Updated: Jun 12, 2022
Just nine weeks into the year 2022, the newsflow thus far has been dominated by massive market headwinds such as the increasing prevalence of inflation, speculation for as much as 6 rate hikes over the course of the year and most concerningly, Russia’s unprovoked invasion of Ukraine. Amid all this market tumult, most S&P sectors have fallen, with commodities being the outlier. Given the unprecedented levels of targeted western sanctions/export controls which have already been implemented on Russia, speculation remains that the west may still target Russian oil production, which is effectively the lifeblood of the Russian economy. If so, this would mean demand of approximately 5.0M bbls/day coming off from the western markets (or specifically 0.5M bbls/day from the US), with no immediate substitution in the pipeline (Europe imports 30% of their energy needs from Russia while in the US imports approximately 10%). Remember, the Keystone pipeline from Canada remains incomplete in the US. Some US offset may come from Venezuelan, Saudi or Iranian imports however, despite their respective regimes. As such, YTD Physical gold has increased by +9.8%, copper has advanced by +11.4% while WTI has increased by +51.5% having recently surpassed $100/bbl and settled on $115/bbl. Gold’s investment track record as insurance for geopolitical risk and as an inflation hedge has long been established. That said, given the combination of geo-political and economic factors currently taking pace, despite being relatively slow to perform, we would argue that physical gold will eventually well surpass $2,000/ounce. We attribute gold’s underwhelming performance (thus far) on the overhang for the possibility of Russian Central bank selling gold in order to shore up their reserves of $USD.
This takes us to Franco-Nevada (FNV). The preeminent name in the royalty/streaming space has a portfolio of agreements with over 400 assets (112 which are currently producing) spread throughout the Americas, Australia and western Africa. Nearly 55% of revenue currently comes from the gold space with highlight assets from Cobre Panama, Antamina, Stillwater, Detour Lake, Hardrock and Guadalupe-Palmarejo. As of Q3/2021, nearly 463,000 GEOs were sold, generating revenues of $824M. Guidance for FY/2021 is expected between 590,000-615,000 GEOs with cash margins near 85%. Q4/2021 Results are due on March 9, 2022. In terms of the growth pipeline, first production from Salares Norte and Seguela is expected next year while meaningful development or exploration updates are anticipated from Valentine Lake, Rosemont and Cascabel. Given that the corporate model is for stream, pre-pay or royalty contracts, the company is entirely insulated from inflationary pressures such as mounting capex or opex.
Given the corporate track record and asset quality, Franco-Nevada has always traded at a P/NAV, P/CF or P/E multiple compared to peers however of note, the stock has underperformed Royal Gold (RGLD) +22.3% and has had inline performance (+15.7%) with peers such as Osisko Royalties (OR) +14.9% and Wheaton Precious Metals (WPM) + 12.6% on a YTD basis. Note as well that during this same timeframe, physical gold (GC=G) is +9.8% while WTI Crude (CL=F) is +51.1%. We find this disconnect as unjustified and believe the market is ignoring the fact that Franco Nevada’s energy assets contributed to 17.4% of total revenues in Q3/2021 and will likely have an even more meaningful contribution on a go-forward basis seeing as crude is at a 15 year high at a whopping $115/bbl. No other senior royalty company has this type of energy exposure. The Q3/2021 breakdown was specifically 8.8% oil, 6.7% gas and 1.9% NGL, with an asset base highlighted by Weyburn in Canada and exposure to the Permian Basin, Marcellus and Haynesville in the U.S. We believe that the combined pillars of precious metal exposure, insulation to inflation and an upside kicker to energy makes Franco-Nevada one of the best vehicles for the current times.