This Pup Is Running with the Big Dawgs

03/30/2012 10:45 am EST


Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Once again, it’s not the size of the dog in the fight, it’s the size of the fight in the dog…only this gold mining stock is certainly no dog, writes Ian Wyatt of Global Commodity Investing.

Toronto-based Franco-Nevada Corp. (FNV) is a gold streaming and royalty company. Though it only has about 20 full-time employees, Franco has tremendous reach in the mining industry, with a diverse portfolio of more than 200 mineral royalties and streams.

It’s portfolio includes 43 producing assets, 22 in an advanced stage of development that are likely to generate revenue in the next five years, and another 141 promising exploration assets.

In exchange for an initial investment that helps miners with the capital cost of bringing mines into production or to explore for resources, the company earns a stream of the mine’s future production—on average 2% of the extracted gold. Think of the non-producing assets as perpetual call options that could pay off handsomely down the road.

While it derives more than 90% of its revenue from precious metals, it has interests in other resources as well, including 135 oil and natural gas assets (along with another 157 undeveloped oil & gas interests). And management has left open the possibility of expanding the scope of its commodity investments in the future.

In the meantime, its precious metals interests include royalties from mines owned by some of the biggest companies in the business, including Barrick Gold (ABX), Goldcorp (GG), and Kinross Gold (KGC), as well as many smaller companies.

These mines are situated around the globe, although approximately three quarters are located in North America, which in this era of growing resource nationalism reduces political risk.

While many gold related shares have underperformed of late, Franco-Nevada has been able to buck the trend. That said, the recent sell-off in precious metals has pulled the stock down. Right now, we can take advantage of this temporary weakness to enter the stock below its 50-day moving average.

The company has been quite active in the past year, using its cash flow to invest in more than $1 billion in deals that include both royalties and working interests. Franco-Nevada’s cash and short-term investments available to commit to new deals total $747 million at present.

It also has outstanding warrants that can be exercised before expiration this month that could put an additional $184 million in its coffers.

Management views this as a target-rich environment, thanks to high and rising gold prices, a wide number of projects in need of funding, and tight equity and credit market conditions that leave resource companies eager for project funding.

The company perpetually looks expensive on a price-to-earnings basis (it currently trades at 31 times expected forward profits). Nevertheless, we find it cheap on a free cash flow basis: its free cash flow yield is more than 5%.

And if we’re right on the continuing bull market in precious metals, Franco-Nevada’s cash flow and profit generation in the next several years will be considerable.

The beauty of holding royalty interests is that Franco-Nevada avoids various risks associated with developing and operating mines. This fact has been reflected in the share price. Since being spun out from Newmont Mining (NEM) in late 2007 (Newmont purchased Franco in 2002), the stock has outperformed both gold and the gold miners by a wide margin.

With its capable management team running the show, we see no reason for that trend to change. Buy Franco-Nevada below $45 per share.

And as a final sweetener, Franco-Nevada pays a 48-cent dividend, an increase of 60% over last year (its fourth consecutive year of raising the dividend), which brings up the current yield to 1.1%.

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