In an interview with Bloomberg, Franco-Nevada Corp. (FNV, Financial) CEO David Harquail said the gold mining industry is no longer increasing in size since gold mines are becoming depleted.
Gold miners do not have any other choice but to invest in new metallic projects. This means production will barely expand nor will general costs reduce.
If we have a look at the world’s largest gold producer and one of Franco-Nevada’s partners, Barrick Gold Corp. (ABX, Financial), the Canadian miner expects that its gold production will get lower over the next four to five years –Â from a production of 5.60 million to 5.90 million ounces in 2017 to a production of 4.5 million ounces in 2021 and thereafter and a 21% decline in the production of gold over the coming years.
The world’s largest gold producer is focusing on innovative mining techniques that will increase the efficiency of its underground operations and increase profitability at those mines that are characterized by low ore grades. The Canadian miner is also investing in developing those systems that will allow the company to determine the characteristics of gold ore deposits with extreme precision, their length and the exact location where there is the highest concentration of the metal in mineral.
All these measures will allow Barrick Gold to mine gold from its reserves at one of the lowest prices of gold per ounce taken as assumption for the determination of its proven and probable gold reserves. However, a time will come when these innovative techniques will not be sufficient anymore to keep operating costs low as the mineral resources are going to run out. For Barrick Gold it will be necessary to find other mineral resources in other countries far from North America.
This is not just a problem for Barrick Gold. It is a problem for the entire mining industry. A solution will be increasing the number of assets, through acquisitions, in continents such as Africa and Oceania. For example, Papua New Guinea, where Harmony Gold (HMY, Financial) is engaged in exploration activities to find new mineral deposits, is one of the most prolific regions of Oceania with regard to gold and copper deposits. However, the process that will see the biggest gold producers transition from American operations to African and Oceanian operations is low and will take several years because mining in these countries is not without problems and risks. At the beginning the risks and costs associated with mining will be high due to the political instability of these countries, the existence of corruption at governmental levels, phenomena of illegal mining activities, diseases, strikes, civil wars and many other economic and social issues.
Goldcorp Inc. (GG, Financial), another big gold producer, is facing issues with its gold production. The Canadian miner is forecasting a 20% increase in its production as part of its strategy to enhance the net asset value and to create value for its shareholders. However, this process is low, and it is going to take several years to be accomplished. For 2017 Goldcorp expects to produce 2.5 million ounces of gold and aims to increase this level to 3 million ounces. This target likely will not be achieved before 2022.
Newmont Mining Corp. (NEM, Financial), the largest gold producer in the U.S., is working on several gold projects to add more ounces to the future gold production. Some of these projects already started commercial production in 2016, and others will start to produce commercial gold in 2017 and 2018. However, its production of 4.5 million to 5.4 million ounces of gold will stay stable at this level and therefore is not expected to increase at least until 2022.
Kinross Gold Corp. (KGC, Financial), one of the partners of Franco-Nevada, doesn’t want to count its chickens before they hatch and gives an outlook for gold production of 2.5 million to 2.7 million ounces of gold equivalent that doesn’t go beyond 2017.
Thus, without clear signs of growth in the future gold production, the next Franco-Nevada strategy to preserve its revenue is looking for more bargains in the oil and gas industry after last year’s deal when the company purchased oil and gas royalty assets in the U.S. for a total consideration of $100 million.
As of today, approximately 95% of Franco-Nevada's revenue comes from precious metals, with gold being the leading revenue source and only 5% of it comes from oil and gas.
According to the company’s CEO, Franco-Nevada can diversify its portfolio of activities to the extent that the oil and gas segment will represent about 20% of the company’s entire business. Harquail wishes to get to that level as soon as possible.
Franco-Nevada’s next strategy may require a sizable amount of funds at the company’s disposal to be invested in the oil and gas industry. An amount will be disclosed by the company with the next financial report to be released March 22.
However, as of the third quarter the company had $277.6 million in cash on hand and securities that can be readily converted into cash. In addition, the company can raise funds needed to enhance the quality of its asset base from a line of unsecured credit of $1 billion with maturity in November 2020. The gold royalty and streaming company generates free cash flow of approximately $250 million every year. A stake of 62% to 63% of the annual free cash flow is used by the company to distribute dividends to its shareholders and the rest can be fully invested in the business to finance the organic growth since the company is debt free. The company pays a quarterly dividend of 22 cents to its shareholders. The dividend yield is 1.39%.
Franco-Nevada closed at $61.24 Thursday, down $3.94 (or 6.04%) from the previous close. A volume of 1,051,176 shares were traded on the New York Stock Exchange. This compares to an average of 767,060 shares traded over the last 10 trading days and an average of 790,453 shares traded over the last three months.
Franco-Nevada has a market capitalization of $10.92 billion and 178.25 million shares outstanding.
Analysts recommend holding this stock, and the average price target is $70.15 per share, which represents an 11% upside from the current share price. The price ranges between a low of $60 per share and a high of $80 per share.
The stock is trading at 2.61 times its book value and 23.32 times its EBITDA. The price-sales (P/S) ratio is 18.97 and the forward price-earnings (P/E) ratio is 68.81.
Franco-Nevada, a leader in the industry of gold royalty and streaming companies thanks to its large portfolio of assets situated in the Americas, Africa, Southeast Europe and Australia.
During the last quarter of 2016, First Eagle Investment (Trades, Portfolio) increased its position in Franco-Nevada by 0.13%.
Disclosure: I don't have any position in any stock mentioned in this article.
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