Oil & Gas Drives Franco-Nevada as Candelaria Grades Drop
On Nov 14, we issued an updated research report on Franco-Nevada Corporation FNV. Though lower grade at Candelaria mine will weigh on its gold production in 2018, the company is poised to deliver improved results driven by strong performance in its Oil & Gas portfolio.
Lower Grade at Candelaria to Drag Down 2018 Production
In November 2017, Lundin Mining announced an updated mine plan to address localized pit wall instability. While decreased grades were expected in 2018, the impact on gold and silver production was greater than anticipated. Consequently, Franco-Nevada lowered Gold Equivalent Ounces (“GEO”) production to 440,000-470,000 GEOs from mining assets in 2018 from the earlier mining asset guidance of 460,000-490,000 GEOs. Even though production is expected to recover in 2019, the processing of lower grade material at Candelaria is anticipated to continue for the remainder of 2018. The lower guidance is disappointing as the company’s top-line will not benefit in case metal prices rise.
Momentum in Oil & Gas Portfolio to Aid 2018 Results
Performance from Oil & Gas portfolio remains robust with revenues doubling to $68 million in the first three quarters of 2018 from $33 million in the prior-year period. This can be attributed to stronger oil prices and increased production from the newly added U.S. assets. Drill activity is higher and drilling productivity is better than expected. Consequently, Franco-Nevada now expects to generate $75-$85 million in revenues from oil & gas for 2018, higher than the previous expectation of revenues of $65-$75 million.
Cobre Panama: A Catalyst Despite Near-Term Uncertainty
The company has so far invested $1 billion for the Cobre Panama project. Over the next two years, Cobre Panama will be ramping up to full production. Cobre Panama is expected to contribute 25% of the company’s NAV and is a key catalyst. Until actual gold and silver starts coming in from the project, it is not clear how well the mine will produce.
Strategic Relationship with Continental Resources: A Key Catalyst
In October 2018, Franco-Nevada contributed $214.8 million to close its previously announced transaction with Continental Resources, Inc. to acquire Oil & Gas mineral rights in the SCOOP and STACK plays of Oklahoma — two of the most economic and attractive plays in North America. It has also committed, subject to satisfaction of agreed upon development thresholds, to spend up to $300 million over the next three years to acquire additional mineral rights through a newly-formed company. Acquisition of mineral rights is ongoing and Franco-Nevada now anticipates funding additional capital contributions of between $35 million and $55 million in 2018 as part of its $300 million commitment.
This represents a new business development opportunity for Franco-Nevada. It gets an acquisition vehicle, which provides the ability to acquire assets at the grassroots level or directly from individual owners. This is a segment of the market previously inaccessible to Franco-Nevada due to a lack of staff or resources to carry out these smaller-scale acquisitions. More importantly, Franco-Nevada benefits from the operator's drill plans, along with their knowledge of local land title and geology.
Lower Metal Prices: A Near-Term Concern
The prices of precious metals, particularly gold are a determining factor for profitability for Franco-Nevada. Gold prices have been affected by the trade tussle between the United States and China, interest rate hikes and a stronger dollar lately. Lower prices will weigh on Franco-Nevada’s performance in the near term.
Shares of the company have lost 23% in the past year, compared with the industry’s decline of 22%.
Poised Well for the Long Term
Franco-Nevada strives to generate 80% of revenues from precious metals over long-term horizon which includes gold, silver and PGM. With around 85% of revenues earned from precious metals year-to-date, the company has the flexibility to consider diversification opportunities outside of the precious metals’ space and increase exposure to other commodities while maintaining its long-term target.
Further, Franco-Nevada appears to be on a promising long-term trajectory thanks to a healthy portfolio of streaming and royalty agreements put in place years ago. With more mines coming online in the next several years, it will benefit from higher levels of precious metals sales as well as higher prices. The company maintains solid growth outlook till 2022, forecasting production in the range of 565,000-595,000 GEOs. Furthermore, Franco-Nevada’s balance sheet remains debt free.
Franco-Nevada currently carries a Zacks Rank #3 (Hold).
Stocks to Consider
Some better-ranked stocks in the basic materials space are CF Industries Holdings, Inc. CF, The Mosaic Company MOS and KMG Chemicals, Inc. KMG.
CF Industries has an expected long-term earnings growth rate of 6% and a Zacks Rank #1 (Strong Buy). The company’s shares have gained 27% in the past year. You can see the complete list of today’s Zacks #1 Rank stocks here.
Mosaic has an expected long-term earnings growth rate of 7% and a Zacks Rank #1. The company’s shares have rallied 60% over a year’s time.
KMG Chemicals has an expected long-term earnings growth rate of 28.5% and a Zacks Rank #2 (Buy). Its shares have risen 50% in the past year.
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