It's a common belief among investors in precious metals that pure mining stocks like Barrick Gold (GOLD 1.68%) are the best ways to gain exposure to gold and silver prices, But did you know that Franco-Nevada (FNV 0.98%) has trampled most mining stocks not just this year, but for several years? Franco-Nevada is one of the three companies that "stream" gold and silver instead of extracting them, or simply, they buy metal streams from miners to later sell in the market. Today, the trio of Franco-Nevada, Wheaton Precious Metals (NYSE: WPM), and Royal Gold rule the global precious metal streaming industry.
Investors have been getting jittery of late after Franco-Nevada's strong run-up -- the stock is up 25% year to date versus, say, Barrick, which is up only about 3%. Franco-Nevada is now trading at a sky-high trailing price-to-earnings of 98 times -- though a P/E isn't a useful measure to value precious metal stocks -- and it can't really be considered cheap at 28 times price-to-cash flow, either.
However, that in no way means Franco-Nevada investors should be worried. In fact, the company is has been doing well, which justifies its premium value to a large extent. The stock looks poised to rally even higher and outperform in the years to come. Here are just some of the reasons why.
Image source: Getty Images.
Why Franco-Nevada is different
To quickly recap how Franco-Nevada makes money, it doesn't own or operate any mines, unlike a mining company like Barrick Gold. Instead, Franco-Nevada enters streaming agreements with miners and obtains the right to purchase metals produced from mines attached to the agreement at prices below spot rates. In return, it provides upfront funding to the miners to support their capital projects.
A business model of this kind also means Franco-Nevada's success depends entirely on whether its miner-partners can supply it with the precious metals as agreed upon. If production at any mine takes a hit, the streaming company suffers. As an example, Wheaton Precious Metals' silver production declined considerably last year after production at Goldcorp's Penasquito mine declined.
Knowing that it has no control whatsoever on production, a strong, diversified, and a growing portfolio of streaming and royalty agreements holds the key to success for Franco-Nevada. Fortunately, management knows this well, as evidenced by the company's recent moves.
Franco-Nevada ended fiscal-year 2016 on a record note and continued its winning streak by recently reporting record gold-equivalent ounces (GEOs) production and revenues for its first quarter, which was possible only because of the company's recently acquired streams. They include the South Arturo mine operated jointly by Barrick and Premier Gold Mines, Antapaccay operated by Glencore, and Antamina part-owned by Teck Resources. This chart shows how new investments such as the ones in Antapaccay and Antamina have fueled growth at Franco-Nevada in recent quarters.
Image source: Franco-Nevada.
The growth has been phenomenal: Franco-Nevada's GEOs have more than doubled since 2012. Of course, 2016 was an exceptional year as the company received its first metal streams from South Arturo and Antapaccay, which pushed its GEOs up by 29% and revenues up by 37.6% versus 2015.
That said, Franco-Nevada still expects its GEOs to improve another 4% at the mid-point this year, and by almost 14% at the mid-point through 2021. In comparison, Wheaton Precious Metals' GEOs growth is likely to stagnate in the next five years as its oncoming gold streams offset declining silver production. So, the market isn't really wrong to be bidding up shares of Franco-Nevada given how rapidly the company is growing.
There's another huge factor that sets Franco-Nevada apart from other streaming companies -- its diversified portfolio.
Oil could be a huge opportunity
While Wheaton Precious Metals and Royal Gold are pure gold and silver players, roughly 5% and 6% of Franco-Nevada's revenues came from oil and gas royalties and platinum group metals, respectively, last year. That not only makes the company the most diversified in the streaming industry, it also provides it with additional growth avenues.
It was only recently that Franco-Nevada diversified into oil after having acquired stake in some oil and gas royalties in the Oklahoma STACK play and the Midland Permian Basin. The company expects its oil and gas revenues could hit $55 million to $65 million by 2021 at WTI crude price of $50 per barrel from $30 million generated last year.
As Franco-Nevada's revenues rise, so should its cash flows and dividends. Franco-Nevada's cash flows have been very volatile, but the company has done an incredible job at expanding its free cash flows over the years.
FNV Revenue (TTM) data by YCharts.
While most precious metals companies either don't pay a dividend or are unable to pay stable dividends, Franco-Nevada has increased its dividends for 10 consecutive years. That makes it one of the best gold dividend stocks to invest in.
No matter which way you look at it, Franco-Nevada has solid growth potential ahead. For investors, core EPS growth coupled with rising dividends should mean strong returns in the years to come.
