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Streaming Profits in the Gold Sector

09/16/2019 5:00 am EST

Focus: COMMODITIES

Adrian Day

Chairman and CEO, Adrian Day Asset Management

While we do not expect the major royalty companies to be the very top-performers in a metals bull market, these companies — on balance — have the lowest risk of any precious metals sector, second only to bullion itself, notes Adrian Day, editor of Global Analyst.

Franco-Nevada (FNV) is the crème of the crop; it has top management, innovative and conservative; a solid balance sheet, with modest debt only twice in that time frame; a willingness to act counter-cyclically; strong diversification in its portfolio; a low cost structure; and a deep pipeline of assets.

Only two of its assets contribute more than 10% of its revenue, and the top operator is responsible for only 12%. This diversification is broader than for other companies, and means Franco is not at risk from a failure either of an operator or an asset. As for costs, its G&A is not much higher today than it was a decade ago, despite the tremendous growth in revenue, representing today less than 5% of its revenue.

Franco reported strong revenues, above estimates, in its latest quarter, with oil and gas revenues offsetting slightly weak metals sales. The company expects metals sales to be at the higher end of guidance for the rest of the year, as Cobre Panama, its latest major asset, ramps up.

Franco ended the quarter with a strong balance sheet, with virtually $400 million in cash against $385 million in total debt. It has $1.1 billion of available liquidity, more than sufficient to make additional large-scale acquisitions.

Osisko Gold (OR) reported a small beat to expectations, partly due to better-than-expected production at Pretium’s Bruejack, though ounces were down on a year ago, partly due to the Renard diamond mine, currently in restructuring.

But the company is expecting a significant improvement in ounces in the second half of the year as the new Eagle Mine of Victoria comes onstream, with first production expected next month, as well as improvement in production from the Eleonore Mine.

The most important development in the last quarter was the deal with Orion, a private equity firm. Osisko bought back from Orion shares in exchange for cash and the transfer of several junior investments.

The shares repurchased were returned to treasury, resulting in an 8% reduction in shares outstanding, while there was no reduction in the cash generating assets (but a $2.5 million reduction in dividend payments). Orion is now down to just over 6% ownership.

The result at quarter end was liquidity of $450 million, plus an investment portfolio now valued at $282 million, down from $400 million prior to the Orion transaction.

Osisko tends to be more involved in the companies on which it holds revenues, whether through its accelerator program — there were several advances at such companies owned by Osisko Mining, in which Osisko Royalties owns over 16% — or in helping companies in difficulties. Osisko is taking an active role in the restructuring of the Renard mine.

The accelerator—or “incubator”—program certainly adds an element of risk, in addition to the greater leverage not in a traditional royalty company. That, plus Osisko’s size relative to the larger royalty streamers partly account for its lower valuation, but the gap has now become quite extreme.

All the royalty stocks have moved up and we are expecting a near-term pullback in the gold sector, so you should wait before buying. Franco is a core holding, so you should take a position on any pullback if you do not own. Osisko, however, is the least overvalued of the royalty stocks and can be bought on a pullback.

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