Franco-Nevada Corporation

Moat: 4/5

Understandability: 3/5

Balance Sheet Health: 5/5

Franco-Nevada Corporation is a leading gold-focused royalty and streaming company.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Franco-Nevada (FNV) operates a unique business model centered around acquiring royalties and streams on mining and energy assets, rather than directly owning and operating them. This approach allows FNV to generate revenue from these resources without being exposed to the operating costs and risks of the underlying projects.

  • Revenue Distribution: FNV’s revenue streams are primarily derived from:
    • Precious Metals (Gold, Silver, Platinum Group Metals): These represent the majority of FNV’s revenue, with gold being the most significant component.
    • Diversified Royalties: FNV also has a smaller but growing portfolio of royalties and streams in other areas, particularly in energy and in some other segments, such as bulk commodities. The importance of this element is growing.
  • Industry Trends:
    • Commodity Demand: The demand for gold and other precious metals tends to be a store of value in economic downturns.
    • Energy Market Dynamics: The energy sector experiences greater volatility due to shifting market conditions, supply and demand dynamics, political tensions, and technological disruption.
    • Mining Sector Landscape: The mining sector is characterized by its long cycle, capital intensive nature, complex operations, price fluctuations, and a need to operate in harsh environments.
  • Margins: FNV benefits from high operating margins due to the nature of its business model which is based on receiving royalties rather than engaging directly in high-cost mining operations.

Competitive Landscape

  • Uniqueness of FNV: Unlike mining companies, FNV doesn’t have to make large capital expenditures in exploration or development; they pay upfront, and they get a stream in the future.
  • Competition: FNV does face competition in the market for acquiring royalties and streams, as other streaming and royalty companies are becoming more prevalent, and private equity funds also participate in these markets.
  • What Makes FNV Different: FNV’s business model is unique as it is structured to be a diversified portfolio of royalties and streams. FNV’s management emphasizes the importance of creating a balanced and diversified portfolio that minimizes exposure to idiosyncratic risk (risks specific to certain mines) and maximizes long-term value creation.

Financials In-Depth

  • Revenue Growth: FNV’s financials have shown resilience despite market volatility. They often experience revenue growth due to both increased prices and volumes. Recently, the company experienced a slight downturn in average prices, but those were offset by increased volume of sales.
  • Profitability: FNV exhibits excellent profitability metrics, benefiting from its royalty and streaming model, as opposed to the large capital expenditures and operating risks faced by mining companies. High revenue and low operational costs yield good results. Net profits, however, may be volatile and fluctuate due to impairments, especially if certain mines are not performing well.
  • Balance Sheet Health:
    • Liquidity: FNV maintains a very strong liquidity position, usually holding a substantial amount of cash and available credit facilities. This enables it to pursue deals when opportunities arise, and to withstand market turbulence.
    • Debt: The company’s debt is low relative to its equity and assets.
    • Financial Stability: FNV does not use much leverage in its financing model, which can protect them during economic hardships. The company has good flexibility and room to allocate their assets in the best manner.
  • Risk Management: Management’s focus on risk management is reflected in its efforts to diversify its portfolio, maintain a strong liquidity position, and manage operating expenses.

Moat Analysis: 4/5

  • Intangible Assets: FNV has limited brand recognition in the consumer space, because their end-customers are other companies, not people.
  • Switching Costs: There are not a lot of switching costs for customers, as they are selling commodities.
  • Network Effects: The network effects for this company are quite minimal.
  • Cost Advantages: This is where FNV shines. Its ability to acquire diversified resources upfront, while not having to pay operational costs, gives them a unique advantage over competitors. Their lower cost structure allows them to generate significant profits even in periods of lower commodity prices.
  • Other: The company also benefits from scale as being one of the largest royalty companies.

Justification: FNV’s moat primarily stems from its unique business model, giving it a structural cost advantage over traditional mining companies, and its scale. However, it isn’t indestructible, due to certain parts of its business model being based on commodity prices and risk of those markets. Therefore a score of 4/5 is most appropriate.

Legitimate Risks That Could Harm the Moat and Business Resilience

  • Commodity Price Volatility: Significant drops in commodity prices (especially gold and other precious metals) could materially reduce FNV’s revenues and profitability.
  • Counterparty Risk: FNV relies on the operating partners to meet their contractual obligations, including production, and any defaults by the operators could lead to reductions in payments.
  • Operating Disruptions: The operating mines are susceptible to operational issues like strikes, geological problems, technical problems, which could reduce the revenues of FNV.
  • Currency Risk: While most of FNV’s revenues are derived from USD sales, they do also operate in international markets. Fluctuations between currencies and USD might impact profitability.
  • Regulatory and Political Risks: Changes in the regulatory landscape or adverse political events in the countries where FNV operates can negatively impact profitability, and possibly even put an end to ongoing operations.
  • Inflation: High levels of inflation can increase operating costs, especially if cost pressures are greater for operators than the royalties or streams.
  • Acquisition Risk: The company is exposed to risk if it overpays for its acquisitions. If the resources obtained prove to have low production and revenue, the company’s returns may be substantially less than expected.

Business Resilience: FNV is fairly well positioned to withstand some economic and market shocks. Their diversified portfolio, strong liquidity, and low debt structure make it a resilient company.

Understandability: 3/5

The company has a fairly simple business model that is easy to understand. A basic understanding of the mining sector and the concept of royalties and streams is helpful. Understanding the business model is not as difficult as it is understanding the accounting complexities behind its many acquisitions. Therefore, an understandability score of 3 out of 5 is warranted.

Balance Sheet Health: 5/5

FNV exhibits high financial health with strong cash positions, low debt and leverage, and strong profitability. The company’s balance sheet is a sign of financial health and robustness. Therefore a rating of 5 out of 5 is appropriate.

Recent Concerns and Management View

  • Inflationary Pressures: The latest reports indicated that high inflation and a potential slowdown in global economies may affect consumer demand. This may have implications for the mining industry that will affect FNV. Management has indicated to have anticipated and adjusted their financial model, given these assumptions.
  • Recent Decline in Price: There has been a drop in the stock’s price recently, potentially from short-term market sentiment and macroeconomic factors. However, management insists that they continue to create value over the long-term and are not too concerned with price declines of short duration.
  • Commodity Prices: The prices of some precious metals have fallen slightly in the short-term, but have remained within an acceptable volatility range. FNV management believes that, over the long-term, prices will return to normal levels.

Despite the concerns listed above, management seems confident that the company is well-positioned in its sector, and is well-positioned to ride out the storm. Management also plans to use the increased buying opportunity to acquire additional assets.