Franco-Nevada's Q1: The Industry Leader Became Too Expensive

Summary

• Franco-Nevada sold 134,941 toz of gold equivalent in Q1.
• A $207.4 million impairment charge of the energy assets resulted in a net loss of $98.8 million.
• The remaining debt was repaid, and Franco-Nevada is debt-free now.
• The Q2 results will be notably worse compared to Q1, due to the coronavirus-related mine closures and weak energy prices.
• After the recent steep share price growth, the shares have become very expensive.

Franco-Nevada Corp. (NYSE:FNV) reported its Q1 2020 financial results on May 6, just like Royal Gold (RGLD) and Wheaton Precious Metals Corp. (WPM). But the company's Q1 was less impressive compared to its main peers. And the Q2 results will be even worse, as the impacts of the coronavirus-related mine closures, as well as the oil price collapse, will be fully felt.

In Q1, Franco-Nevada sold 134,941 toz of gold equivalent, which is 10.6% more than in the same period of the previous year but 12% less than in Q4 2019. The decline was caused especially by gold sales that equaled 117,698 toz in Q4 but only 105,751 toz in Q1. The results should be even worse in Q2, as two of Franco-Nevada's key assets, Cobre Panama and Antamina, together responsible for nearly 25% of the company's attributable gold equivalent production, remain suspended. Also 11 of the smaller assets had to reduce or completely halt production; however, 5 of them have already restarted their operations. As a result, Franco-Nevada withdrew its 2020 attributable production guidance.

(Source: Author's own processing, using data from Franco-Nevada)

Franco-Nevada's average realized gold price increased to $1,583/toz (compared to $1,480 in Q4), and the average realized palladium price increased to $2,248/toz (compared to $1,800 in Q4). The average realized platinum price of $903/toz remained almost unchanged compared to Q4 ($907/toz), and the average realized silver price even declined to $16.9/toz (compared to $17.31 in Q4). In total, the revenues equaled $204.5 million, which is 34% more than in Q1 2019 but almost 7% less than in Q4 2019. The major portion of revenues, 69.4%, was generated by gold sales, followed by energy sales (11%), PGMs (9.4%), silver (9.2%), and other metals (1%).

(Source: Author's own processing, using data from Franco-Nevada)

Although the company's operating cash flow increased to $195.2 million in Q1, reaching the highest level in more than two years, the net income experienced a free fall. While in Q4 the net income equaled $113.3 million, in Q1 it turned into a net loss of $98.8 million. The net loss is attributable to the impairment of $207.4 million related to the energy assets, namely to the SCOOP/STACK and Weyburn royalties. The adjusted net income equals $109.2 million, which is only slightly worse compared to the Q4 adjusted net income of $110.8 million. The Q1 2020 EPS and adjusted EPS equal -$0.52 and $0.58 respectively.

(Source: Author's own processing, using data from Seeking Alpha and Franco-Nevada)

Franco-Nevada's positive cash flows have translated into a notable improvement of its financial health. The volume of cash on hand grew to $209.8 million, or by nearly 60% quarter over quarter. The remaining debt of $80 million was eliminated and after five quarters, and the company became debt-free again. As a result, the net debt equals -$209.8 million. Moreover, the company has a credit facility of $1.1 billion at its disposal, which means that it is well-positioned to utilize the current market situation and make some new deals.

(Source: Author's own processing, using data from Seeking Alpha and Franco-Nevada)

During Q1, Franco-Nevada used its at-the-market equity program to issue 435,000 new shares that were sold for $46.1 million. The average price was $105.84 per share.

The company also announced an increase to its dividend. The Q1 dividend will equal $0.26 per share, which is 4% more than in Q4 2019. The dividend is payable on June 25, and although its existence is nice, it offers an annualized dividend yield of only 0.73%.

In Q1, Franco-Nevada made also a tiny acquisition, as it acquired a 0.62% NSR on Alamos Gold's (AGI) Island Gold project for $13.4 million. However, the mine produces only around 150,000 toz gold per year. Franco-Nevada will be probably receiving less than 1,000 toz gold per year from this royalty, which is relatively negligible for a company of its size.

(Source: Author's own processing)

As can be seen in the chart above, which shows the historical price-to-earnings, price-to-operating cash flow, and price-to-revenues ratios, Franco-Nevada tends to maintain high levels of all three indicators. But the recent steep share price growth elevated them to very high levels even by the company's standards. As of May 6, Franco-Nevada shares closed at $142.45, which translated into a market capitalization of $27.06 billion. Its cumulative EPS for the last four quarters equals $0.96, cumulative operating cash flow equals $669.3 million, and cumulative revenues equal $905 million. The price-to-earnings ratio stands at 148.39, the price-to-operating cash flow ratio at 40.43, and the price-to-revenues ratio at 29.9.

(Source: Author's own processing)

Also when compared to its main peers, Wheaton Precious Metals and Royal Gold, Franco-Nevada is the most expensive. While its price-to-earnings ratio is slightly lower than Wheaton's price-to-earnings ratio, this indicator is heavily impacted by non-cash impairment charges that both the companies realized over the recent quarters. As a result, the price-to-operating cash flow ratio and price-to-revenues ratio seem to be more representative. In both cases, Franco-Nevada's ratios are the highest by far.

The share price was experiencing steady growth from the very beginning of Q1. However, in late February, a sell-off began. The coronavirus-related gold and stock market decline pushed Franco-Nevada share price to the low at $77.18, which was reached on March 16. After this, the share price started growing, and it grew by 85% in less than two months. Right now, the bull trend still lasts, however, the shares are starting to be dangerously expensive. The RSI is in overbought territory, and the share price, as well as its 10-day moving average, are very distant from the 50-day moving average. The shares have become too expensive, and it is hard to expect the current valuation ratios to be maintained in the long term. A correction should come sooner or later.

What I like about Franco-Nevada's Q1

• The operating cash flow increased.
• The debt was eliminated completely, and the company is debt-free now.

What I don't like about Franco-Nevada's Q1

• The gold equivalent sales and revenues declined.
• A substantial net loss was recorded (although it was caused by an impairment charge).
• The share price is dangerously high.

Analyst’s Disclosure: I/we 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.

Comments

[applyberry]

Your not wrong that FN is a little pricy for it present numbers reported this quarter. The what the market is pricing is FNs having paid off their debt can take huge advantage using dirt cheep debt as gild rises. There is a 30 percent chance that gold will hit 3000 within 1.5 years. If this should happen FN would triple from here because of their leverage capacity.

[Peter Arendas]

Yes, if gold really goes to $3,000, FNV will keep on growing. The problem is that many other companies, the cheaper ones, will grow even more.

[seriousinvest]

I noticed you also wrote an article on WPM which you also believe is overpriced. I have a lot of FNV & WPM. I'd like to trim my positions but not my overall exposure to precious metal miners. I looked at GOLD & NEM and I think they are both very pricey. What companies do you think are currently fairly valued (or better yet undervalued)? I would appreciate your listing a few if you don't mind.

[Peter Arendas]

The majority of gold miners had a nice run-up over the recent weeks, but there are still some names that are not too expensive. From the bigger names, for example, Kinross or Equinox. Some of them are even cheap, but you must be prepared for increased risks: Gran Colombia Gold, RNC Minerals, Roxgold, Eldorado Gold.

[Hadi1]

Thanks for the good article. To me FNV at this valuation doesn't make sense, specially with the energy exposure of their portfolio, which they interpret it as a well diversification!

[Vangel]

@Hadi1

Compared to what? FNV is very cheap when you compare it to the S&P 500 or most companies that are in it. It may be expensive relative to the smaller royalty companies like EMX, OR, or silver companies like SSRM. But those are far riskier.

[Peter Arendas]

Based on the ratios, FNV is more expensive not only compared to the smaller royalty companies but also compared to its main peers, compared to the gold producers, and I'm pretty sure that S&P 500 doesn't include many companies with price-to-operating cash flow above 40 and price-to-revenue close to 30.

[Vangel]

@Peter Arendas

" I'm pretty sure that S&P 500 doesn't include many companies with price-to-operating cash flow above 40 and price-to-revenue close to 30."

So? You do realize that the business model is very different, don't you? Or that the royalty companies have ALWAYS had very different ratios because of the difference?

Royalty companies get royalties because they gave money to miners who pay them those royalties. That is where the revenues come from. And because there is little in the way of capital needed for depreciation when compared to your typical S&P company that revenue and cash flow is available to the shareholders.

In the case of FNV, it bought a royalty for around $4 million when it first started out in the royalty business. That investment has paid the company more than $1 billion so far and is still paying off nearly forty years later. Anyone using your metrics would have avoided FNV yet it has been one of the best investment opportunities since its formation.

[tin1]

FNV is like a gold mining ETF but without the built in cost of mining. It will also be the go to asset for institutional money wanting into the gold space. Their premium may be present for most of this bull market with some pullbacks of course.

[bonzo barzini]

I thought FNV looked expensive when I bought it@25, but I am so glad I went ahead and bought. I won't sell any till gold is at least $3000.

[JJ Butler]

I can't buy at these levels...
But long any long terms shares held placed in the not for sale aisle.

[Vangel]

@JJ Butler

Will you buy at twice the price? Three times? Or use your money to purchase stocks that will underperform because you want to diversify good holdings by adding riskier bad ones?

[gospeltruth]

You didn't mention that FNV chairman Pierre Lassonde resigned the other day. How will this affecy the stock price?

[Peter Arendas]

I don't think that this will have any meaningful impact.

[Adrian Day]

This has been well telegraphed by the market. He became Chairman Emeritus to make room for David Harquail as chairman after he stepped down as CEO. Together with Paul Brink, new president and CEO, the three make a strong team, and Pierre Lassonde is still involved. Mr. Brink has the Franco DNA in his blood and I am not expecting any changes because of this.

[alessandro molinari]

Franco Nevada has always been more expensive than peers. it is not overrated, it is listed on a premium basis. the discussion should focus on whether the peer award is justified. there are some elements to consider in order to evaluate this: diversification, the safety of the jurisdictions, the quality of the mines, the governance, the past management of the company in choosing which royalty to acquire, the ESG criteria. you should make a prospect and give values on these criteria to peers. or perhaps it is a coincidence that the historical share price of franc nevada was higher than the peers, with an annualized return of 20%. in the mining world other examples of listed and discounted companies are bhp / rio tinto versus glencore. would you have preferred to be a shareholder of BHP or Glencore? if some companies are listed on premium there is a reason. it can be argued whether this is justified or not

[Peter Arendas]

I agree, the premium valuation of Franco is a long-term phenomenon. The problem isn't that Franco is more expensive than Wheaton or Royal. My point is that all three companies are too expensive.

[fr72]

I would probably agree with the conclusion for the short term. Agree that the upward movement in gold (and gold equities, especially FNV) will continue at least for the next 18 months, but as you know, markets don’t move in a linear fashion, so some sort of pullback is inevitable

[Vangel]

Agreed with the analysis but not the conclusion. When currencies die the demand for companies like FNV will go much higher. The rising gold price will cause reserves to explode and will eventually reward shareholders. This is a keep and forget holding.

[sliman21]

All true. It is the go to name for large institutions that want a gold stock with no mining risk.

[Peter Arendas]

I see your point. When we talk about market sentiment, there is no reason why FNV couldn't go even higher. But if you take a look at the valuation, further growth is irrational. I wrote a similar comparison in the discussion to my Wheaton Precious Metals article, I will adapt it to Franco-Nevada here:
In Q1, Franco-Nevada generated an operating cash flow of $195.2 million. Annualized, it equals $780.8 million. But the market capitalization is $27.3 billion right now. It means that if Franco-Nevada decided to distribute the whole operating cash flow to its shareholders (which is obviously impossible), you would have to wait for nearly 35 years to get your investment back. Without taking into account any time value of money. It means that right now, at the current price, Franco-Nevada can still be a good speculation, as the share price may keep on growing due to the momentum and positive sentiment. But as an investment, buying the shares at the current price doesn't make much sense.