Royalty and streaming companies (hereinafter royalty companies) provide capital to mining companies in return for a share of future production. The upfront capital may provide development or construction capital, finance an acquisition, or could help repair a broken balance sheet.
Often the stream is part of a package, along with equity and debt. With gold equity markets low and interest rates high, streams are a very competitive form of financing at this time.
Royalty companies have significant benefits over mining companies. First, they are not responsible for higher costs or fixing things that go wrong, as they often do in the mining business. It could be rising costs, higher taxes, or even damage at the mine.
Second, because of this business model, the G&A tends to be very low and relatively fixed, resulting in high margins, which can be as high as 90%.
Despite these advantages, royalty companies generally participate in the mine upside. And there is plenty of leverage from royalties on non-producing properties that move towards production, without the royalty company spending an additional penny.
Franco-Nevada, a $20 billion company, was the first of the gold royalty companies and is best in class. It has revenue from over 100 assets, while it holds royalties or streams on over 300 non-producing projects, some in the development phase, many of which will eventually start generating revenue.
Unlike some other companies, Franco has diversified into oil and gas for about 17% of its revenues, as well as iron ore, at about 4%. Gold represents about 65% of total revenues.
The company is a free-cash-flow generating machine, with a rock-solid balance sheet. Currently, there is over $1.2 billion in cash and no debt, with another $1 billion available from an undrawn credit facility.
The opportunity now comes as a result of the closure of the mine on which Franco has its largest stream (representing 16% of its Net Asset Value). Panama ordered the mine closed after a contract dispute. We suspect the dispute will be resolved when a new government comes into office in May, and in the worst case, there will be an award from international arbitration.
In the meantime, Franco recently lost 22% of its value, well offsetting the full value of the stream, and at a time when other peer companies have appreciated 10% or more.
Warren Buffett, using a baseball analogy, says investing is like baseball without any strike outs. You should stand at bat waiting for the perfect pitch. For years, Franco – my favorite gold company – has been expensive. Now you have your opportunity to load up on this high-quality gold company.