CA - Franco-Nevada: Lower Energy Prices Weigh On Q1 Results

2023-05-12 13:22:48 ET

Summary

• Franco-Nevada released its Q1 results last week, reporting quarterly sales of ~145,300 gold-equivalent ounces, a 19% decline from the year-ago period.
• Franco's results were impacted by lower energy prices plus lower deliveries from key assets and while we'll see a better Q2, energy prices haven't yet got up off the mat.
• From a bigger picture standpoint, the resolution at Cobre Panama is positive given this is Franco's largest contributor and several new assets will come online by Q3 2024.
• That said, while Franco-Nevada is unrivaled from a diversification and quality standpoint, with 113 producing assets on some of the best ore bodies globally, investors are paying a very rich valuation for exposure to this portfolio.

We're more than halfway through the Q1 Earnings Season for the Gold Miners Index ( GDX ) and one of the first companies to report its results was Franco-Nevada Corporation ( FNV ). Unfortunately, the results weren't pretty from a headline standpoint, with a 19% decline in quarterly gold-equivalent ounce [GEO] sales, a 14% decline in precious metals GEO sales, and an 18% decline in revenue year-over-year. Weaker energy prices and disruptions at two major assets affected the Q1 performance and while these don't affect the long-term thesis, Franco Nevada has two tough quarters ahead from a comp standpoint as it laps a year of very favorable energy pricing. Let's dig into the results below.

Q1 Results

Franco-Nevada Corporation ("Franco-Nevada") reported its Q1 results last week, reporting quarterly sales of ~145,300 GEOs, a 19% decline from the year-ago period. This was below even my more conservative estimates because of the disruption at Cobre Panama which has since been resolved , lower production at Glencore's (GLCNF) Antapaccay Mine in Peru due to attacks by anti-government protesters that led to a temporary suspension of operations , and the impact of lower iron ore, palladium, and energy prices. The result is that Franco-Nevada is tracking at just ~21.2% of its FY2023 guidance (670,000 GEOs), and meeting this figure won't be easy unless energy prices rebound and or precious metals prices can pick up the slack.

Digging into the precious metals portion of the portfolio, Franco-Nevada reported quarterly sales of ~111,300 GEOs from the dominant portion of its portfolio, precious metals, with this figure down 14% year-over-year. As the chart below shows, which highlights revenue from its key assets, revenue declined year-over-year at multiple assets, including Antapaccay ($19.1 million vs. $28.3 million), Antamina ($13.2 million vs. $22.0 million), Guadalupe-Palmarejo ($16.2 million vs. $23.0 million), Stillwater ($6.9 million vs. $10.0 million), and Goldstrike ($1.9 million vs. $5.2 million).

As noted previously, anti-government protests affected Franco-Nevada's attributable sales from Antapaccay, and attributable GEOs from Antamina were impacted by lower silver grades and a lower gold/silver ratio. Meanwhile, Guadalupe-Palmarejo saw much lower sales related to a reduced amount of production from Franco-Nevada's royalty ground, and Goldstrike's production was abnormally low in Q1 due to planned roaster maintenance, the conversion of the autoclave from RIL to CIL and inclement weather. Finally, Cobre Panama's sales were impacted by a brief stoppage in Q1 while First Quantum ( OTCPK:FQVLF ) and the Government of Panama worked towards an agreement, and Stillwater's production dipped, which was related to damages to shaft infrastructure during maintenance in Q1.

Fortunately, Glencore's Antapaccay Mine has resumed normal operations and concentrate shipments, and First Quantum and the Panamanian Government signed a Draft Concession agreement, pointing to catch-up in deliveries from these two assets in Q2. Meanwhile, Stillwater's remediation of the shaft infrastructure was completed in April and we should see a more significant contribution over the rest of the year from Goldstrike. Finally, Cobre Panama commissioning of the CP-100 Expansion (increasing throughput to 100 million tonnes per annum) was completed in Q1 despite disruptions, and annualized throughput at this rate is expected by year-end, pushing copper production to ~400,000 tonnes at the asset in 2024/2025 and upwards of 160,000 ounces of gold.

While we should see a catch-up from Franco-Nevada's precious metals assets in Q1 that had an unusually weak quarter, Franco-Nevada also saw a massive decline in energy revenue, with a 30%, and 43% decline in oil and natural gas revenue year-over-year. This was not overly surprising, and I warned that this would be an issue in my previous update, given that sentiment was through the roof for crude oil and natural gas last year, and after a period of extreme exuberance, we often see violent corrections in commodities to reset sentiment. Clearly, the corrections have been quite significant in both commodities, and Franco-Nevada has had a tough time lapping these difficult comparisons, with a further impact from lower output at Marcellus and Haynesville in Q1.

Looking at the chart below, we can see just how significant this impact has been, with Franco-Nevada's energy-related revenue plunging to $49.0 million in Q1 2023 vs. $75.6 million in Q1 2022. Currently, prices are even lower than the prices averaged in Q1 2023 ($76.13/barrel, $2.76/mcf for Henry Hub), and well below Franco-Nevada's 2023 guidance assumptions of $80.00/barrel and $3.00/mcf for Henry Hub, respectively). Plus, the company certainly hasn't got any help from iron ore prices or palladium prices either, placing further pressure on revenue and operating cash flow. The result is that revenue was down 18% year-over-year while operating cash flow sunk to $209.8 million (Q1 2022: $230.6 million) despite the benefit of higher gold and silver prices.

Given that energy, palladium and iron ore prices have remained weak quarter-date (especially natural gas), I see risk regarding Franco-Nevada's ability to meet its guidance midpoint of 670,000 GEOs even if we adjust for the recovery in GEO sales in Q2 from Antapaccay, Goldstrike, and Cobre Panama plus initial contributions before year-end from Salares Norte (Chile), Seguela (Cote d'Ivoire), and Magino (Ontario). And while this wouldn't be nearly as much of an issue if Franco-Nevada was trading at a discount to fair value like some other precious metals names, I continue to see the stock as richly valued with no real margin of safety at current levels.

Recent Developments

Moving over to recent developments, Franco-Nevada had a quiet quarter from an acquisition standpoint, completing only two small deals. This included the acquisition of an Australian royalty portfolio which contained a 1.5% NSR royalty on Ramelius Resources' ( OTCPK:RMLRF ) Rebecca Mine, and a 1.0% NSR royalty on the Kerr-Addison property in Ontario, Canada. Meanwhile, within Franco-Nevada's development portfolio, Salares Norte is working towards commercial production by year-end, Seguela is expected to pour first gold by June, and Argonaut's ( OTCPK:ARNGF ) Magino is expected to pour first gold this month.

Elsewhere, G Mining Ventures ( OTC:GMINF ) continues to make progress at Tocantinzinho and Marathon Gold ( OTCQX:MGDPF ) remains on schedule and budget at Valentine. These two assets should begin contributing meaningfully by Q4 2024 and Q2 2025, respectively, with Tocantinzinho being a clear needle-mover with Franco-Nevada having the highest exposure to this asset among its royalty/streaming peers with a 12.5% gold stream at 20% of the spot price (declining to 7.5% after 300,000 ounces have been delivered). Also encouraging is that Hochschild's ( OTCQX:HCHDF ) Posse and Equinox's ( EQX ) Greenstone will start contributing by year-end 2024 as well.

However, from a negative standpoint, it looks like the Global Minimum Tax could come into effect by year-end, which proposes a 15% minimum tax on the income of large multinational enterprises with annual consolidation revenues of $750+ million Euros. This would affect its future taxes if implemented given the lower tax rate on its Barbados assets, with an incremental 13% tax. As for any potential impact to net asset value, Franco-Nevada's CFO Sandip Rana noted that this could result in a 3-4% impact to net asset value, which may not appear that significant, but is for a company that trades at the richest valuation sector-wide.

Valuation & Technical Picture

Digging into Franco-Nevada's valuation, while the stock has pulled back from its recent highs, the stock continues to trade at ~30.4x cash flow even if we assume it generates $5.10 in cash flow per share this year. This is well above its peer group that includes Osisko Gold Royalties ( OR ) at ~24.0x FY2023 cash flow estimates, Triple Flag ( TFPM ) at ~20.0x FY2023 cash flow estimates, Wheaton Precious Metals ( WPM ) at ~28.8x FY2023 cash flow estimates, and Sandstorm Gold Royalties ( SAND ) at ~15.8x FY2023 cash flow estimates. And while Franco-Nevada deserves a premium multiple for its scale and diversification (113 producing assets), I see limited upside from current levels.

In fact, using what I believe to be a fair multiple of 30.0x forward cash flow, I see a fair value for Franco-Nevada of $165.00 per share (FY2024 estimates: $5.50), pointing to a mere 6% upside from current levels. This doesn't offer nearly the margin of safety to justify a new position in the stock, and if energy prices aren't able to rebound, these estimates could end up being on the high end. Plus, if we look at the technical picture, Franco-Nevada trades in the upper portion of its support/resistance range, pointing to a less favorable reward/risk from a technical standpoint as well. So, with the stock trading just shy of fair value and having industry-lagging growth, I continue to favor names like Sandstorm Gold Royalties .

Summary

Franco-Nevada reported a soft start to the year, tracking at just ~21.7% of its guidance mid-point with neither energy nor palladium prices making much progress regarding moving in the company's favor quarter-to-date. And while Q2 will be a stronger quarter due to catch-up deliveries at Antapaccay and Cobre Panama, it looks like FNV will struggle to meet its guidance midpoint if we see continued pressure on energy prices. The good news is that the major Cobre Panama issue has been resolved, the company continues to have the most valuable royalty portfolio sector-wide, and several assets are marching towards first production to make up for energy weakness if it persists.

However, while the long-term thesis remains intact and Franco-Nevada continues to be arguably the lowest-risk way to gain precious metals exposure, there is a risk of underperformance when paying ~30x forward cash flow and over 2.1x P/NAV for the company. This is because these figures are well above its historical averages and a massive premium to some of its peers. And between a potential hit to NAV related to the global minimum tax, I continue to see limited upside to fair value. So, for investors looking for exposure to precious metals with a more attractive reward/risk profile, I see the far better being Sandstorm Gold Royalties ( SAND ), trading at just ~15.5x forward cash flow and less than 1.10x P/NAV.

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