Franco Nevada--new position in the leading streamer

 FRANCO NEVADA—a new position in the leading streamer

The business model is for FNV to pay a mining or energy company a sum for the right to a perpetual stream or royalty over an existing asset. That royalty can come in various ways, per cent of production, a per cent of revenues or other calculations. The seller is looking for funding and usually can't obtain bank debt and equity is too dilutive or can't be raised. FNV has also specialised in acquiring royalties of gold and silver by-products from copper mines. In this case, the sellers look to help finance a usually large mine by selling off the by-product and focusing on the core metal.  FNV has a portfolio that now includes energy assets and other bulk and base metals outside precious metals. Precious metals have ranged at 66-88% of revenues over the last several years.

The competition for royalty rights is active and value added for the acquirer depends on accurately assessing the long-term ability of the asset to expand and remain economic. The beauty of the model is that once the initial payment is made the operating company must bear the operating risk and also fund any expansion capex, the streamer gets a free ride. A successful investment can see returns balloon over time due to the fixed capital commitment.

FNV is the oldest and most successful operator in the field and has a large asset bank. The issue over the last year is that their large asset, operated by First Quantum in Panama has gained the ire of the local population and then the Government and legal system, and the mine has been put on care and maintenance. The mine is a substantial asset and apparently generates 5% of Panama's GDP.

There is uncertainty over what if any, recompense and action the mine operator and FNV can take in the international arbitration courts for losses incurred. The numbers are large. The share price has understandably been quite weak because of this happening. FNV has a claim against Panama of $5b ($26ps), and also has a claim against First Quantum of about $0.7b ($3.60ps) because the initial investment has not been recouped. FNV has stated that they wish to pursue a restarting of the mine and if that fails, arbitration. There are elections in Panama in May. The collection of any sums from arbitration could be an issue. FNV has impaired the asset $1.2B. the situation is fluid and arbitration could take several years.

Looking over the previous decade of results, the business is relatively consistent and has been successful in building value. Issues have arisen in a few impairments, sometimes due to the mine becoming uneconomic or nationalisation. These appear the largest risks. There is also exposure to operational issues where production is missed due to a variety of reasons, and also there is some exposure to the oil and gas price in volumes and part profit in a few properties.

FNV gave 5 year guidance which included the permanent loss of Cobre Panama as well as winding down a couple of larger mines and still see 2-3% growth in GEO, that a positive result and points to growth in the remaining properties and new properties coming on. CP restarting would increase the GEO growth to 8-9%.

Overall I see the streamers as a lower-cost way to play the resource sector generally and PM in particular. Of course, the superior business model is not a secret and the group trades at a premium. At $108 FNV looks like a reasonable proposition versus other listed operating miners.

 Please note the disclaimer.

 Note Nov 2022

What this note is about investing in gold but also about attempting to manage the risks of investing in gold. The note will be of some interest to some but little interest to others. Firstly, when I think about investing in gold stocks, imo, I am most probably moving out on the risk curve of stock market investing.

For years I have described “the riskiest stock in the world” as being an undeveloped goldmine in West Africa. The series of risks includes but is not limited to, the commodity price, capex being on time and on budget, that the mine grades hold over the life of the mine, variable operating costs, managing the mine, geopolitical risks, as well as fx, weather, govt policy etc. That’s a long list, they are exposed to just about everything as well as usually having a significant exposure to these risks when they occur.

In a broader sense when looking to invest in gold I can think of four avenues having distinctly different risk profiles. The first is bullion, the second is an undeveloped deposit, the third is an operational mine or series of mines and finally what I want to talk about here being streaming and royalty companies.

All these investments have exposure to gold but with quite different risk profiles. Investing in gold, being a commodity, comes with a certain higher level of risk. What I'm thinking about here is exposure to gold in a lower risk way.

During my research I've come across streaming and royalty companies. What these companies do in essence is fund deposit’s or operational mines, these are usually gold mines but they could be any type of commodity really, where the owner or operator for one reason or another cannot find cheap funding. Either the debt markets or equity markets are too expensive.

The royalty or streaming company will agree to fund a certain level of capital for a right to a royalty stream based on % of revenue or a stream, ie percentage of production. These companies have a very interesting business model. Their core competency is in evaluating existing and prospective mines and calculating whether they're worth backing. Usually, they are quality deposits with potentially huge expandability. There is a certain level of cyclicality involved in the requirement for funding, where the funding environment for mines can be good or bad. A bad environment for funding obviously helps the streamers etc.

An interesting feature of the business model is that they are exposed, usually, to a series of mines but have exposure to price and volumes and not margins, so the risk is reduced two actual production numbers and price and not the cost environment. Another interesting feature is that most agreements are life of mine, so that means if the operator expands the operation with their own capital then the funding company gets a huge free kick of higher production with no incremental capital having to be invested. Contracts vary across from case to case and there is usually customization but the basic tenets appear to apply.

There is also competition amongst these funders and competitive advantage relies on the balance sheet, ability to consider flexibility in funding, a history of being a successful partner and their technical expertise.

The three largest royalty-type companies that I have found are Franco Nevada (FNV), Wheaton precious metals (WPM), and Royal gold (RGLD) in order of quality, imo.

How would I expect these companies share prices to perform through the cycle? There is evidence over the long term that they do better than the gold mining index and the bullion price. Personally, I see them as potentially a lower risk way to play the precious metal space. With a likely long term smoothed performance compared to the volatility of gold companies. I suspect the best time to buy them, in a relative sense, is when gold sentiment is quite high but you still want exposure to the space. Currently, I see little value in switching to streamers from goldminers, since the miners have been absolutely slaughtered this year. The streamers have outperformed significantly. At some point I can see an investment case to hold these streamers ahead of the miners after the sector is done very well.

I hope I've done a reasonable job trying to describe the various risk profiles when investing in gold. Although I do not hold any streamers/royalty companies currently I do see streamers & royalty companies as credible and lower risk way to play the sector with a chance for longer term outperformance and long term wealth accumulation.

 

Disclosure I do not have any streamers and hold a few gold miners.