Is Franco-Nevada Doomed to Underperform?

Franco-Nevada’s rating was recently downgraded to “underperform.” Is this company’s valuation inflated?

Jul 14, 2014 at 2:33PM

Franco-Nevada (NYSE:FNV) was recently downgraded  by leading analysts to an "underperform" rating. This means that analysts estimate that the current valuation of the company is too high. At the same time, other royalty and streaming companies such as Royal Gold (NASDAQ:RGLD) and Silver Wheaton (NYSE:SLW) have higher ratings of "overweight" and "buy," respectively. Is Franco-Nevada's stock overvalued? How does the company measure up to its peers?  

Growth in operations
This year, Franco-Nevada plans to increase its attributed gold equivalent ounces (GEO) production by 5.6% to reach an average of 255,000 GEO. Most of this growth will come from an expected rise in production in the U.S. and Australia.

In addition to this, several of the company's assets outside of North America and Australia such as Tasiast, MWS, and Palmarejo are expected to increase their production as well. During the first quarter of this year, the company acquired the Sabodala stream, which will further expand its operations in the coming quarters. Franco-Nevada's 2014 operations in Canada are expected to be in line with last year's attributed output. 

Royal Gold and Silver Wheaton are also expecting operations growth in 2014. Royal Gold's attributed production is projected to rise by 65% year over year, while Silver Wheaton expects its silver equivalent production to inch up by 0.5% compared to 2013. 

Based on the above, Franco-Nevada offers better growth prospects than Silver Wheaton but a much slower growth rate than Royal Gold. This means that Franco-Nevada is in the middle of the pack among precious metals royalty and streaming companies in terms of growth. 

Finding the right mix
One of the main differences between Franco-Nevada and the above-mentioned companies is that the company sells not only gold but also oil and gas. This year, Franco-Nevada expects to generate around $67 million in revenue from oil and gas. In the first quarter  alone, nearly 18% of its revenue came from oil and gas. Gold accounted for 67% of its revenue, and the rest came from platinum group metals and other minerals. 

For Silver  Wheaton, silver accounts for 75% of its operations and the rest is gold. Nearly 70% of Royal Gold's revenue comes from gold, and the rest comes from silver, copper, nickel, lead, and zinc. 

Franco-Nevada's oil and gas operation could be an advantage for investors seeking to expand their portfolio not only to bullion but also to energy commodities. This difference may have contributed to the modest decline in the company's profit margin, however, as indicated in the chart below. 

Franco Nevada Profit Margin Q

Source: Google Finance

The chart shows the operating profitability of leading royalty and streaming companies and the price of gold in the first quarter of 2013 and 2014. Even though Franco-Nevada had the lowest profit margin in the first quarter of last year, the plunge in the price of gold only reduced its profit margin by two percentage points. The other royalty and steaming companies were more adversely affected by the drop in precious metals prices. The profitability of all three companies was similar in the past quarter. 

The drop in the price of gold in the past year didn't hold back Franco-Nevada from raising its quarterly dividend by 11% to $0.20 per share or an annual paycheck of $0.80 per share. This comes to an annual yield of 1.36%. In comparison, Royal Gold offers a slightly lower yield of 1.1% while Silver Wheaton's annual dividend yield is 1.03%. 

Foolish bottom line
Franco-Nevada has room for growth, so long as precious metals continue to recover and the company reaches its annual guidance. Among the leading royalty and streaming companies it sells not only gold but also oil and gas; this could provide a more balanced mixture for investors seeking exposure to these commodities. 

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Lior Cohen has no position in any stocks mentioned. The Motley Fool owns shares of Silver Wheaton. (USA). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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