Franco-Nevada Corporation (FNV) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to Franco-Nevada Third Quarter 2012 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Stefan Axell, Manager of Investor Relations. Please go ahead.

Thank you, Steve. Good morning, everyone. We are pleased that you have joined us today for the Franco-Nevada Q3 2012 financial results overview, as well as a discussion on the recent Weyburn net royalty interest acquisition. Accompanying our call today is a presentation which is available on our website at franco-nevada.com, where you will also find our full MD&A and financial results. On the line, we have David Harquail, President and CEO; as well as Sandip Rana, our CFO, who will discuss our Q3 2012 results; and Geoff Waterman, our COO, who will discuss the Weyburn NRI transaction. In addition, we have most of our management team to answer any questions during the Q&A period. Before we begin formal remarks regarding our Q3 results and our Weyburn transaction, we would like to remind participants that some of today's commentary may contain forward-looking information. In this respect, we refer you to our detailed cautionary note regarding forward-looking statements on Slide 2 of our presentation. I will now turn the call over to Sandip Rana, our CFO, to discuss Q3 results.

Thank you, Stefan. Good morning, everyone. Thank you for taking the time to join us on our call to discuss the company's financial results for the 3 and 9 months ended September 30, 2012. With respect to our financial results, as you all have seen from the press release issued yesterday after the market closed, the company had another solid quarter. Our overall royalty and stream operations continued to perform well. The company again surpassed the $100 million mark in revenue for the quarter. Revenue was lower at $105.2 million for third quarter 2012 when compared to $113.3 million for third quarter 2011. But overall production or attributable gold ounces to Franco-Nevada from our royalty and stream properties was not significantly different from our expectations for the quarter and for the 9 months ended September 30, 2012. On a year-to-date basis, revenue was $312.9 million compared to $292.7 million a year ago, a 6.9% increase. With respect to pricing, average commodity prices were generally lower in the quarter, with the average gold price being $1,655 per ounce compared to $1,700 per ounce in third quarter of 2011, a decrease of 2.6%. However, for the 9 months ended September 30, 2012, the average gold price was higher by 8% at $1,652 per ounce compared to $1,530 per ounce for the 9 months September 30, 2011. The decrease in average gold prices in the quarter, along with lower stream ounces delivered, led to a decrease in gold revenue in the quarter. Gold revenue of $79.9 million was lower by 8.2% for the quarter ended September 30, 2012, compared to prior year. As mentioned, the company received less stream ounces, partly due to the absence of a minimum ounce requirement from Ezulwini, which is not in place in 2012. However, this lower stream…

Thank you, Sandip. Please turn to Slide 11. Yesterday, Franco-Nevada announced that it entered into a purchase and sale agreement to acquire an 11.7% net royalty interest in the Weyburn unit for CAD 400 million, with a closing date on or about November 30. For clarification, a net royalty interest is similar to a mineral net profit interests, as royalty payments are net of operating and capital costs. We like the Weyburn unit. Franco acquired its initial interest in the Weyburn unit in 1995. A 1.15% working interest was added earlier this year, and this net royalty will add to Franco's 2.26% working interest and 0.44% overriding royalty interest. The Weyburn unit is located 129 kilometers southeast of Regina, Saskatchewan and encompasses approximately 53,000 acres. The unit was formed in 1963 and is the third largest conventional oil pool in the Western Canadian sedimentary basin. The Weyburn unit is operated by a proven and experienced operator, Cenovus Energy. The current production is 26,000 barrels per day. And as noted in Cenovus' 2011 AIF, investment in undeveloped reserves is projected to continue for well over 40 years. Please turn to Slide 12. As previously stated, we like the Weyburn unit. This net royalty increases Franco's interest in one of the largest conventional oil pools in Canada and will provide immediate cash flow from a proven operation. Historically, the margins on the net royalty have ranged between 40% and 50%. This net royalty will add approximately 1,400 net margin barrels per day to Franco's current 2,100 barrels of oil equivalent production per day. Net margin barrels are the barrels equivalent to the net royalty received after all operating and capital cost deductions based on the price received per Weyburn unit production. The Weyburn unit produces medium sour crude between 28- and 32-degree API with approximately 2% sulfur. We expect that this will approximately double revenues from the oil and gas portfolio and have an even larger impact in the oil and gas portfolio's EBITDA, as revenues from this royalty are equivalent to EBITDA. This net royalty will add significantly to the proven and probable oil and gas reserves and extend the reserve life from 12 to 18 years. The cost of these additional reserves is CAD 16.53 per barrel. Going forward, Franco expects Weyburn unit production to increase annually, peaking in 2020 at around 30,000 barrels per day. Under the current Enhanced Oil Recovery program, the Weyburn unit is expected to be in production until 2050. However, there is opportunity for increasing recoveries beyond that expected from the current Enhanced Oil Recovery program. An expansion of this oil recovery program, would shift peak oil production out beyond 2020. And production from the Weyburn unit would continue past 2050. The Weyburn unit is a world-class asset with long life reserves, and Franco believes that the addition of this net royalty interest will be the right balance to Franco's portfolio. I'd now like to turn the call over to David Harquail. David?

Thank you, Geoff. Just for some historical perspective, Geoff Waterman was with us in the original Franco-Nevada back in '95 when we bought our first interest in Weyburn. He has been ably managing our oil and gas interests ever since and is now our Chief Operating Officer. We have a lot of continuity with the Weyburn assets, and that's why I'm so confident in this investment. Our Oil & Gas division is probably one of the least appreciated strengths of Franco-Nevada. Some analysts on Franco had been applying low multiples on our oil and gas assets, typical of traditional oil and gas working interests that deplete very quickly. However, royalties on unitized, long-duration assets, which Geoff has just described, are worth substantially more. Oil and Gas has been a very good business for Franco-Nevada, and we're delighted to have this opportunity to add to one of our favorite assets. We will highlight the strengths of our Oil & Gas division in our next Investors Day. Now that we've effectively doubled our Oil & Gas division, and assuming we do nothing else, we expect our precious metals revenues for the near term be closer to 80% of overall revenues. That assumes current commodity prices. As our Detour, Subika and ultimately, Cobre Panama, and gold revenues begin generating, we expect to see growth in the precious metals percentage of overall revenues. We are looking at further acquisitions, and our focus is now back towards new precious metal opportunities. On Slide 14, there's an update of our available capital for more acquisitions. We still have over $1 billion in available capital. We have what we need. You can also see that we have not levered our balance sheet and have substantial additional credit capacity. We believe Franco-Nevada can be regarded as an investment-grade credit. Finally, we are just approaching the fifth anniversary of the IPO of the current Franco-Nevada. In those 5 years, we've announced 5 dividend -- successive dividend increases and have almost quadrupled the value of the share price. I regularly get challenged that a 1.3% yield is too low. We like to remind investors about that capital appreciation and the value of their shares, which has impacted the yield. We also like to point out to anyone who bought us at the IPO is now getting close to a 5% yield on their cost base. This is very good for gold investments. We're very happy that many of those IPO investors are still with us and are profiting with us. Last night in the U.S., watching the Obama win, they were chanting, "4 more years." Here at Franco, I will have our management team chant, "5 more years." And we're just delighted that's been a -- it's a great ride, and we expect more to come. So with that, all of the management team that's here, we would be very happy to take any of your questions.

[Operator Instructions] And your first question comes from the line of David Haughton from BMO.

With the Weyburn acquisition, my understanding is that although it closes at the end of November, it -- the royalty is effective from the 1st of October. Is that correct? So you get the full benefit in this quarter?

Yes. That's correct, David.

And previously, you had a revenue guidance of $430 million to $460 million. Are you prepared to give us a guide now that Weyburn is in the mix?

David, Sandip here. We still anticipate that overall 2012 revenue will be at the low end of its previously provided guidance range, which is the $430 million to $460 million.

Okay. Even with the contribution of Weyburn.

Yes.

Okie dokie. And I heard your conversation about the firepower and where you're positioning. But do you see that there's scope for more non-gold acquisitions? And if more oil and gas opportunities came your way, how would you feel about that?

David, it's -- we've always guided the Street that we see ourselves primarily as a gold-focused royalty and stream company. We feel that if we went below 80%, cause concern to a good part of our investor base. So we're not completely ruling out other deals. But we would have to demonstrate to the marketplace that we can quickly get above 80%. So right now, our focus is on other investment deals. I'd rather -- precious metal deals. My preference is to build up our percentages like we did before. And then when we -- as we get overweighted the precious metals, then be more opportunistic on the oil and gas deals. But if we see another non-precious deal that looks really good, I'll just have to have Paul Brink work doubly hard to get that precious metals revenues up as well.

Paul -- I'm sure that Paul would love to do that hard work.

He's working hard. Unfortunately, he's not here with us today, but I can get to speak to it. But I think the best thing for us right now is to do another precious metals deal. That would give us more capacity on the non-precious.

And that also speaks to one another point. I know that you've got a diversified portfolio, some 45 or so, producing mineral assets. But Palmarejo still represents, at this stage, 20% of your revenue mix. Do you feel comfortable or uncomfortable with such a large exposure to a single asset?

Well, obviously, we do try to diversify and add additional assets. With Palmarejo, we are fortunate that we have this annual minimum in place at a minimum of 50,000 ounces per year, which should go on for another 4 years. So as our other properties, the Detour and the Cobre Panama, has come onstream, the percentage will decrease for Palmarejo.

And David, the other thing to remember too is on a stream, they tend to be -- we report them on a gross basis. So on EBITDA basis, the proportion of our EBITDA from Palmarejo is smaller. We do have to pay that $400 an ounce.

[Operator Instructions] And your next question comes from the line of Cosmos Chiu with CIBC.

Got a few questions here. Maybe the first question is for Geoff. Can you walk me through, I guess, at Weyburn? It's got to be a medium-grade, slightly sour oil. I think in the past, it's always been -- the price realized will be at a discount to WTI. Is that still holding true? And how should we look at it?

Yes, Cosmo. There is a quality differential because of the grade of the oil and the sulfur content. Our benchmark is actually the Edmonton Light posting because the fact that it's Canadian oilfield. And it's currently running -- our average this year is about $8 a barrel. And if you look historically, WTI and the Edmonton Light posting, when you factor in foreign exchange, pretty well equal. Earlier this year, we had a differential between the Edmonton Light and WTI. But currently, Edmonton Light is -- let's see, it's about $4 above WTI.

Okay. And Geoff, the $8 per barrel, that's a discount.

Yes. That the quality differentials because of the lower grade of the oil and the sulfur content.

And that reflects like the past 5 years' average.

And then just want to confirm, Weyburn is pretty much 100% oil, right?

It is 100% oil.

Okay. And what's that tax treatment behind from Franco's perspective on its acquisition? Is that one of those structures where taxes will be lower in the first few years until your $400 million acquisition cost has been recovered?

No. So the taxes it's considered cost fees. So we'll get a 10% declining balance tax deduction each year. So we could -- we will be taking a deduction in 2012 a 10% of the acquisition price.

Okay. So it's a 10% kind of straight-line depreciation.

Declining balance.

Okay. And then maybe moving on to the quarter here. The Subika number that we saw in the Q3, is that for the full quarter sort of? Or is it -- when did they kind of come in terms of -- at the royalty?

It came in partway through the quarter, but we actually haven't gotten all the full detail on it yet. So that's something we'll be able to guide better on. But we just don't know how much of the quarter it represented. We only have a royalty on part of the Ahafo property of Newmont. So we'll chase up those details. We only got that sort of late in the quarter.

Okay. And then, David, I don't know if you can comment on the South African situation here. I know both MWS and Ezulwini have been impacted. My understanding is that maybe the labor situation in MWS is a little bit better on a relative basis. I don't know if that's true. And in terms of Ezulwini, the 30-day shutdown, was that in Q3? Or is that going to go into Q4? And I guess, overall, we know there will be impact in Q4. But to the best of your knowledge, is it -- how much longer could it be impacting your royalty?

The more significant one is Mine Waste. And we were talking to them just a couple weeks ago, and they already had 2 of the 3 lines back up. So I haven't had a confirmation on the third line, but we knew it was back to at least 2/3. They haven't yet gone any of the higher-grade dumps on the Anglo side, which is where our royalty now applies to as well. So we're still mining from the lower-grade First Uranium dump. So actually, we're actually quite optimistic on that asset. It seems to be in strong hands with Anglo. There's still some upside to perform. And we're not too worried to extent that it was impacted temporarily with the labor interruptions. Ezulwini is a different story. They're taking a longer-term shutdown. I think Gold One management team is having a hard look at that operation, combined with the labor issues. I think part of the negotiating position is they're taking an additional 30-day hiatus, which will impact mostly in our fourth quarter. And I think there's a reasonable chance they might extend it longer because there is this ongoing negotiation. Gold One has had a especially problematic challenge, not so much at their Cooke operations but at another operation in South Africa. And so I think they're trying to send the right messages to the overall labor union. Nice aspect about this one is that we have a very long-term tenure on this property. We feel very secure about it. We're not as concerned about the near term, but it could have an impact in our fourth quarter numbers. But it's not a big number for us at this stage. Last year, we had the benefit of a minimum guarantee royalty. We always knew they were never going to be close to the minimum this year. We've always budgeted a much smaller number. It's a bit disappointing, but it's not that material an asset for us right now.

Your next question comes from the line of Greg Barnes of TD Securities.

Geoff, to make this simple, do we just take the net margin barrels of 1,400 per day, I guess, it is, multiply that by oil price minus the discount?

Yes.

That would give us the revenue net to Franco.

Correct, before tax.

So Greg, in a way, we're trying to do with oil and gas what we've done with our royalty asset where we talked about royalty equivalent units. And so we're going to keep expanding that because we actually want to get out of the commodity forecasting business, which -- because we're, I think, one of the few companies that guides on revenues. And we want to start guiding on barrels or royalty equivalent units of ounces, so that we can be or maybe even more accurate in terms of the guidance to provide the Street.

Okay. Just one sort of a question. You have some warrants coming due next year, I believe. It should bulk up the balance sheet cash wise, too.

Yes. So they're due, I believe, June of next year. And yes, tag price is just over $64 a share.

Canadian.

Canadian, yes.

And how many?

$4.5 million roughly.

Your next question comes from the line of Paolo Lostritto from National Bank Financial.

In the past, we've used the decline rate on the Weyburn oilfield of about 5%. Now that this represents a larger portion of your revenue, I just wanted to get kind of what your thinking is on the decline rate from that field.

So going forward, as we look at our production forecast for the unit, we see it increasing due to the implementation of the balance of the current EOR program, Enhance Oil Recovery program. And as I said in my presentation, we're expecting production to increase through 2020 to approximately 30,000 barrels a day for the unit. And thereafter, without any further Enhanced Oil Recovery program in place, we would see declines running at 3% to 5%.

Your next question comes from the line of Brian MacArthur from UBS.

I just want to go back a little bit to what Greg was asking. You have the price. You have a discount. And obviously we have operating costs and royalties, whatever, we have to take off. But then, given this increasing production, does the capital change over time as well? Or can we assume that sort of linear historically? I'm just trying to figure out whether that's going to have a negative impact on the downside.

With respect to capital, I guess you could equate it to as our production is increasing, that's due to the capital that's being deployed on the balance of the Enhanced Oil Recovery program. So you could go on and say, that's a model that are linearly. And then once that recovery program -- once the capital has been fully deployed there, we'd see a significant drop-off in the capital to be expended on the project. Of course, if we -- if the unit goes in to a second phase EOR program, then we'll see additional capital going towards that.

So Brian, the easy way I look it as a layman is that it's actually been a pretty steady capital contribution all the way through. Each time they decide to do another program, they just sort of tag it on to the expiry of that first capital program. So right now, we have a capital program that takes us for the expansion to 2020. But actually, these start decreasing spending in the next few years. So we could see a substantial -- to decide, for instance, not to do another capital program, we'd actually see a substantial step-up on the cash flow from those assets. So it's an upside to us. Except, we would like to have this a long-term asset. So we wouldn't mind them actually reinvesting the cash flow. But we don't expect it to be any -- substantially any higher than what we're experiencing right now. We believe we're at peak capital expenditures on this project at this stage.

[indiscernible] So just to get it clear, all that I’d worried a bit is just an, let's say, an event you don't want to happen, have the oil price drop to 60 or 50. Your margins are compressed. But they probably wouldn't reinvest as fast, so you don't get caught on that sort of equation.

And that's exactly what's happened on this one. They never really had a cash call to the working interest partners on this. Because what they do is they do manage their capital programs. When times are tougher, they just slow down on the capital capacity [ph].

You're right. As I stated in my presentation, I've been involved with this since 1995 for this unit. Our initial interest was a 1.1% working interest. And in 17 years, given the ups and downs in oil prices, it's never been cash flow negative.

Great. And maybe just -- you made another interesting comment. I thought -- we talked about forecasting revenues in oil, keeping over 1% of revenue. And obviously, that whole revenue percentage is a little bit in how we account all the time between streams. Or in this case, the revenue is coming in out of EBITDA level as I understand it, not a 100% level. If you look at this asset, maybe you can't comment on this, what sort of percentage increase in, say, a long-term NAV basis, would this have been relative to where we were before? Because it looks pretty attractive even on a long-term basis, so the relative percentage might even go up if you see what I'm saying.

Brian, you're spot on. This is very accretive for us. We can buy oil and gas assets at much higher accretion numbers than we can, precious metal assets. So if you look at it from day 1, absolutely. It's just we don't have the same expiration optionality as we do with our gold assets, and we probably think gold prices maybe -- have even more potential longer term than oil prices. But NAV accretion, what is the percentage of our overall NAV? We've definitely even higher stepped up a proportion of oil and gas NAV with this transaction. We think we've gotten it at a terrific price. We think good things come to people when they're able to write checks.

I'm showing there are no further questions at this time. I'll turn it back to Mr. Axell.

Thank you, Steve. I want to remind investors that our full year 2012 results are expected to be released on March 19, 2013, with a conference call scheduled for the following morning. Thank you for joining us today and your continued interest in Franco-Nevada.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.