NEW YORK (
, a gold royalty company recently listed on the
New York Stock Exchange
, is making a strong argument to claim the title of "the safest gold stock."
Gold stocks are notoriously risky, subject to geopolitical risks, rising input costs and production snafus. Enter royalty companies. They give cash upfront to miners who need to fund operations in return for, on average, 2% of the gold produced over the life of the mine. Or the company pays the miner a fixed amount for a portion of its gold, typically at cost, which at today's prices would be about $800 an ounce. Then the royalty company can turn around and sell the gold for market value, currently $1,830 an ounce.
"Once we buy a royalty ... we don't have to spend another dollar after that," says CEO David Harquail, "so we don't have the same issues as an operating company that has to spend money building and operating mines." Harquail says the company wants to avoid the typical mining risks like inflation, which it does with the exception of a handful of profit royalties where Franco Nevada gets a portion the gold miner's profits rather than gold.
, which has a neutral rating on the stock, wrote in a recent note that inflation will continue to infect miners, "which will continue to spark interest in Franco Nevada's business model which has minimal exposure to rising costs."
With 41 producing assets, 23 advanced assets and 145 exploration projects Harquail argues that the company is well insulated from any big production miss. "On average, the good things that have happened on the properties more than outbalanced any disappointments," says Harquail, "so our luxury is we have a much broader portfolio."
To further sweeten the pot, if miners find more gold in their deposits, Franco Nevada makes more money. The company announced during its second quarter results that
has started expanding its Tasiat project with the potential to deliver 1.5 million ounces a year. According to Franco Nevada, at just $1,500 gold prices, its 2% share would translate into $45 million annually.
The biggest risk is actually total market panic or total calm. The more royalties Franco Nevada adds, the less risk there is, which is great when the gold price is high and other gold stocks are killed by volatility. However, when markets are calmer and investors are feeling better about taking on risk, Franco Nevada doesn't provide the sex appeal other miners like
"We're kind of in between a gold ETF and a gold mining company," says Harquail and that strategy for 2011 has paid off. The
SPDR Gold Shares
is up 32.8%, the
Market Vectors Gold Miners
, a basket of large cap miners, is up 9.15% while Franco Nevada, which went public in Canada in 2007, soared 36%.
The company, which has $335 million in cash as of the second quarter, said revenue grew 112% year-over-year and increased revenue guidance for 2011. Franco Nevada has raised its dividend 60% this year and will continue to do once investment opportunities dry up.
Ninety percent of second quarter revenue came from precious metals (68% gold and 22% from the platinum group), 8% from oil and 2% from other asses. Harquail is looking at diversifying into base metals, specifically iron ore and copper, as the next growth opportunity.
has a buy rating on the stock due to its low risk exposure in a risk averse market and its strong organic growth profile.
Bank of America Merrill Lynch
, which has a neutral rating on FNV, raised its full year estimates after second quarter results but says there are risks, namely commodity price weakness and mine operating problems that might delay royalty payments or stop them altogether especially if governments in South America and Africa consider nationalizing gold mines, as some have started to do.
Investors will have to pay up for the stock, which trades at 29.66 times estimated 2012 P/E, well above its peers, but most analysts think it's worth it. Shares have 6 buy ratings and 5 holds with an average price target of $48.94. In an environment where investors are scared and looking for safety, analysts think that Franco Nevada can offer upside with that safety net.
Written by Alix Steel in
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