold companies as they must make acquisitions to replenish reserves. However, it's a positive that Franco-Nevada does not have this burden.

When it comes to growth rates, I prefer to see companies growing annual EPS by a minimum of 12% per year. Franco-Nevada meets these requirements, with annual EPS growth of 33% expected for FY-2019 ($1.17 vs. $1.56), and annual EPS growth of 20% expected for FY-2020. The fact that this growth in annual EPS is coupled with annual EPS being at multi-year highs is a positive sign. While earnings growth is impressive at double-digit rates, it's much less impressive when it's occurring in a downtrend for earnings. This is because EPS growth is easy to generate after it's fallen off a cliff. For Franco-Nevada, this is not the case.

(Source: YCharts.com, Author's Chart)

Some investors prefer to use earnings to value companies, but I believe the best metric is annual earnings per share. While it's great for a company to put up record earnings, it doesn't mean much if those earnings have translated to lower earnings per share. This often means that the company participated in deals that we're accretive, and they've grown total profits, but at the expense of their share count. Meanwhile, earnings per share weed out these situations as profits are measured relative to the current share count. For shareholders, earnings per share is the only metric that should concern them, not total earnings.

(Source: YCharts.com, Author's Chart)

To better illustrate what I mean about Franco-Nevada's annual EPS at all-time highs, we can look at the above chart below. As we can see, Franco-Nevada's earnings per share have grinded higher over the past eight years, while Agnico Eagle and Barrick's annual EPS are still trying to return to their prior highs. Their growth in EPS is undoubtedly impressive, but it's less impressive, given that it's occurring below all-time highs. Simply put, the best companies see steady EPS growth, and this growth is coupled with all-time highs for EPS.

Based on the above charts, we can see that Franco-Nevada is one of the earnings leaders in the sector, second only to Kirkland Lake Gold. For those looking for quality, and adherence to a tight share structure, Franco-Nevada is the clear stand-out in the streaming space. Streaming peers Sandstorm Gold (SAND) and Osisko Gold Royalties (OR) do not have nearly as impressive of earnings trends with FY-2019 EPS estimates more than 50% below prior highs. While their earnings trends have swung back to positive, they can't match Franco-Nevada.

(Source: Company Presentation)

From a cost standpoint, the company remains responsible as they've kept their G&A costs low. As the above chart shows, G&A as a percent of market capitalization has fallen from 0.80 in 2008 to near 0.20 in 2018. Many companies are notorious for increasing their pay and costs of doing business as they grow, but this isn't the case with Franco-Nevada.

Franco-Nevada is the industry-leader for margins as Holden Brook Weaver pointed out in his recent article and is also an earnings per share leader vs. nearly all of its peers. Given the company's robust double-digit EPS growth expected for FY-2019 and FY-2020, there's a clear argument to own the name. The fact that this EPS growth comes at a much lower risk vs. other producers is a bonus. This is because Franco-Nevada does not have to worry about the ongoing development and sustaining capital to add to its production profile.

So, why own the stock now after a significant rally? Let's take a look at the technicals below:

Franco-Nevada is already up over 30% for the year, but the stock is only 10% above its most recent multi-year base breakout. Based on this, the stock is not all that extended on its long-term charts. Franco-Nevada spent the past three years going mostly sideways since the July 2016 highs and has finally taken this level out. This is a significant development, and the prior strong resistance at $85.00 will now likely act as support on pullbacks. For this reason, I see minimal downside in the name if we were to see further weakness.

(Source: TC2000.com)

Moving to a weekly chart, we can zoom in a little more in the past two years of trading. As can be seen, Franco-Nevada broke out a large bowl pattern near the $85.00 level and is now building what looks to be the left side of a new base with $90.00 - $100.00 dimensions. The 40-week moving average (red line) is now trending up with a steep slope for the first time since 2016, and this bodes well for the bulls. If we were to see a resumption to this correction and a drop beneath the lows at $90.00, I would expect buyers to step up at the 40-week moving average, which will be near $85.00 by June. Based on this, there is minimal risk in taking positions after 10% corrections in the name. This is why I started a new position in the stock at just above $90.00.

(Source: TC2000.com)

With Franco-Nevada just having broken out of a 3-year box last quarter, and in the midst of building a new base, I see the stock as attractive, and likely to see higher prices. If I didn't already own the name, I would be using drops beneath the $91.00 level to start positions. The 40-week moving average provides a reference point if the trade sours as there's no reason this level should be broken.

Franco-Nevada is the leader in the gold space both technically and fundamentally, as well from a gross-margin standpoint. The stock has recently pulled back, and further weakness would likely provide an opportunity to start positions or add to the name. I remain long the stock and would not be surprised to see the stock above the $110.00 level in 2019. I see the stock as a core holding to reduce volatility in gold portfolios that might otherwise be in more jumpier junior and small-cap names.

Disclosure: I am/we are long FNV. 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.