Franco-Nevada: Forget Volatile Miners – This Is How To Win With Gold (NYSE:FNV)

Introduction

Gold bulls are in a very good place right now, as the shiny metal has made a number of new highs this year.

Currently, COMEX gold futures are trading north of $2,160. That’s more than 30% above the 2022 lows.

According to Bloomberg, a major driver of demand comes from China, where the central bank and private buyers have been busy accumulating what one might call the world’s oldest “currency.”

Gold’s gains over the past five weeks have also been underpinned by long-standing supports including heightened geopolitical risks and buying by central banks, led by China. Chinese consumers have also been stocking up, purchasing gold coins, gold bars and jewelry as a way to safeguard their wealth from a property downturn and losses in the country’s stock market. – Bloomberg

My most recent gold-focused article was written on March 12, when I covered mining giant Agnico Eagle Mines (AEM).

In that article, I explained that I believe the biggest bull case for gold is a situation where the Fed will be forced to cut rates before achieving its 2% inflation goal.

Right now, it seems the market is expecting that to happen.

Core inflation is close to 4%, WTI crude oil is above $80, labor inflation remains elevated, and we had three straight months of higher-than-expected inflation readings.

Meanwhile, credit quality is deteriorating, making it more likely that the Fed will have to pick financial stability over fighting inflation.

This is actually one of the reasons why I expect inflation to remain higher for longer.

These developments are very bullish for gold – and very bad news for consumers.

With that said, there are many ways to invest in gold. One of them is buying streamers and royalty giants.

That’s where the Franco-Nevada Corporation (NYSE:FNV) comes in, a company I have never discussed on Seeking Alpha or anywhere else.

It’s a fascinating low-cost gold mining play with subdued risks that, I believe, is trading far below its fair value.

So, let’s dive into the details!

A Superior Business Model

Do you know what bothers me about gold miners? Their elevated costs.

Mining operations are very expensive, they tend to be risky, and have a history of poor returns.

Over the past ten years:

• The Gold ETF (GLD) has returned 56%.
• The VanEck Gold Miners ETF (GDX) has returned just 27% – including dividends.
• Franco-Nevada returned 174%, also including dividends.

That’s where streamers come in.

Franco-Nevada is not a typical gold miner. Instead of operating mines, they provide upfront capital to mining companies, allowing them to benefit from the production of these mines.

For that, it uses two instruments.

• Royalties: This is a set percentage of a mine’s future production that Franco-Nevada gets to buy at a discount. In other words, it’s a predefined percentage of whatever a mine produces. The main benefit is consistent income as long as the mine is producing.
• Streaming: Franco-Nevada provides miners with upfront cash to support their operations. In return, they secure the right to buy a portion of the mine’s future gold production at a predetermined, low cost. In this case, FNV benefits if gold prices soar, as it gets to sell its gold at a higher price.

This comes with considerable tailwinds for investors, including gold price exposure without the risks of operating a gold mine.

Moreover, the company is not directly impacted by mining costs, including maintenance, which tends to rise along with inflation in key segments like energy (fuel) and labor.

Looking at the numbers below, we see that the company had a 2023 adjusted EBITDA margin of more than 80%. Even better, $0.56 of every $1.00 in revenue turned into net income!

On top of that, the company can easily diversify its income, which gold miners can only achieve by opening new mines.

As we can see below, the company has 432 assets, of which 116 are producing assets, with major exposure in nations with low-risk jurisdictions, including Canada, the United States, and Australia.

Last year, the company added a number of new royalty interests, particularly in gold mines and projects across Canada, Chile, Australia, and the United States.

With regard to reserves, since its IPO, the company has increased reserves from existing assets by 3.5x. This bodes very well for the longevity of future earnings potential.

The company also has commodity diversification, as roughly 22% of its revenues come from non-precious metal operations, including oil and gas.

This includes a $125 million acquisition of 1,400 net acres in the Haynesville shale region. This adds natural gas exposure to the company, which I’m a big fan of. Last year, these assets produced roughly 6,500 Mmcf of gas through producers like Southwestern (SWN), Chesapeake (CHK), and Comstock (CRK).

Moreover, it has a better free cash flow profile, as it does not need to reinvest its proceeds to keep mining operations running.

As a result, FNV has a much better risk/reward profile than most mines.

I already briefly showed the 10-year return at the start of this article. However, even going back to 2007, when FNV went public, the company’s New York-listed shares have returned more than 12% per year.

During this period, the gold mining ETF was a losing bet for investors.

So, what does this mean for shareholders?

FNV Shareholders Remain In A Great Spot

In 2023, Franco-Nevada sold 627,045 GEOs (gold equivalent ounce), which was within the guided range of 620,000 to 640,000 GEOs.

Precious metal GEOs totaled 488,189, meeting the guidance range of 480,000 to 500,000.

However, year-over-year production was down, as the company halted production at its Cobre Panama operations in November 2023 due to political and legal challenges in Panama. This resulted in a substantial noncash impairment loss of roughly $1.2 billion.

Adding to that, the volatility in commodity prices, in general, impacted Franco-Nevada’s revenue streams.

While gold and silver prices saw increases, palladium prices declined significantly year-over-year.

Additionally, weaker energy prices (this mainly applies to natural gas) put pressure on non-metal GEOs. The overview above shows that gas revenues imploded compared to 2022.

The good news is that the company is upbeat about 2024, as it expects to see total GEO sales between 480,000 and 540,000. The midpoint of that range is 2.4% above the 2023 result.

By 2028, the company aims to produce north of 540,000 GEOs, which would imply at least 10% organic growth, with more growth opportunities in mines like Cobre Panama.

Moreover, the company maintains a very healthy balance sheet. It’s debt-free, with $2.4 billion in available capital. That’s roughly 11% of its current market cap. Most of that consists of cash and cash equivalents.

All of this bodes well for its dividend.

Unlike most gold miners who have a history of cutting their dividends whenever gold prices fall, FNV has a very consistent dividend track record.

Since going public, it has never cut its dividend.

On January 30, the company hiked its dividend by 5.9% to $0.36. This implies a 1.3% yield.

Although FNV is not a good play for income-focused investors, it is a fantastic play for income growth and stability in a sector that may benefit from rising prices on a long-term basis.

Valuation

It also helps that FNV is very cheap.

In fact, the company’s stock price performance triggered me to write this article.

As we can see below, FNV’s stock price has not only ignored the rise in gold, it has gone down. The same applies to the entire mining sector, as investors had no interest in buying miners. They wanted the gold only.

This is what the FNV-to-gold ratio looks like:

Generally speaking, FNV is superior to owning physical gold, as it tends to outperform gold futures.

It also trades at a blended P/E ratio of just 33.3x. While that may sound expensive, the company’s normalized P/E ratio is 53.2x, as it has strong earnings power and superior margins. It is very common that high-margin streamers/royalty companies trade at “elevated” P/E ratios.

Although EPS expectations are highly dependent on the price of gold, silver, and other commodities, the stock is trading well below its fair price. Even a 40x P/E multiple would imply a fair price target of $144 for New York-listed shares.

That’s roughly 26% above the current price.

The current consensus price target is $135.

All things considered, I really like FNV and believe it would make a great fit for my dividend growth portfolio.

After writing this article, I’m considering selling the mining stocks in my trading account to incorporate this gold streamer into my dividend portfolio.

It would go well with my oil and gas royalty investments and provide high-margin commodity exposure without buying a miner with a poor long-term total return profile.

Takeaway

Investors seeking exposure to gold should consider Franco-Nevada, which is a unique gold streaming and royalty company with what I believe to be a superior business model.

Unlike traditional miners that come with high operating costs and risks, FNV benefits from upfront capital investment in mining operations, offering stable income and insulation from operating expenses.

With diversified assets and a debt-free balance sheet, FNV presents an attractive investment opportunity supported by its stellar dividend track record and growth potential.

Moreover, given the recent slump in its stock price, I have started to really like the valuation.

Pros & Cons

Pros:

• Unique Business Model: FNV offers exposure to gold through a superior streaming and royalty model, which minimizes costs.
• Diversified Assets: With key assets in low-risk jurisdictions like Canada, the United States, and Australia, FNV enjoys a diversified portfolio.
• Debt-Free Balance Sheet: FNV has a debt-free balance sheet with ample liquidity.
• Consistent Dividend Track Record: Unlike traditional miners prone to dividend cuts, FNV has maintained a consistent dividend growth streak.
• Undervaluation: Due to its recent stock price decline, I believe FNV is highly attractively valued.

Cons:

• Dependence on Commodity Prices: FNV’s earnings are highly dependent on gold and other commodity prices.
• Market Sentiment: FNV’s stock price performance may be influenced by broader market sentiment towards the mining sector.
• Sector-Specific Risks: Despite its unique business model, FNV operates in the mining sector, which comes with industry-specific risks, like geopolitical uncertainties.