FNV - Sprott Q2: Lackluster Earnings Growth Lately Ratings Downgrade
2023-08-09 09:51:40 ET
Summary
- Sprott focuses on natural resources and precious metals, but lackluster earnings growth has led to poor stock performance lately.
- Impressive growth in assets under management has not translated into earnings growth, due to excessive management compensation and a decline in commission-related income.
- Despite potential for future growth, the current environment and relative valuations make Sprott less appealing.
Investment Thesis
Sprott ( SII ) is an investment company that focuses on natural resources, where most of the investment products are either precious metals or uranium related. The stock is listed in the U.S. and Canada ( SII:CA ), where the reporting currency is U.S. Dollars.
I have covered the stock many times over the last 5 years, those articles can be found here . I have also owned the stock during much of this period, but I have recently divested my holdings due to lackluster earnings growth and what is starting to look like excessive management compensation.
The company has failed to convert the very impressive growth in assets under management ("AUM") over the last few years into earnings growth, and the stock price performance has consequently been rather poor over the last 3 years.
Exchange Listed Products & Private Strategies
I have in the prior articles on Sprott highlighted the strong growth in AUM, which has primarily come from the exchange listed products and private strategies segments. The exchange-listed product segment has continued to see AUM and earnings growth this year, but we have after more than 7 months of the year seen less impressive inflows than in the prior years, with less than $500M, while 2020-2022 saw annual inflows in the $2-3B range.
Figure 2 - Source: Sprott Quarterly Reports Figure 3 - Source: Sprott Quarterly Reports
The private strategies segment has over the last year seen very consistent growth numbers, both in terms of AUM and adjusted base EBITDA.
Figure 4 - Source: Sprott Quarterly Reports
I do think Sprott has done a very good job in these segments, and I expect them to have solid long-term growth prospects. However, the divergence between AUM and earnings is in my view due to two other factors, excessive management compensation, and a decline in commission related income.
Excessive Compensation
Sprott does presently have a market cap of around $800M and did in 2022 have total revenues of $145M, so this is after all a relatively small company. At the same time, key management compensation was last year reported to be $25M, which is too high for my liking.
Figure 5 - Source: Sprott 2022 Annual Report Figure 6 - Source: Sprott 2022 Management Information Circular
There were 5 people in 2022 with a total compensation above $3M, 4 people if you exclude the former CEO of the company. Key management compensation has in 2020 gone from $14M to $25M in 2022 and is a big part of the reason why net income has failed to keep up with the growth in AUM. We can see the same negative trend for free cash flow, even if that is partly related to some larger capital investments, which might pay off in the long run.
Figure 7 - Source: Sprott Annual Reports
I have often compared Sprott to the royalty & streaming companies, where Franco-Nevada Corporation ( FNV ), for example, does today have a market cap of around $27B and total revenues were $1.3B in 2022. However, despite the much larger size compared to Sprott, it only had about half the key management compensations in 2022, which puts Sprott's compensation levels into perspective.
Figure 8 - Source: Franco-Nevada 2022 Annual Report
Commission Related Income
Another big factor in lower earnings lately is the decline in commission related income over the last 18 months, where net commissions appear to have peaked in the end of 2021, which is around the time when net income peaked as well.
Figure 9 - Source: Sprott Quarterly Reports
This has much more to do with the poor sentiment in Sprott's industries than anything the company has done. However, given the divestment of the Canadian broker-dealer business very recently, it has the potential to keep earnings lower in the near term. Longer term, I don't necessarily think this divestment is a bad move though.
Q2 23 Result
The second quarter result in 2023 was otherwise less exciting, where both AUM and adjusted base EBITDA didn't move a lot compared to the first quarter this year. Adjusted base EBITDA did increase slightly in the three core segments, which was primarily because average AUM was higher in Q2 compared to Q1, even if quarter ending total AUM was marginally lower.
Figure 10 - Source: Sprott Quarterly Reports
Conclusion
I like Sprott and the products the company is offering, but the company has failed to convert AUM growth into earnings growth lately, and the stock price has consequently done poorly.
When the sentiment turns more positive for the precious metals and uranium industries, I don't doubt Sprott will do better, both operationally and in terms of the share price. That said, a free cash flow yield in the 3-5% range, and a dividend yield of 3%, is simply less appealing in the current environment, with higher interest rates and when miners have very depressed valuations in relation to the metals.
So, the relative valuation together with the excessive management compensation are the primary reasons I divested my holdings in Sprott, with a minor loss of 2% over the last 13 months.
Figure 12 - Source: My Recent Trades in Sprott
For further details see:
Sprott Q2: Lackluster Earnings Growth Lately, Ratings Downgrade