Many investors see Franco-Nevada (FNV 1.04%) as just another way to invest in the precious-metals market. It's natural to assume that because the company makes financing arrangements for which it primarily gets repaid in streams of gold and other precious metals, its stock price would move in lockstep with the precious-metals markets. Yet over the past decade, Franco-Nevada has dramatically outpaced gold as an investment, and the company's business model suggests that further outperformance could persist for years to come.
How Franco-Nevada has done compared to gold
Over the past year, Franco-Nevada has done well in comparison to the gold market. Gold prices are up about 5% from this time last year, but Franco-Nevada shares have seen their price rise by 17%. That doesn't even include the dividends that the company has paid along the way.
A look at the company's performance over the long haul shows even more dramatic differences:
When gold was climbing during the late 2000s and early 2010s, Franco-Nevada managed to grow at an even-faster pace. Yet when gold prices hit their peak and started to deteriorate from 2012 onward, Franco-Nevada nevertheless managed to find ways to boost its stock price.
How Franco-Nevada wins even when gold drops
The key thing to understand about Franco-Nevada is that the company is opportunistic in its investments. When gold prices are high, the streams of precious metals that Franco-Nevada has coming in are worth more. But the chances of Franco-Nevada making lucrative new investments aren't as good, because most mining companies don't have as much need for outside capital when the gold they produce is worth more money. Moreover, even miners that do need cash infusions typically have no trouble getting financing from any number of sources when the gold market is strong.
By contrast, when the gold market drops, mining companies often fall on hard times. Profits decline, and marginal players in the industry start losing money. That increases the need for financing, but weak industry conditions also make conventional financing sources reluctant to provide cash. That gives Franco-Nevada the opportunity to swoop in and secure favorable terms in exchange for much-needed financing.
You can see how that cycle works in Franco-Nevada's recent acquisitions. In October 2015, Franco-Nevada provided $610 million in exchange for a silver stream on production from the Antamina mine in Peru from Teck Resources (TECK +2.51%). The company initially expected silver streams of 2.8 million to 3.2 million ounces annually, but 2016 deliveries amounted to 4.4 million ounces. Teck's decision to increase deliveries was motivated in part by low metal prices and the desire to strengthen its balance sheet.
Antamina mine in Peru. Image source: Teck Resources.
Similarly, when mining giant Glencore was struggling to manage its extensive debt, Franco-Nevada managed to make a deal that gave it a gold and silver stream in exchange for a $500 million one-time payment. Already, the mine has delivered on its promise, and Franco-Nevada expects the mine to keep producing until 2030. Even more importantly, Franco-Nevada structured the deal to get rights to potential future expansion of the mine site. Those kinds of concessions are a big key to Franco-Nevada's overall success.
Will Franco-Nevada stay ahead of gold?
Because of the success of its business model, Franco-Nevada has demonstrated an ability to outperform gold over its history, and that outperformance looks likely to continue. Franco-Nevada believes that the precious-metals markets have rebounded sufficiently that future opportunities for streaming arrangements are likely to diminish. In response, Franco-Nevada is looking more at the energy sector, where oil and gas royalty interests offer the same kind of risk and reward as streaming deals in the precious-metals market. By moving from a current 95-5 mix of precious metals to energy toward a more balanced 80-20 mix, Franco-Nevada thinks it can diversify and take advantage of better conditions in the oil and gas market.
In the long run, Franco-Nevada will likely invest anywhere that natural-resources markets offer profitable opportunities. With the right to participate in rising gold prices, as well as the potential for growth independent of what precious metals do, Franco-Nevada is setting itself up for the best of both worlds.
