I am mostly in the gold business. The gold price turned down five years ago before the other commodities. Gold is now showing some signs of life and this could be a good barometer for what is to come for the rest of the commodities.
My company, Franco-Nevada, is not a mining company. We don’t run any mines and don't do exploration. We avoid M&A, financial engineering or leverage as we see those more as reallocat-ions of value. The real wealth comes from the ground. Finding ore is the fundamental driver of wealth creation in the resource business.
Exploration takes perseverance and any one property has long odds of success. We have made a business from exploration by taking a large portfolio approach. We own only a small underlying royalty interest, or a small share of the production, from as many geologically prospective properties as possible.
We acquire these interests from land owners, prospectors, junior explorers and operators. If we leave the exploration and mine development to the companies that are already highly motivated to find more ore, we will then get lucky. With enough patience through multiple commodity cycles, the industry has the ingenuity to find and produce more ore. Sometimes spectacularly more.
The key for our business is land. We need to have a broad portfolio. Our royalty lands cover over 40,000 sq km, which is about the size of Switzerland. These lands have 47 producing mines, 40 advanced mining projects and 176 exploration projects. That’s over 260 properties, not including our oil and gas interests.
Financially, our Australian assets are small relative to our overall business. But our Australian royalty properties are on great belts and I have high hopes for our portfolio. For the Australian gold industry today, the headwinds of declining gold prices, capital and cost inflation and a strong Australian dollar have turned into tail winds. I believe there is an inevitable reawakening coming to the historic gold mining camps of Australia. It is not just the special situations of Northern Star, St Barbara or Doray Minerals, which get all the brokerage coverage. There will soon be stirrings from a deep sleep at the forgotten gold belts.
With royalties, our first dollar in is our last. Royalties are not subject to capital calls or cost inflation. If a project goes on care and maintenance, it means a deferral in our royalty revenues rather than any holding costs. The gold will not rust and will eventually be produced. If there is a problem at the mine, the royalty owner is the last person called. I can leave my cell phone off on weekends. Some of the journalists have called us the “Gucci shoe miners”. I will set the record straight. I have never owned any
When I was at Newmont, we were operating 23 different mines around the world. It felt as if we were always on the back foot. There seemed to be a new crisis every week. All these daily challenges were a big distraction for Newmont’s board and management. That created a huge opportunity cost. New opportunities that should have been acted on were deferred and lost.
For Franco-Nevada, our key lesson learned is to not let the day-to-day business distract us from the more important job of long term capital allocation. We are perfectly comfortable leaving all project decisions to the operators. Not being involved gives our board and management the luxury to focus on where we can best invest our cash flow. This strategy has allowed Franco-Nevada to build a very scalable business. We can run this portfolio with fewer than 30 people.
The evidence so far is that this royalty business model is working. Our ticker, “FNV”, has outperformed the benchmarks. Since 2007, the number of producing assets has doubled and revenues tripled. But G&A overhead costs have stayed the same, showing this is a scalable business. Dividends have been increased each year despite the downturn in the gold price. This is a high margin and robust business.
How much has the face of money changed for the mining industry? When I first started, mining was a sleepy business. Equity markets were dominated by retail investors and pension or endowment funds. On the debt side, project lending was the go-to activity for ambitious bankers. Both the equity and debt markets were reasonably responsible allocators of capital. They were supportive during the downturns and patient enough to see projects built.
In the 1980s there was increasing involvement by the mutual funds or unit trusts that specialized in the gold sector. It seemed to be a good idea to have specialist mining fund managers involved in capital allocation. But most of these specialized funds were open-ended. Their unit holders would flood new money in at the peak of commodity cycle only to ask for their money back at the bottom of the cycle. These were the ultimate buy high, sell low investors.
The gold industry was very accommodative to what investors wanted. Easier money came with the bull market, but mining boards felt more obliged to be responsive to shareholder pressure. In the last decade, I have seen four successive investment themes applied to the gold industry by investors: “ounces”, “maximise NPV”, “growth” and “maximise free cash flow”. None of these themes work well through the cycle and waste a lot of capital.
Mining has been around for millennia. There is a lot of wisdom with the old timers who knew mining would always be a highly cyclical
business. It was why the industry would use debt sparingly and be willing to accumulate capital in the good times. It was why mining companies focused on developing only low quartile cost projects with long lives. The industry veterans knew they could never time the commodity cycle. But if they managed their risks, they could manage their business to be around long enough to profit from the up-cycles. The mining industry lost its way when it started to cater to the wrong type of investors. Own your strategy and make it relevant to the investors that matter.
I am optimistic that the equity markets and mining industry are taking positive steps. The market is clearly differentiating those companies that clearly own their strategic plans. Companies such as Randgold, Agnico Eagle and the royalty companies are trading at twice the sector multiples. The mining industry is also reducing debt. A highly cyclical business is leverage in its own right. Putting financial leverage on top of cyclical leverage makes it even more risky. The investors that matter have put a much higher valuation on companies that have done a better job with their balance sheets.
Franco-Nevada is fighting to be a relevant investment choice to the large generalist funds, the Fidelitys and BlackRocks that count their assets in the trillions. None of them need to own mining stocks. But I see more and more of them taking a long view on the commodities.
Ten years ago, if a large generalist fund wanted exposure to gold, it had to buy the equity of one of the gold mining companies. Today, our biggest competition is not gold operating companies, it is the gold ETF products. These are capitalized at about $60bn, or 50% of the entire equity value of all the gold operating companies put together. In silver, the value of the ETFs dominate over the value of all the equity of silver mining companies put together.
The large generalist funds are looking for good stories to own in the mining sector. So we present our investment case in a manner that they can understand best. Franco-Nevada is not a passive bullion bar sitting in a vault. We can provide alpha through more gold being found on our properties and yield by paying dividends. When we need to get across the idea of our company in a New York minute, we simply say “Franco-Nevada is a gold ETF on steroids.”
For me, it is a huge privilege and pleasure to have interests in so many interesting mining projects around the world, especially if I don’t have to run them. We would like to be involved in more mines. Franco-Nevada today has no net debt and over $1.2bn in available capital for further investments. My hope is that Franco-Nevada’s recent success is an indication that, for the mining industry, the big freeze is coming to an end and the ice is breaking.
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