Franco-Nevada Corporation (FNV) Q3 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. My name is Ryan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Franco-Nevada Corporation third quarter results conference call. [Operator Instructions] I would now like to turn our call over to the Manager of Investor Relations of Franco-Nevada, Stefan Axell. You may begin.

Thank you, Ryan. Good morning, everyone. We are pleased that you have joined us for the Franco-Nevada Q3 2013 Financial Results Conference Call. Accompanying our call is the presentation, which is available on our website at franco-nevada.com where you'll also find our MD&A and financial results. On the line, we have Sandip Rana, our CFO, who will review our Q3 2013 results; and David Harquail, President and CEO, who will discuss our 2 recent transactions. In addition, we have several members of our management team to answer any questions during the Q&A period. Before we begin formal remarks regarding our Q3 2013 results, we would like to remind participants that some of today's commentary may contain forward-looking information. As such, we refer you to our cautionary -- detailed cautionary note on Slide 2 of the presentation. I'll now turn the call over to Sandip Rana, CFO of Franco-Nevada.

Thank you, Stefan. Good morning, everyone. As you all have seen from the press release issued yesterday, the company reported financial results for the quarter and 9 months ended September 30, 2013, which had lower revenues and net income compared to the same periods in 2012. However, when one considers the continued volatility in commodity prices, in particular gold and platinum prices, as well as the negative sentiment towards the mining sector as a whole, management believes that the results continue to showcase the strength of the Franco-Nevada business model and the quality and diversity of the assets within the portfolio. From an operational standpoint, our royalty and stream assets continue to perform well. We believe this is clearly evident through the number of gold equivalent ounces earned by the company in third quarter. As you turn to Slide 3, you will see the key financial results for the company. Overall revenue of $98.8 million was lower than third quarter 2012 of $105.2 million. This reduction is predominantly attributable to the continued pullback in gold price as the average gold price was $327 per ounce less in Q3 2013 versus Q3 2012 and also significantly lower than the first half of the year. Within our portfolio, our net profit interest royalties are most affected by movements in commodity prices due to the leveraged nature of these assets. With the continued retreat in gold prices, our NPIs did not deliver significant gold equivalent ounces to the company during third quarter. At Goldstrike, with the lower gold price, continued capital spend and lower production on our claims at the mine, the company did not report a net profit interest for third quarter. This, combined with the lower NSR, resulted in an $11.4 million reduction in revenue for Goldstrike when compared to third quarter 2012. In addition, the company recorded a minimal accrual for the Musselwhite and Hemlo NPIs in the quarter. But if we exclude gold equivalent ounces associated with our NPIs for third quarter 2013 and for the prior year, gold equivalent ounces actually increased by over 12% as our other NSR royalties and stream assets continued to perform well. Detour continues to ramp up, and it's delivering more ounces each month. The operator, Detour Gold, is forecasting gold production of approximately 270,000 ounces for 2013. Duketon is benefiting from a full year production from its Garden Well mine, and its Rosemont mine is also beginning to ramp up. The operator, Regis Resources, expects Rosemont to produce 48,000 to 53,000 ounces for its 2014 financial year. As well, our Subika royalty and our MWS stream had very strong quarters and contributed both higher production and revenue to the company. Our Palmarejo stream also had a strong quarter for the company, delivering 14,000 stream gold ounces. But due to the lower gold price, revenue was lower year-over-year. With respect to the PGM assets, they generated $12.7 million in revenue in third quarter compared to $15.8 million a year ago. This decrease is a combination of lower platinum prices and lower production from our Sudbury assets partially offset by higher palladium prices. Our other mineral assets also performed well, with an increase in revenue in the quarter mainly attributable to the Peculiar Knob iron ore royalty. Oil & gas revenue more than doubled to $22.3 million for fourth -- for third quarter 2013. This significant increase is attributable to increased oil production volumes to our portfolio as a result of the Weyburn acquisitions made in 2012 as well as stronger oil prices realized in Q3 2013. Our net income and net income per share for the quarter were lower than the prior year due to the reduction in revenue but also due to a decline in finance income and slightly higher depletion. Looking at our non-IFRS measures, the company earned adjusted EBITDA of $80.3 million or $0.55 per share for the quarter. On an adjusted net income basis, the company earned $35.3 million or $0.24 per share compared to $45.3 million or $0.31 per share a year ago. As mentioned, the main contributor for the reduction in both of these measures is due to the lower revenue. Our margin continues to be strong at 81.3% for the quarter, illustrating the strength of our business model and its ability to generate cash flow. As part of the company's 2013 guidance, we provided guidance based upon gold equivalent ounces for our mineral assets. For third quarter 2013, the company earned 57,452 gold equivalent ounces, which compares to 58,330 gold equivalent ounces in third quarter 2012. The decrease year-over-year is mainly due to the reduction in NPI royalty GEOs, which, as mentioned, have been impacted by the lower gold price. One of the key advantages of our business model is scalability. Our costs have increased over the last few years, as can be seen on Slide 4. However, when you look further and break out the costs into those that are fixed and those that are variable, one can see that the fixed costs, which is basically our G&A, have remained relatively stable over the last 5 years. The variable costs, being costs of stream ounces, production taxes and oil & gas working interest costs, have increased, particularly as we do more stream transactions. But having this variable cost increase is not necessarily a negative as higher stream costs imply that we have been delivered more stream gold ounces, and higher production taxes imply that we are earning more revenue in Nevada. Both are positive. The fixed portion, being the corporate administration costs, continue to be less than 5% of revenue. As you turn to Slide 5, the geographic revenue profile continues to be lower risk with 83% of revenue being from North America and Australia, with Canada being the largest contributor. The Rest of World portion has increased as more royalties are generating revenue in Africa. The latest, Subika, began generating revenue to the company in the latter half of 2012. 74% of our revenues is from precious metals as our oil & gas revenue has increased with the addition of Weyburn NRI and the stronger oil prices realized. Also, please note that the diversification by asset is also expanding with revenue being sourced from more and more properties, resulting in the company being less economically dependent on certain royalties as it once was. The company now benefits from 44 revenue-generating mineral assets. Slide 6 provides a reconciliation of adjusted net income earned in Q3 2012 to adjusted net income generated in Q3 2013. The key movements include lower taxes, which is a reflection of the jurisdiction where taxable income is generated offset by a reduction in revenue due to the pullback in commodity prices; a reduction in finance income; and slightly higher depletion due to the composition of the assets generating revenue. The end result is a decrease in adjusted net income from $45.3 million or $0.31 per share to $35.3 million or $0.24 per share in Q3 2013. As you will recall, we did provide guidance for 2013 of 215,000 to 235,000 gold equivalent ounces from our mineral assets and oil & gas revenue between $55 million and $65 million for the year. The gold equivalent ounces were determined using prices of $1,600 per ounce gold, $1,600 per ounce platinum and $725 ounce palladium. The oil price assumed was $90 per barrel. Based upon the continued pullback in mineral commodity prices, management has reviewed its gold equivalent ounce guidance using prices of $1,350 gold, $1,400 per ounce platinum and $725 per ounce palladium for the remainder of the year. At this time, we continue to maintain our guidance of 215,000 to 235,000 gold equivalent ounces from our mineral assets, but due to the stronger oil prices, we expect to exceed $65 million in oil & gas revenue for the year. And now I will pass the call over to David Harquail, our CEO, who will provide a review of the recent [indiscernible].

Thank you, Sandip. It was another consistent and good quarter for Franco-Nevada. Today, I am going to fill in for Paul Brink who normally provides the updates on our business development activity. He's traveling today. On Slide 8 is the math of our original Kirkland Lake land holdings in Ontario. As you can see, we know this camp very well. Our preexisting royalties cover over 30 kilometers of strike length of the Larder Lake Break on what was operated by Queenston Mining. Osisko Mining is now the operator of these lands. This map hasn't been updated for our new deal with Kirkland Lake Gold, but what that deal will give us is royalties in all of the area that you can see on the left as labeled the $24 million-ounce Kirkland Main Break. For students of gold mining history, this break not only includes the currently producing Macassa Mine, but also the legendary Lakeshore, Wright Hargreaves and Teck-Hughes mines. In the 1930s, these mines made Sir Harry Oakes one of the richest men in the British Commonwealth. We've been impressed by the new discoveries found next to Macassa. We are hopeful that even more can eventually be found next some of the historic great mines. And Franco-Nevada style, we are taking a very long-term view on this asset. On Slide 9 is some detail on the package of royalties that we picked up from Barrick. None of them on their own is material. We expect this package to pay for itself from what we see already, while giving us exposure to 20 different opportunities covering over 2,000 square kilometers in Canada, the U.S., Australia, Peru and Brasilia -- I'm sorry, Brazil. If you know our track record, on average, we historically seemed to realize something exceptional from 1 out of 20 assets. This acquisition is consistent with Franco-Nevada style of making a business, building our long-term exploration optionality. On Slide 10 is an update of our available capital. And as you can see, we remain very liquid with no debt, and Franco-Nevada has the most net cash of any precious metal company. Our working capital has been building faster than we are spending it. Paul Brink and his business development team have been very active. My observation is that there has been a state of denial by many participants in the gold mining industry that is now coming to an end. I'm confident we'll be booking more comparable business by year end and potentially more material business soon. With that, as Stefan mentioned, we have a good part of the management team here. And with the operator's help, we'd be happy to take any of your questions.

[Operator Instructions] We have a question online from Cosmos Chiu from CIBC.

Maybe if I can touch on a few things here, maybe first on Goldstrike. We've seen kind of Barrick talk about cost-cutting at the different operations. Do you expect this to have a positive impact on your NPI in Q4, or maybe in that -- from that perspective, to expect some kind of NPI contribution in Q4?

Based upon our forecast, we do think that there potentially could be an NPI pay out in Q4, but it's all dependent on their capital spent. As you said, they have been cutting back costs. But there's -- as you know, there's a lot of factors that play into it, whether they mine on our claims, how they spend capital and then just operating costs in general. But right now, we are forecasting an NPI in Q4.

Yes. So maybe just a little bit?

Yes.

And then in terms of the Barrick portfolio that you purchased, acquired during the quarter, it sounds like a nice little package that you've acquired. Do you have knowledge -- maybe David, are there any other nice little packages out there hiding in other companies? And would you just consider this like an area of growth opportunities?

Cosmos, you're absolutely right. This is -- there's actually lots of packages actually being marketed right now. I think everybody's been going through their portfolio, seeing what are the sort of noncore assets within their companies. We're active on a couple of opportunities right now. That's why I expressed my confidence we'll probably be booking more business before year end on these types of things. But most of them, you have to characterize as odd lots. They really won't be that material to our near-term cash flow projections, but it's exactly the type of stuff that we love. So we'll -- you'll be seeing in our reports now that we'll have over 230 mineral assets that takes our total asset counts up to close to 370 different assets. And I think that's one of our strengths. As we can continue to add asset, we'll just continue to get more lucky over time.

Okay. And maybe if I can switch gears a little bit, in terms of touching on your acquisition of the Kirkland Lake royalty, I might be mistaken, David, but I've always thought Franco was never a big fan of buyback options. Did you just make an exception for this royalty here given the upside that you see? Or how should we look at things going forward?

You're absolutely right. We like to keep all the options in hand, but we still are -- there is still competition in providing financing for different opportunities. And what we did do is, at least on this option, we termed it out at just 3 years, so they have to be able to exercise that option within 3 years. So we're very hopeful that -- sorry?

Maintain as well.

Yes, we would maintain majority of the royalty regardless of the buyback. But we're just hopeful that the market won't be so generous, the gold prices won't come back so quickly that they're able to buy it back from us too quickly. But if they do so, at least we'll have gotten a great return for at least that portion of the investment.

Yes, for sure, yes. And then maybe on the -- touching on Palmarejo here, I guess reading through recent disclosure coming from Coeur, Dave, the company has really talked about the exploration in areas beyond the reach of Franco's royalty. David, are you concerned that the royalty at this asset here has reached what I would consider a high watermark in 2013 and indeed in 2012 and future revenue could be lower?

It's lower right now because of gold prices, but don't forget that we have a minimum commitment of at least 12,500 ounces per quarter. That's good for at least another 3-some years. And so we have some comfort and support from that as well as beyond that, there is still quite a number of potential zones on that main property. So remember, trucking to that mill, the more distant you get from that, the more challenges to economics. So I'm convinced that Guadalupe and La Patria, which are on our 30,000-plus acreage property there, will ultimately be mined. And so I think we're going to have a long-term tail. But do recall, when we gave guidance on Palmarejo, that 5 years out, we were expecting Palmarejo to be a smaller asset for our company. Just the nature -- we've had a tremendous performance there, but nothing great can last forever.

And maybe if I can ask one last question, going to the oil & gas royalties, strong quarter in the Q3, I know you've moved up your guidance for the full year to the -- beyond the upper end. But do you still think that's too conservative? Are you expecting kind of the same level in terms of production in Q4 versus Q3? Just I can't seem to work out the numbers given the -- even with the renewed guidance for 2013.

I'll let Geoff Waterman -- he runs our oil & gas assets, comment on that.

Cosmo, for Q4, we're exceeding the $65 million, I think we're on-site there. The strong Q3 we had was a function of pricing, and we saw the price differential between the U.S. and Canadian grades really narrow. And that was a function of our refinery utilization and drawdowns down in the States. Well, starting towards the end of -- we're starting in October, we started to see some inventory buildup. So we're starting to see that widen, and of course, we're seeing the prices come down. We've got WTI now down around, I think, it's $96 per barrel. So that's going to have an impact on keeping our expectations just over that $65 million mark.

Yes. It's good that you brought up the differentials, Geoff. So I guess in the quarter, it was about $4 a barrel if I'm not mistaken. You've always talked about $8 per barrel in the past. So should we just keep that at the -- for my sort of modeling purpose, should I keep at the $8 per barrel kind of differential?

Yes, I keep it at $8.

Your next question comes from the line of David Haughton from BMO.

Yes. Sandip and David, so just following on from that premium differential, is it just a short-term thing? Or can you see further erosion of that $8 dollar per barrel differential? Because this year, it not only was going to be $8 per barrel, but there is also going to be a further discount, at least in the way that we'd heard it described in the last analyst presentation. So should we just think about this as a short-term item?

Yes, David, this day, the last quarter, that's a short-term narrowing. We still see it running at $8 barrel for the year. In fact, right now, it's currently just over $8. But I maybe -- just it's clear -- my -- make sure I'm clear is I think there has been some improvement on the quality of our product because just incorporated in LNG plants, that's injecting better-quality materials. So we are getting a partial quality improvement, are we not, Geoff?

We're getting slightly, but it's not really material. What we're doing there is the NGL plant started production towards the end of June. It's producing butanes right now. We're blending that butane with the sales oil, gives us a slightly better price. We're talking maybe under $1 a barrel.

Okay. Also, just over the last couple of weeks, S&P came out with their view that the stream should be debt. What's your view on the implication of that for the royalty players, David, and also the implications it might have for your future deal flow?

It's not the big deal for us, David, because if you look at our portfolio, we've got 232 mining assets. Of them, only 6 of them are streams. And if you look at the majority of our deals this year, they've all been royalty deals. I think the streaming structure, I think, is really beneficial when there's a big tax implication for the operator. I'd tell you right now, taxes is not a big concern for a lot of operating companies. And so we would much rather prefer to do our royalty deal on assets where we can register very securely on title to the property. That's our preference in that direction. It's where we need to be competitive. We're keeping that as an option in our string of activities so we can go for some of the other opportunities out there. But it's only a very small part of our business. I think it's -- well, for most of the operators, when they're looking at streaming, they're going to be -- even if they're looking at it as another debt competent, streaming is going to look very attractive because it's still got covenants that are a lot more friendly to operators in terms of that we're sharing a production risk, we're sharing a commodity risk, we're not -- we don't have a short-term fixation as debt does. And so that's attractive to a lot of the CFOs. So on the margin, maybe it makes the difference, but I don't think it makes -- has any real impact on our business development activities.

All right. And just moving on to Cobre Panama, no payments in the third quarter from what we can see. Do you have expectations of any payments or contributions during the fourth quarter?

Yes, we have a contract there. I think what's happening is First Quantum is still finalizing their plan. And we've asked them to have a look at what the new plan is before we go forward, like we like to understand essentially what are the changes to the project, et cetera. We've had good communications with First Quantum, and what we want to do is really have the new projects which are promising sometime this quarter reviewed. We had one of our representatives on-site about 4 weeks ago, so they're still doing a lot of earth works on the property. In our mind, they seem to be clearly committed and going forward. But they are still fine-tuning what the development plan is. So once the development plan comes public, I think we'll be able to be more -- much more granular in when we're going to be making our cash contributions to this project.

Okay. And just setting the current scene, there's quite a number of major assets for sale. I know that one of the areas that you had seen as potential for growth is that a royalty or a stream could help close the gap between what the vendor and the bidder might be prepared to pay or accept for an asset. Is that still something that you're working on? Can you see participation in those kind of deals in this current environment?

Absolutely. It's a big opportunity for us. Right now, David, there is no shortage of things to work on, and I'm confident we'll be booking, as I said in my remarks, more business this year and into next.

Okay. And with the Barrick royalties, it seems a fairly odd transaction, relatively small for Barrick and also, frankly, for you in this environment. How did that come about?

Actually, David, if you know us, this is actually our bread and butter. We're buying small royalties all the time. It's just generally that we don't put press releases on smaller transactions, but we're always looking to buy land exposure on good mineral trends. If you -- if we -- if you remember, when we came public in 2007, we had a 176 mineral royalties. Our count is now over 230, and that's net of some royalties that we've written off or have been dropped or handed back to the local governments. So it's part of the business. It's just -- I think the only thing that -- which is not surprising that the, I guess, the financial community will focus on is just more material assets that have near-term cash flow benefit to the company. But this has been part of our regular business that usually doesn't get a profile. We're just recording it on our quarterly because it is at least a $20 million deal, so we think it's worth mentioning. But that's something we're doing all the time. We -- you can almost look at it as our exploration division or R&D division. And so it's going to be an ongoing aspect of our business but definitely not material at this time.

Your next question comes from the line of John Doody from Gold Stock Analyst.

A couple of easy questions. The shelf registration that you recently filed for $1 billion, this is -- can you want to comment on that at all?

John, it actually replaced one that we had put up, I guess, was 18 months or was it...

[indiscernible]

September of 2000. So exactly the same terms, so sort of a standard thing to just keep our options open, especially if there's an opportunity to do a bigger deal at some point. But all it did was replace the one we already had. We never touched the previous shelf perspectives we had there for you -- sorry there. We used a small portion on something. That's -- so it just keeps our flexibility open. Just like we have a $500 million revolver, we haven't touched this new revolver since we put it in place. We just want to have that flexibility for opportunities that might come down the road.

Okay. There have been some rumors around that you might be looking at a big deal. Would -- could anything -- and you talked about the plethora of deals out there now. Could anything be big enough that you would be looking at to need to tap that to shelf?

We just -- we have to keep our options open, John. I really can't comment about what we might do in near term. It's we're active on both big and little deals. So you heard in the last question, people are worried about us doing too many little deals. We're trying to keep a balance in terms of how we're putting our portfolio together. But right now, I think we feel -- I feel we have what we need right now to do what's immediately in front of us.

Okay, great. On to Cobre, are there any hints about any significant changes that -- or are you just fairly much in the dark until the new plan is released next quarter? Or this quarter, I guess now.

No, it's just -- I guess the -- well the -- as I mentioned, as -- it seems to be consistent with everything that First Quantum is saying publicly, that they're committed to go forward the project. We've seen that with the earth work activities that are at the site. They've absolutely moved to doing the EPCM in-house, so it's been quite a change in the number of contractors at the project. And they're looking at a lot of changes that -- at the site itself. And I know that they've talked to their shareholders about relocating the plant site, reorienting the power plant, and those decisions are still ongoing, from what they've said publicly. So I can only comment to what the public statements are. It's in assets that we're very much committed to, and we're looking forward to making our commitments on this project.

Okay, great. And last question is, what are the public reporting thresholds now for the size deals that you might do? At what dollar amount does it get released?

It's somewhat discretionary. I think right now, the management discretionary authority now with the board is $30 million, so maybe we'll look at that. I always have an argument with our VP of Finance on what's material or not because I love to talk about our little deals, but I'm being told a lot of these aren't just material enough to put in our disclosure. So, John, I'd love to share with you everything that we're doing on these smaller transactions. But what we don't want to do is confuse the market as well in terms of the quantity of these deals and what's material to the company. So materiality, I'd say right now, we just I guess put in our quarterly a $20 million number, but we didn't put a separate press release on it. I'd say with Kirkland Lake deal that we just announced, again, we waited to our quarterly to put out our own release. So I would say $50 million is probably -- and above would be where we put a separate press release on a transaction, which is just a little south of 1% of our market cap. Anything below that really can't justify a separate press release.

[Operator Instructions] Your next question comes from Robert Reynolds from Crédit Suisse.

My question relates to Peculiar Knob. I just wanted to get -- can you provide some clarity on what the expected mine license for that asset?

That's an iron ore project that we have in South Australia. It's just started production, a very complicated formula that's tied to an index price that determines the percentage. There is actually a number of different deposit that are being developed there. Not all of them are on a royalty ground. So I think this one -- it's -- I'd say it's a probably relatively short life. I'm just trying to do it from memory, but I think it's something like -- 4, 5 years to 6 years would be sort of the life that we're modeling in our models right now. It could be longer, but I'd assume a 5- or 6-year life on this one.

And is that asset fully ramped up? Or could we expect further increases in revenue assuming iron ore prices stay consistent with Q3 levels?

I think we're modeling about the same, is it for next year? So consider it fully ramped up. There were some delays in 2012 when they were getting their shipping arrangements in place at the port. But I'm not that close enough to it, but I'd say it's running at steady state now.

Your next question comes from Carey MacRury from TD Securities.

Just had a question on Sudbury PGM stream. The revenue bounced back pretty well this quarter versus last quarter, and I'm just wondering what the outlook for that looks like going forward? I know a number of mines have been closing there.

Yes, so as you know, Podolsky was put on care maintenance earlier this year, and they're focusing on the nickel ores at McCreedy. But we're confident and look forward to further improvements at Levack Morrison as they move -- bring to the mine. And now they have access to the Craig shaft. So we are expecting improvements going forward 2014 onward from that deposit.

We have no further questions online. I would now like to turn our call back over to Axell. You may begin.

Thank you, Ryan. I want to remind investors that our full year 2013 results are expected to be released on March 19, 2014. We're also planning an analyst day presentation for the following day, at which time we will provide 2014 and 5-year outlook as well as an updated version of our Asset Handbook. Thank you for joining us today and for your continued interest in Franco-Nevada.

This concludes today's conference call. You may now disconnect.