Franco Nevada (FNV): A core holding in gold

"We have very few buy recommendations currently; one exception is Franco-Nevada (Toronto: FNV.TO)," says resource expert Adrian Day.

In his The Global Analyst, the advisor explains, "Franco Nevada is one of our all-time favorites; it has top management, a solid balance sheet, and risk-averse business plan," Here's the advisor's bullish assessment.

"The company previously merged with Newmont, and was reborn in a spin off nearly two years ago. Although the stock has nearly doubled since the IPO, it still represents good value.

"Franco is a royalty company, owning royalties on other projects, producing and exploration. Royalties are a great business. It is a low-risk, high-margin business; for Franco, 85% of its revenue is free cash flow.

"Though the royalty owner is subject to the vagaries of resource prices and other risks of mining, it is not responsible for spending time and capital to fix problems, yet it is exposed to the upside, both from higher prices as well as exploration success.

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"Royalties can either be acquired, typically so-called 'legacy' royalties usually from land owners, or created, from companies that want capital (perhaps to put the mine into production). Franco buys both, and its last two major gold royalty purchases are an example of each.

"At the end of last year, it acquired a legacy royalty of 7.29% (net smelter) on part of Barrick’s Gold Quarry mine in Nevada.

"Then, in February, in an innovative deal, it acquired 50% of the gold revenue stream (an effective royalty) on Couer’s new Palmarejo silver-gold mine in Mexico. Couer needed capital to put the mine into production, while as a silver company, it was willing to give up the gold. 

"Immediately prior to these transactions, approximately 50% of Franco’s revenue was from gold, but these two transactions, now generating cash flow, have boosted the precious metals share of revenue (primarily gold plus the Stillwater PGM mine) to 80%. 

"As production ramps up, next year should see precious metals revenues move up as a share of total revenue by a few percentage points, even without any new transactions.

"The balance is oil & gas and base metals. The company wants to keep its precious metals revenue at a minimum of 75% or so going forward.

"Today, Franco’s gold royalty revenues make it the leading gold royalty company, with a market cap over C$3 billion. Yet it trades at lower valuation metrics than other royalty companies.

"To a large extent, I believe this is purely a hangover from the lower valuation it was awarded when so much of its revenue was oil and gas.

"The company has a superb royalty portfolio, with over 300 royalties at all stages of development. Some 80% of its revenue is from mines in the U.S. and Canada, with more from Australia, giving it a triple A political risk rating.

"Indeed, now the company has brought its gold revenues from large, low-risk mines in politically safe jurisdictions to over 80%, it would be prepared—at the right price—to add high-potential but less-certain projects in less safe jurisdictions.

"It can afford to do this, with over $700 million of available capital, including an undrawn credit facility of $150 million.

"Franco is a core gold holding for all investors; we want to own it. It is appropriate for all investors and we are ranking it 'conservative' even though, as with all resource investments, it can be volatile.

"Overall, Franco is a great company at a very good valuation. There is near-term price risk if the gold price or broad stock market falls, but if it gets cheaper, we may buy more. So buy a position now, but keep some powder dry."