Royally Flush with Gold

08/11/2010 12:17 pm EST


Gavin Graham

Chief Strategy Officer, INTEGRIS Pension Management Ltd

Franco-Nevada's growing stream of mining royalties offers upside exposure to gold and a yield to boot, writes Gavin Graham in the Internet Wealth Builder.

Franco-Nevada (Toronto: FNV, OTC: FNNVF) was relisted in December 2007 after it was spun off from Newmont Mining (NYSE: NEM). Set up as a company that invested in gold and precious metal royalties, it offers a great opportunity for investors to take a position in gold and enjoy some income at the same time.

In essence, Franco-Nevada receives a percentage of every ounce of gold or precious metal produced by a mine (usually between 0.5% and 5%) without worrying about the cost of producing the ore.

Chairman Pierre Lassonde was a co-founder and, with [chief executive officer] David Harquail, the management team ensures the formula remains unchanged from its previous successful model. They list three reasons why the business model is so robust:

1. They are not on the hook for any further investment in the operation. The majority of Franco-Nevada's royalties are revenue-based and thus not subject to capital and operating cost inflation.

2. It is a high-margin business. The free cash flow margin in 2009 was 87%, one of the highest of any business.

3. Royalties come with a perpetual option on any new discoveries or expansions on the more than 300 royalties the company owns.

Franco-Nevada owns 19 gold royalties and one platinum royalty on operating mines, in addition to one platinum and 14 gold properties in an advanced stage of development. While gold and platinum provided 80% of its royalty revenues at the end of 2009, it also owns five operating base metal and coal royalties and six operating oil and gas royalties. Another gas property and four base metal properties are at an advanced stage of development. More than 80% of revenue comes from developed economies, with another 15% in Mexico, which has a long history of mining development.

In 2009, Franco-Nevada had $213 million in revenue (the company reports in US currency). That was up 36% from $157 million in 2008, of which $143 million was royalty revenue. Free cash flow (FCF) was $124 million, and the company had $600 million of liquidity with no debt or hedges. Royalty revenue for the 2010 first quarter came in at $41.8 million, up 43% over last year.

Gold has increased in value every year for the last decade, making it the best performing asset class between 2000 and 2010. In doing so, bullion outperformed the next best asset, long term-government bonds, by almost three times. But it doesn't have to [continue that] for this stock to perform well.

Franco-Nevada's revenues and profits will keep growing. With limited exposure to rising operating costs or environmental issues and with a geographically diversified portfolio, this is a low-risk way to gain exposure to gold, one that is not dependent upon a rising gold price.

For US investors, Franco-Nevada is regarded as a Passive Foreign Investment Company (PFIC), which means that any income or increase in value is subject to tax at the top marginal rate.

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