WPM - Why Franco-Nevada Is No Longer Worth Its High Price Tag

Summary

• Franco-Nevada Corporation is a well-established and large gold company, with a market value of $26 billion.
• However, Franco-Nevada's stock is currently trading at a high price compared to other companies in the royalty and streaming sector.
• Its Cobre Panama asset makes up 18% of its revenues, and could be shutting down in 2023 or in the coming years.
• I break down Franco-Nevada Corporation's risk and other gold stocks to consider.

Why Franco-Nevada Is No Longer Worth Its High Price Tag

Franco-Nevada Corporation ( FNV ) is a well-established and large gold company, with a market value of $26 billion, over 600,000 ounces of gold equivalent production each year, and annual revenue of over $1 billion. The company has a strong history of performance, with its stock price rising more than 1,100% since it went public in 2001.

However, Franco-Nevada's stock is currently trading at a high price compared to other companies in the royalty and streaming sector, and there is concern that one of its major sources of production (Cobre Panama) may shut down for part of 2023. This could affect the company's valuation. Investors may prefer to look at other options in the gold sector instead.

Here's an analysis of Franco-Nevada, and other stocks to consider.

Franco-Nevada: A Detailed Overview

Franco-Nevada is a company that helps gold mines and other operations by providing them with financial support in exchange for a percentage of the gold they produce. This is called a royalty, or stream.

When you invest in Franco-Nevada by buying shares, you gain exposure to the gold and silver market without having to deal with many of the risks and expenses of operating a gold mine. Franco-Nevada's royalty and streaming agreements usually shield investors from cost inflation and other mine operating risks, making it a secure and reliable choice for those seeking to invest in the precious metals industry, as compared to gold mining companies.

Franco-Nevada is also well-diversified, with a wide range of assets all over the world in various stages of development. In total, Franco currently owns 416 assets , with 113 in production, 44 in the advanced phase of construction or development, and 259 exploration assets.

Its growth profile is impressive, as the company expects annual output to rise to between 765,000- - 825,000ozAu by 2026, up from 2022's guidance of 680,000 - 740,000ozAu.

Its operations are mostly located in politically favorable mining jurisdictions, too. Approximately 91% of its assets come from the Americas (Canada, USA, Mexico, and Central America. Currently, 70% of its production comes from gold & silver, and 25% from energy (oil and gas).

However, if you dig deeper you'll find that ~ 17% of its revenue is focused on a single asset (Cobre Panama), with three other assets (Antapaccay, Candelaria, and Guadalupe) making up an additional 21%. Therefore, these four assets combine to account for 38% of Franco-Nevada's 2022 revenue, so it's actually less diversified than investors may like.

In fact, Franco-Nevada has committed over $3 billion in capital to just four investments, all located in South America.

Cobre Panama - a large copper-gold mine owned and operated by First Quantum Minerals - is by far its largest investment, with a massive $1.36 billion commitment, so the stakes are really high. Franco-Nevada has already earned back 100% of its investment in Antapaccay, but only 36% from Cobre Panama.

Franco-Nevada's stock performance has been impressive. Since it started trading its shares on the Toronto and New York stock exchanges in 2001, its stock is up 1,100%, easily outperforming peers. But it might be hard for the stock to keep up that outperformance in 2023 and beyond (more on this below).

Uncertainty Surrounding Recent Developments in Panama

In January 2022, the Government of Panama proposed a new contract for MPSA, a subsidiary of First Quantum, that included future payments and royalties on production at the Cobre Panama Mine. This contract would have to be approved by the National Assembly.

MPSA made proposals that were favorable to the government, including yearly payments of $375 million in tax and royalty revenue, as long as the prices of metals and the profitability of the mine did not decline significantly.

However, in December 2022 , the government stopped the discussions and announced plans to suspend operations at the mine.

This is not good news for Franco-Nevada, plain and simple. While it owns 416 assets, Cobre Panama is by far its most important one. It comprises ~17-18% of its annual revenues, and it's a key growth driver in the years ahead. I believe this news casts considerable doubt on the investment, to which Franco-Nevada has committed $1+ billion.

First Quantum sought to reassure investors on December 28 by announcing that discussions with MPSA and the Government of Panama had resumed on December 26 regarding the long-term future of the Cobre Panamá mine. The talks continued on December 27 and are still in progress. The company says it remains committed to finding a mutually beneficial agreement as soon as possible.

The ongoing discussions about the Cobre Panama mine do not bode well for Franco-Nevada and could potentially affect the stock's inflated valuation. Additionally, the decision to invest a significant amount of capital in an asset located in Panama, which is not known for being a favorable mining jurisdiction, is questionable.

According to the Fraser Institute's 2021 Annual Mining Survey, Panama ranked poorly in several categories, including the "Legal System" and "Taxation Regime."

Due to the significant uncertainties and lack of an established track record in mining, I would not feel confident investing over $1 billion in this country for the long term.

Franco-Nevada: Understanding the Stock's Valuation

Franco-Nevada has been a sector leader since its 2001 IPO, and investors appear to be bidding up its stock price based on its past performance and perceived "safety" in the gold sector.

Here's a look at Franco-Nevada's valuation compared to its streaming and royalty peers:

(Sources: Seeking Alpha, Yahoo Finance)

Franco is the most expensive stock in the royalty and streaming sector other than Wheaton Precious Metals. Franco trades at nearly 35 times its earnings and has an EV/EBITDA of 22.51 - even after the Cobre Panama news. The stock is trading nearly even year-to-date, underperforming only Royal Gold (up 6.90%).

However, Wheaton has a stronger organic growth profile than Franco-Nevada. Wheaton is guiding for annual production to go to 850,000ozAu (10-year average), representing 26% growth from 2022 levels; Franco-Nevada only expects production to grow by between 11%-19% by 2026, based on its 2022 guidance and 2026 outlook. (And, this production assumes that the Cobre Panama situation is resolved).

Royal Gold trades at a significantly lower EV/EBITDA ratio than Franco. It owns far fewer assets (186, or 230 fewer than Franco), but it gets most of its current revenues from a mine in Canada (a far better jurisdiction than Panama), and will grow its Canadian exposure further when its newly-acquired Great Bear Royalty starts producing in several years.

Osisko Gold Royalties Ltd. and Sandstorm Gold Ltd. are smaller royalty & streaming companies and carry more risk than the three names mentioned above. But they also have bigger growth potential, and therefore, more long-term upside.

Osisko is the more diversified, lower-risk company in my opinion, given its largely North-American-focused portfolio (Canadian Malartic, in particular) and its excellent development projects (Windfall, Cariboo to name a few). Sandstorm's valuation and growth potential also can't be ignored here, and it might be a good fit for investor's willingness to take on a bit more risk for a high upside.

Franco-Nevada: The Final Take

In conclusion, Franco-Nevada is a large and well-respected gold company, with a market value of $26 billion, over 600,000 ounces of gold equivalent production annually, and revenue of over $1 billion. Its stock price has increased over 1,100% since it went public in 2001 and it is still widely considered a secure investment in the precious metals industry.

But I have concerns that the Cobre Panama mine, a major source of production for Franco-Nevada, may shut down in 2023 or in coming years, which could affect the company's valuation.

I also don't think it was a wise decision by Franco-Nevada to invest $1+ billion on a single asset in a high-risk jurisdiction (Panama). While hindsight is 20/20, I think other investors might agree that this isn't a huge surprise given the poor jurisdiction ratings for Panama. While Franco claims to own "a diversified portfolio with low risk," this is a bit deceiving given Cobre Panama's 18% contribution to its revenues.

The bottom line: Franco-Nevada's Panama-risk, combined with the stock trading at a high price compared to other companies in the sector, means that investors should consider other options in the gold royalty and streaming sector.

What do you think of Franco-Nevada as we enter 2023? Let me know in the comments below.

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