Franco-Nevada: 'First-rate' play on gold

by Gavin Graham, contributing editor Gordon Pape's Internet Wealth Builder

Franco-Nevada (FNNVF or FNV: Toronto) offers a great opportunity for investors to take a position in gold.

Franco Nevada invests in gold and precious metal royalties. In essence, Franco-Nevada receives a percentage of every ounce of gold or precious metal produced by a mine (usually between 0.5% and 5%) without worrying about the cost of producing the ore.

The company rose five times in value during the 1990s before being bought by U.S. gold miner Newmont in 2002. Franco-Nevada was relisted in December 2007 after it was spun off from Newmont.

The company now owns 19 gold royalties and one platinum royalty on operating mines, in addition to one platinum and 14 gold properties in an advanced stage of development. While gold and platinum provided 80% of its royalty revenues at the end of 2009, it also owns five operating base metal and coal royalties and six operating oil and gas royalties.

Another gas property and four base metal properties are at an advanced stage of development. More than 80% of revenue comes from developed economies with another 15% in Mexico, which has a long history of mining development.

In 2009, Franco-Nevada had $213 million in revenue (the company reports in U.S. currency). That was up 36% from $157 million in 2008 of which $143 million was royalty revenue. Free cash flow (FCF) was $124 million, and the company had $600 million of liquidity with no debt or hedges.

Royalty revenue for the 2010 first quarter came in at $41.8 million (up 43%) over last year. Free cash flow was $37.1 million (C33c per share vs. C25c) with an 89% FCF margin. Encouragingly, management refused to raise its bid for another gold royalty company, International Royalty Corporation, in February when it was outbid by Royal Gold, showing discipline in its use of shareholders' cash.

FNV recently agreed to advance $350 million and issue two million 2017 warrants to Taseko Mining to gain a 22% royalty stream from Taseko's new Prosperity gold project in B.C., which is 125 kilometres from Taseko's existing Gibraltar copper mine.

Taseko estimates Prosperity will produce 7.7 million ounces of gold and 3.6 billion pounds of copper, with an annual average of 300,000 ounces of gold and 1.5 million pounds of copper in its first five years. It will take 2.5 years and cost C$815 million to build the mine after receiving a federal environmental certificate, which has been applied for. It received its B.C. provincial environmental certificate in January.

Gold has increased in value every year for the last decade making it the best performing asset class between 2000 and 2010. In doing so, bullion outperformed the next best asset, long term-government bonds, by almost three times. But let's assume for a moment you don't think that will continue. Guess what? It doesn't have to for this stock to perform well.

Franco-Nevada's revenues and profits will keep growing for the next few years. In 2009, gold royalty revenue grew 42% over 2008 as new gold revenues from mines at Palmarejo in Mexico (operated by Coeur d'Àlene) and Gold Quarry in Nevada (Newmont) came on stream.

In 2010, Franco-Nevada is anticipating a full year of production from Palmarejo and Holloway in Ontario (St. Andrew's Gold) and the start of steady processing at Hollister in Ontario.

In 2011, Red Back's Tasiast mine in Mauretania and La Mancha's Ity mine in Ivory Coast should have produced enough gold to begin paying royalties (2% for Tasiast and 1-1.5% for Ity) to Franco-Nevada. Regis Resources's Duketon mine in Australia should be at the same stage. After that, the profit-based royalties from the Hemlo properties, Newmont's large Subika mine in Ghana, and the Detour Lake project should kick in.

Thus, Franco-Nevada has strong growth in revenues locked in for the next few years. As far as risks, they are limited - something very few resource companies can say. Franco-Nevada's business model makes it an exception.

With limited exposure to the possibility of rising operating costs or environmental issues and with a geographically diversified portfolio, this is a low-risk way to gain exposure to gold, one that is not dependent upon a rising gold price.

It is important to note that for U.S. investors, Franco-Nevada is regarded as a Passive Foreign Investment Company (PFIC), which means that any income or increase in value is subject to tax at the top marginal rate.

Overall, I believe Franco-Nevada offers the potential for long-term growth and an increasing revenue stream over time. Combine that with the relatively low risk and you have a first-rate gold security. Buy now.

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