Minor Upgrade Franco-Nevada Corp.’s two new iron ore royalty investments have “materially positive merits” despite coming at near-peak prices for the metal, according to RBC Dominion Securities analyst Josh Wolfson.
In conjunction with its April 19 annual analyst day, the Toronto-based royalty and stream company disclosed a US$538-million Vale iron-ore focused royalty debenture and a $93-million equity investment in Labrador Iron Ore Royalty Corp.
“FNV has timed the announcement of its purchase with sharply higher iron ore prices,” said Mr. Wolfson. “Nonetheless, we do not view future lower iron ore prices as an item that will overshadow forecast returns of these transactions. Benchmark iron ore prices today are an elevated approximately $175 per ton and more than 100 per cent above their 5-year trailing average prices; nonetheless, at RBC’s long-term iron ore price of $72 per ton, we calculate a 9-per-cent IRR [internal rate of return on the Vale investment and 8 per cent after-tax cash yield near-term in upcoming years. We highlight that production guidance for Vale includes more than 60-per-cent volume growth which is expected to counterbalance expected steep commodity price declines from today, resulting in more stable expected gold-equivalent production longer-term (although by individual year this could vary). At LIF, FNV reports that it has already recovered 95 per cent of its investment via dividends and shares have appreciated 160 per cent, easily justifying this investment in our view.
“Iron ore will become a material component of FNV’s underlying production, and we forecast the company will be near its maximum threshold of non-precious metals production of 20 per cent. We expect this will limit non-precious metals transaction investment opportunities and skew future investments towards gold, silver, and PGM’s.”
Following the deals, Mr. Wolfson thinks Franco-Nevada’s asset base “remains highly diversified and liquidity is favourable.”
Keeping a “sector perform” recommendation for its shares, he increased his target to US$135 from US$130. The average on the Street is currently US$169.99.
“When assessing FNV’s valuation, the company benefits from receiving a premium valuation to the precious metals royalty group, while maintaining a larger proportion of non-gold and silver royalty assets,” said Mr. Wolfson. “Post-closing in 2Q, we forecast FNV will maintain total liquidity of $1.2-billion. On a go-forward basis at spot gold, we calculate FNV will generate $1.07-billion in total annual FCF (or $840-million net of $230-million in dividends). When assessing FNV’s valuation, the company has managed to retain its relative premium to precious metals royalty peers, even though new investments have predominantly focused on non-precious metals assets. FNV’s ability to benefit from higher non-gold and silver exposure, absent an effect on its valuation has been a meaningful benefit to the company, its growth, and its cost of capital. We do not see multiple contraction due to non-precious metals exposure as a realistic risk today (assuming management adheres to its 80-per-cent exposure limit), but we acknowledge when specific commodity prices diverge, FNV’s more diverse commodity exposure has been a focus point.”