Franco-Nevada Corp. (NYSE: FNV) 11.17.2020

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Analyst: Chris Harootunian Email: [email protected] Sector: Basic Materials Stock Type: Large Growth Industry: Gold MKT CAP: $25.6325B Current Price Fair Value 52 Wk Range $134.80 $99.68 $77.18 – 166.11

Company Overview:

Franco-Nevada Corp is a precious-metals-focused royalty and investment company. The company owns a diversified portfolio of precious metals and royalty

streams, which is actively managed to generate the Key Stock Statistics bulk of its revenue from gold, silver, and platinum. The Yield 0.77% company does not operate mines, develop projects, or Beta 0.61 conduct exploration.

Revenue $973.80M Executive Summary: Operating Margin 54.87 Franco-Nevada Corp. has exhibited strong growth and Net Income $263M returns this year, and since the purchase of this stock EPS 1.39 for the portfolio. In April of 2017, the Wisman fund Operating Cash Flow $742M purchased 57 shares of FNV at $69.86 a share. It is Free Cash Flow $560M currently trading at 134.80 and has returned 26.2% Return On Assets 4.95 YTD with a holding return of 86.1%. Due to the Return on Equity % 5.19 uncertainty of the COVID-19 pandemic and the P/E 97.09 volatility of the economy it is time to consider selling a P/B 4.92 portion of the shares. The outlook for the gold industry P/S 26.30 is cloudy and FNV’s peers are trading at a more P/FCF 34.48 affordable price. Projected 5 Year Growth 7.67%

FNV: Franco-Nevada Corp. – Equity Research Report Chris Harootunian

examples of these in the mining and energy industries include a Net Smelter Return Royalty (NSR), Overriding Royalty (ORR), Gross Royalty (GR), and Freehold or Lessor Royalty (FH). Profit-based Interest Royalties are based on the operating profit as defined in the royalty contract. The payments for these kinds of royalties are often not paid until the operator has recovered its capital costs. The most common form of these royalties is Net Profits Interest Royalties (NPI). Franco-Nevada Corp. (FNV) Overview Franco-Nevada Corp. has shares listed on the Toronto and New York Stock Exchange under the ticker symbol Streams and Working Interests FNV. They aspire to make FNV the go to gold stock for In addition to royalties, Franco-Nevada holds stream the generalist investor. They intend to accomplish this and working interests. Streams are metal purchase by emphasizing minimal risk, paying dividends, and agreements that allow the holder of the agreement to maintaining a strong balance sheet. FNV wants to be a purchase all or a portion of the gold, silver, or other lower risk gold investment for investors who wish to products from a mine in exchange for an upfront invest in precious metals that pays dividends. They payment and an additional payment on each delivery. intend to leverage gold to confront the political Streams are not royalties because they are not an volatility and financial market instability investors face. interest in land and there is an ongoing cash payment required to purchase the physical metal. A Working Products and Services Interest (WI) is when holders have an ownership Franco-Nevada Corp.’s business model revolves around position in the property and operation and hence are managing and growing its portfolio of royalties and liable for cash calls on their share of capital, operating streams. and environmental costs usually in proportion to their ownership percentage. Working interests are not Royalties considered to be royalties because of their ongoing funding requirements although, for profitable Royalties are ongoing interests in the production or operations, they can be economically similar in their future production from a property. Royalties generally calculations to NPIs. share a few desiring characteristics. They are not subject to cash calls to fund exploration, development, Business Segments capital, environmental or closure costs and so are lower risk in this respect than an operating interest. They In Q3 of 2020 Franco-Nevada Corp. sourced 91.9% of provide exposure to the upside of commodity prices as its revenue from gold and gold equivalents (73.7% well as increases in reserves and production. They gold, 9.3% silver, 7.6% PGM, and 1.3% from other provide an interest in new discoveries made on a mining assets). Energy made up only 8.1% of its property which can result in significant value creation revenue (oil, gas, and NGLs). The focus of their for Franco-Nevada. They do not involve operational or portfolio is on precious metals with a target of no more development management so a large and diversified than 20% of its revenue from energy. Geographically, portfolio can be assembled without the need for revenue was sources 85.3% from the Americas (48.9% significant corporate overheads. The two most common Latin America, 16.0% U.S. and 20.4% Canada). types of royalties are Revenue-based Royalties and Profit-based Interest Royalties. Revenue-based Competitive Advantage Royalties are based on the value of the production or Franco-Nevada Corp. possesses many advantages to net proceeds received by the operator with defined their business model. These advantages include deductions as specified by the royalty contract. Some providing an exposure to precious metals price

Shippensburg IMP Fall 2020 2 FNV: Franco-Nevada Corp. – Equity Research Report Chris Harootunian optionality. They also provide a perpetual discovery necessary to discuss FNV’s financial statements and option over large areas of geologically prospective some key financial ratios. A valuation of the FNV stock lands with no cost other than the initial investment. using the FCFE Stable Growth Model will be included. They provide limited exposure to the risks associated with operating companies. They are a free cash-flow Key Fundamentals and Economic Drivers business with limited cash calls. They are also a high- margin business that can generate cash through the Basic Materials Sector entire commodity cycle. They are a scalable and The basic materials sector is an industry category made diversified business in which many assets can be up of businesses engaged in the discovery, managed with a small and stable overhead. They are a development, and processing of raw materials. The forward-looking business in which management sector includes companies engaged in mining and metal focuses on growth opportunities rather than operational refining, chemical products, and forestry products. or development issues. Perhaps most importantly they Within this sector are the companies that supply most are debt free and have been providing and increasing of the materials used in construction. That makes the dividends for twelve consecutive years. companies and their stocks sensitive to changes in the business cycle. They tend to thrive when the economy Recent News, Stock Performance is strong. The basic materials sector is subject to the law of supply and demand in the same way as consumer goods are. If the demand for consumer goods drops, the demand for the raw materials involved in their production also drops.

Since Franco-Nevada Corp.’s IPO in Dec. 2007, their share price has outperformed both gold and other gold equities, margins have remained high, overhead has remained low, and their effective tax rate has remained stable. FNV has been able to increase dividends for 12 consecutive years. FNV delivered record revenue, EBITDA, and net earning in Q3 with all material This chart from Fidelity shows how the sector closely Mining assets having returned to normal operations follows the S&P 500 YTD. As of 11/17 it is beating the through the quarter. Continues to lead its royalty and S&P by 2.36%. streaming peers with the highest EBITDA margins and a record earnings margin of 55% in Q3. 25 new royalties were added to their portfolio bringing the number of mining related assets to 316. Their energy assets also benefitted from a rebound in oil and gas prices. They continue to be debt free. Investment Thesis This section will provide an analysis of FNV’s stock. To analyze this stock, it is necessary to look at the basic materials sector as well as the gold industry. It is also

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This chart depicts the U.S. Dollar compared to the gold The Metals and Mining Industry has tremendously price over the last 10 years. outperformed the S&P 500 in YTD, 1, 3, and 5 year. The gold industry is currently severely impacted by the COVID-19 Pandemic. Margins are currently high due to declining energy prices and currencies in gold mining countries, but there are caveats. COVID is a threat to the mining companies, and travel restrictions prevent access to mines. Lockdowns in countries such as Canada, Mexico, Peru, and South Africa have forced operations to be scaled back or to cease completely for a while. The restrictions imposed by governments, supply shortages, and lack of transportation have all negatively affected the costs of operations and reduced YTD the Metals and Mining Industry is beating the gold-mine supply. S&P 500 by 27.65%. Financial Ratio Analysis Gold Industry When doing a financial ratio analysis, it is necessary to compare FNVs stock to that of its competitors. Some competitors include Newmont (NEM), Barrick Gold (GOLD), and Wheaton Precious Metals (WPM).

Dividends Franco-Nevada pays an annual dividend of $1.04 per share and has a dividend yield of 0.8%. Newmont pays an annual dividend of $1.00 per share and has a dividend yield of 1.6%. Franco-Nevada pays out 57.1% of its earnings in the form of a dividend. Newmont pays out 75.8% of its earnings in the form of a dividend, suggesting it may not have sufficient earnings to cover its dividend payment in the future. Barrick Gold pays This chart depicts the gold price over the last 10 years. an annual dividend of $0.32 per share and has a dividend yield of 1.3%. Both companies have healthy payout ratios and should be able to cover their dividend payments with earnings for the next several years. Wheaton Precious Metals pays an annual dividend of $0.40 per share and has a dividend yield of 0.9%. Wheaton Precious Metals pays out 71.4% of its earnings in the form of a dividend. Both companies have healthy payout ratios and should be able to cover their dividend payments with earnings for the next several years.

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Valuation

Newmont has higher revenue and earnings than Franco- Nevada. Newmont is trading at a lower price-to- earnings ratio than Franco-Nevada, indicating that it is Fair Value currently the more affordable of the two stocks. I used a FCFE Stable growth model to value FNV. The results I received using a growth rate of 7.7% and a cost of equity of 10% was a fair value of $137.51.

Barrick Gold has higher revenue and earnings than Franco-Nevada. Barrick Gold is trading at a lower Morningstar currently values FNV at a 36% premium. price-to-earnings ratio than Franco-Nevada, indicating Their one-star price is $118.33 which is less than its last that it is currently the more affordable of the two close and the results of the model value ($137.51). stocks. They evaluate FNV’s fair value at $98.90 meaning it is currently extremely overvalued.

Franco-Nevada has higher earnings, but lower revenue than Wheaton Precious Metals. Franco-Nevada is trading at a lower price-to-earnings ratio than Wheaton Precious Metals, indicating that it is currently the more affordable of the two stocks.

Profitability

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Risks our Materials holdings. Our current weighting for this sector is 4.6% while our target weight was determined External Risks to be 3%. I believe we should trim our holdings to get down to our target weight for Materials. FNV is a Gold is a precious metal and as a result is used for highly overvalued stock and its peer competitors are investment purposes across the globe. Due to escalating trading at a more affordable price. The gold industry prices of gold, it is at present being oversold in the also faces long term risks in the face of the COVID-19 bearish market. In times of high inflation, currency pandemic. fluctuations, and geopolitical crisis, gold is considered to be the safest investment. The purchase of gold is expected to rise as consumers are focusing on long-term References investments. However, factors such as degrading ore grades, technical issues, and strikes are anticipated to https://www.morningstar.com/stocks/xnys/fnv/quote hamper the growth of the global gold market. The global gold market is likely to be affected by the https://finance.yahoo.com/quote/FNV?p=FNV fluctuating supply of mined gold as the global gold production is a mix of scrap recovery, central bank https://www.franco-nevada.com/Home/default.aspx supply, and mined gold. More than half of the global gold supply comes from mined gold. Gold is a https://www.vanguardcanada.ca/individual/articles/educ commodity and has no means of traditional value like ation-commentary/investing/benefits-and-risks-of-gold- bonds that pay interest or stocks that pay dividends. tlrv.htm Gold price is based solely on supply and demand from global interests. Gold can have a poor relationship with https://www.franco-nevada.com/our-assets/terms- inflation and buying gold as an inflation hedge may or explained/default.aspx may not prove effective due to prices depending on global supply and demand rather than inflation rates. https://www.aarp.org/money/investing/info- Gold prices are notoriously volatile. Major gold 2020/buying-gold-risks.html discovery can depress the price of gold with a flow of new supply. Gold prices may rise in value when the https://www.investopedia.com/terms/b/basic_materials. economy is doing poorly, but they can also fall when asp#:~:text=The%20basic%20materials%20sector%20i conditions improve. Gold prices fell nearly by half from s,chemical%20products%2C%20and%20forestry%20pr 2011 to 2016. oducts.

Internal Risks https://www.macrotrends.net/1333/historical-gold- prices-100-year-chart The biggest risk facing Franco-Nevada Corp. is increasing lockdowns from COVID-19. If lockdowns https://www.fidelity.com/?bar=p are sanctioned the gold supply could diminish. This would negatively affect FNVs acquisitions and sales. https://www.mckinsey.com/industries/metals-and- Also, if strict travel bans are put in place it would affect mining/our-insights/covid-19s-impact-on-the-global- the ability for gold to be transported. Mining operations gold-industry-implications-for-the-next-normal-and- could be halted. This is also subject to the people beyond operating the mining getting COVID themselves.

https://www.marketbeat.com/stocks/NYSE/FNV/compe Recommendation titors-and- I recommend that the Wisman fund trim its shares of alternatives/#:~:text=Companies%20in%20the%20indu FNV. We currently hold 57 shares making up 79.6% of stry%20of,and%20AngloGold%20Ashanti%20(AU).

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