FRANCO NEVADA Corp Q2 FY2023 Earnings Call

Good morning, and welcome to Franco-Nevada Corporation's Second Quarter 2023 Results Conference Call and Webcast. This call is being recorded on August 9, 2023. I would now like to turn the conference over to your host, Candida Hayden, Senior Analyst, Investor Relations. Please go ahead.

Thank you, Toby. Good morning, everyone. Thank you for joining us today to discuss Franco-Nevada's second quarter 2023 results. Accompanying this call is a presentation, which is available on our website at franco-nevada.com where you will also find our full financial results. The presentation is also available to view on the webcast. During our call this morning, Paul Brink, President and CEO of Franco-Nevada, will provide introductory remarks; followed by Sandip Rana, Chief Financial Officer, who will provide a brief review of our results. This will be followed by a Q&A period. Our full executive team is available to answer any questions. Participants may submit questions by telephone or via the webcast. We would like to remind participants that some of today's commentary may contain forward-looking information, and we refer you to our detailed cautionary note on Slide 2 of this presentation. I will now turn over the call to Paul Brink, President and CEO.

Thanks, Candida. And good morning. For Q2, our core assets returned to normal production and deliveries at Cobre Panama and Antapaccay caught up from the disruptions in Q1. Revenue from our diversified assets was impacted by lower oil, gas, and iron ore prices compared to the relative highs in the prior year period. As a result, we expect total GEOs for the year to be at the low end of our guidance range. With the Cobre Panama CP 100 expansion physically complete, we started to see the benefit of higher throughput for the quarter and First Quantum expects to exit the year at the 100 million tonne per annum throughput rating. Following public consultation, the refreshed concession contract was signed by the government and First Quantum and is expected to be presented before the National Assembly during the current city. G Mining continues to do a tremendous job with the construction of the Tocantinzinho gold mine in Brazil. We've now funded $183 million of our total $250 million stream deposit and the project is on track for commercial production in the second half of 2024. The quarter saw first production from a couple of new mines, Argonaut's Magino mine in Ontario and Fortuna's mine in Cote d'Ivoire. Goldfields expects first production from Salares Norte in Chile before year-end. We added a number of royalty interests during the period. In Chile, we acquired a 2.64% gold royalty on Barrick's Pascua property. We also acquired a 1.5% NSR on Hawk Child’s Mining's Volcan Gold project and we increased our holding on Lundin Mining's Caserones copper mine. So we now own a total of 0.57% NSR on the mine. In Canada, we acquired an additional 1.5% NSR in Marathon’s Valentine Gold project and we now hold a total 3% NSR on the project. During the quarter, we entered an agreement to provide royalty financing to exploration stage companies in partnership with EMX Royalty Corp. We have great respect for EMX's team of on-the-ground geologists, and they'll be responsible for sourcing the transactions. We were active with community contributions over the three months. We contributed to Sibanye-Stillwater's community initiative in Montana and to the I-80 Fund, which supports small businesses in rural Northern Nevada. We also partnered with perpetual resources to build social capacity at the Stibnite Gold project. Franco-Nevada is debt free, is growing its cash balances and at the end of June, we had $2.3 billion in available capital. Our business development team is active. For many operators and developers, royalty and stream financing is currently the lowest cost of available capital with high rates, debt financing is expensive, and there's little depth in the market for new issue gold equity. With that, I'll hand the call over to Sandip.

Thank you, Paul. Good morning, everyone. Our diverse portfolio continued to generate strong cash flows and high margins during the second quarter of 2023. Antapaccay and Cobre Panama returned to normal operations and were key contributors to the strong financial performance in the quarter. As well, the remainder of our mining portfolio performed in line with our expectations. For the diversified assets, the retreat in iron ore and energy prices from 2022 did result in a reduction in diversified revenues and associated GEOs in the second quarter of 2023 compared to the prior year. On Slide 4, we highlight the gold equivalent ounces sold for the last five quarters. Overall, GEOs sold for the second quarter were 168,515, down from the second quarter of 2022. For the quarter, precious metal GEOs were 132,033, up slightly from the same quarter last year and up 19% from the first quarter of 2023. For the quarter, the largest contributors to precious metal GEOs were Antapaccay and Cobre Panama. At Antapaccay, GEOs delivered and sold were higher in the quarter compared to the prior year. Following the temporary suspension of operations and constrained logistics experienced in Q1 2023, operations returned to normalized levels in March resulting in significantly higher deliveries to Franco-Nevada with 19,683 GEOs sold in the quarter compared to just over 10,000 GEOs in Q2 2022. For Cobre Panama, operations ramped back up to full production following an interruption due to export restrictions in the first quarter. Together with the benefit of additional processing facilities related to the CP 100 expansion project, we received strong deliveries from Cobre Panama with 36,650 GEOs sold in the quarter. Marigold and Tasiast were also strong contributors during the quarter due to mine sequencing and higher grades and recoveries, respectively. A few assets which performed below expectation were Antamina, Guadalupe, and Stillwater. For Antamina, we had lower GEOs sold than the prior year as the operator was affected by a tropical cyclone that affected Peru's Northern region in March 2023. This also impacted production in April, which will affect our third quarter deliveries. At Guadalupe, the operator mined fewer ounces from lands covered by our stream resulting in lower GEOs delivered and sold. And at Stillwater, production was impacted by an incident that damaged shaft infrastructure in March 2023. This was remediated in April. However, the decrease in GEOs compared to prior years also reflects a less favorable PGM to gold conversion ratio. Q2 2023 saw continued volatility in commodity prices. Slide 5 shows the average commodity prices for Q2 2023 and the prior year. Precious metals did see an improvement year-over-year with gold, silver, and platinum averaging higher. However, palladium, iron ore, and energy prices were down significantly. A large component of diversified GEOs and revenue is energy. Production has remained strong and was 25% higher on a BOE basis during the quarter. However, as seen on Slide 6, the bar charts highlight the retreat in oil and gas prices year-over-year. WTI averaged $73.78 a barrel in the second quarter, down 32% versus the prior year. Natural gas averaged $2.32 per Mcf, down 69% versus the prior year. As a result, the sharp fall in energy prices impacted our GEOs sold generated by our energy assets, which were 28,683 for the quarter compared to 50,387 in Q2 2022. As you will recall, energy prices saw a sharp increase in 2021 and 2022 due to many factors with the largest being geopolitical tension. Slide 7 highlights our total revenue and adjusted EBITDA amounts for the three months ended June 30, 2023, and 2022. Revenue and adjusted EBITDA have decreased year-over-year. The decrease is the result of a lower contribution from diversified assets, partially offset by better performance from precious metals. The company recorded $329.9 million in revenue in the second quarter and $275.6 million in adjusted EBITDA, achieving a margin of 83.5%. As you turn to Slide 8, you'll see the key financial results for the company. As mentioned, GEOs and revenue were lower in the quarter compared to the prior year. On the cost side, we had an increase in the cost of sales, which was $47.1 million, compared to $45.5 million in Q2 2022. The largest component of this is the per ounce fixed cost we pay for stream ounces. We sold 102,785 stream ounces in the second quarter compared to 98,163 a year ago. Depletion increased to $75.1 million versus $69.6 million a year ago. Depletion is based on actual mining GEOs sold and barrels of oil equivalent received from energy assets as we received higher GEOs from Antapaccay and Cobre Panama, which are higher per ounce depletion assets. This resulted in a higher overall depletion expense. For the second quarter of 2023, adjusted net income was $182.9 million or $0.95 per share compared to $195.8 million or $1.02 per share in the prior year. Slide 9 highlights the continued diversification of the portfolio. As shown, 79% of our Q2 2023 revenue was generated by precious metals. This compares to 69% in Q2 2022. The geographic revenue profile has revenue being sourced 89% from the Americas. With respect to asset diversification, Cobre Panama was again our largest revenue generator at 22% of total revenue for the quarter, followed by Antapaccay and Candelaria. The last chart highlights our operator diversity. Our largest exposure to revenue being generated by any one operator is 22%, which is First Quantum who operates Cobre Panama. Slide 10 illustrates the strength of our business model to generate high margins. On the slide, you can see that the cost of sales has remained fairly consistent over the period shown. The amount of cost of sales will depend on the mix of royalty versus stream GEOs, including mining and energy. During the second quarter of 2023, the cash cost per GEO, which essentially is the cost of sales divided by gold equivalent ounces sold, was $280 per GEO. This compares to $238 per GEO in the second quarter of 2022. Corporate administration costs, including stock-based compensation, were less than 3% of revenue for the quarter. The total can fluctuate quarter-over-quarter but has tended to average approximately $8 million each quarter historically. In a rising commodity price environment, we expect to benefit fully as we do not expect our cost structure to change significantly. Slide 11 summarizes the financial resources available to the company when including our credit facility of $1 billion. Total available capital at June 30, 2023, is $2.3 billion. The company is debt-free. On Slide 12, we reiterate our guidance for the year based upon updated commodity prices, as highlighted on the slide and our expectations of production from our royal stream interest for the second half of the year. We are maintaining our guidance range for total GEOs sold of 640,000 to 700,000. However, we expect to be at the lower end of that range due to the conversion of non-gold revenue to GEOs based on our revised commodity prices. And now I'll pass it over to the operator as we are happy to answer any questions.

Your first question will be from Fahad Tariq at Credit Suisse. Please go ahead.

As you think about the diversified commodity prices, so iron ore, energy prices being lower. Does that in any way change what you're focusing on in your deal pipeline? I know in the past, you've talked about countercyclical investing. So I just wanted to kind of tie that in with how the commodity prices are moving?

Thank you. To be more specific, we aim to be opportunistic investors. Our primary focus remains on precious metals. However, when we invest in other commodities, we seek better entry points based on either lower current commodity prices or the potential for lower long-term prices when assessing the deal. Therefore, price weakness presents an opportunity.

Okay. And then just on the balance sheet, just given the strength of the balance sheet, $1.2 billion of cash undrawn revolver, can you just walk us through maybe how you're thinking about just the use of capital in the context of there aren't that many large deals out there? Just trying to think of how the balance sheet will be utilized?

Sure, it's Sandip here. Really, there's no change in strategy. Franco has always had a strong balance sheet, and we're happy having cash on the balance sheet. Obviously, dividend is important, but the number one priority is to deploy that capital to add assets. We know it's a cyclical business. There are times when our capital will be needed, and there are other times where we might not be as active. So we're happy accumulating cash on the balance sheet, but the second most important thing is the dividend, which we intend to raise as we have done in the past.

Next question will be from Josh Wolfson at RBC Capital Markets. Please go ahead.

Thanks. On the global minimum tax, with the draft legislation out in Canada, I'm wondering if there's been any further clarity on what the potential impact is and whether this is something that is expected to be affecting 2024 taxes paid?

Yes, Josh. No change. As we said last quarter, the estimate is 3% to 4% of our NAV based on GMT being implemented January 1, no changes.

Okay. And then just to confirm, that is consistent with, I guess, the initial interpretations of the legislation?

Yes. Correct.

Okay. And then speaking of countercyclical investing, that Fahad was asking, with the Pascua-Lama royalty purchase, it's obviously a reasonably well-known asset, but a sort of a larger dollar value, I guess, for an option style of royalty. I'm wondering if there's any additional views the company has on the potential there. Or if this is just sort of a tuck-in long-term option with no further interpretations at least based on what we've heard from Barrick over the last couple of years?

Josh, we believe one of our competitive advantages is the long-term nature of our portfolio, which allows us to invest in long-dated interests. Our experience shows that great endowments tend to be developed and improve over time. Pascua is definitely one of those promising undeveloped gold deposits. You are correct to consider it from a countercyclical perspective. We've encountered this before; a strong example is Duketon, where we acquired a royalty on an underground mine that had been abandoned, but it eventually grew into a successful operation. This is how we approach these situations. Pascua represents a type of deposit that will always attract operators willing to invest capital. It's located in a secure jurisdiction, and we believe it will be developed over time, making it a significant investment.

Great. Those are all my questions. Thank you.

Next question will be from Heiko Ihle at H.C. Wainright. Please go ahead. Heiko, please unmute your line.

Can you hear me now?

Yes, we can hear you.

Helpful. Sorry about that. Yes, I was on mute as you correctly identified. I personally thought interest rates would be topping out or potentially even leveling off by now. Clearly, that hasn't really happened. But I was curious with longer-term interest rate assumptions that you use in your models given your future funding commitments and things like the expansion of underlying streams and also for future acquisitions, please?

I think short, we're in a very fortunate position. We don't have any debt. So as rates go up, while many people are constrained, we're not. It really puts us in a position that I think we've got more latitude in our investments than many other people who are constrained by debt.

But I assume that with commitments that you have in the future, you have some sort of internal models that you used to place yourself against your competition, mill?

We have our models, but as we don't have debt, and typically, we don't carry debt as a long-term source of financing. When we've had it, we've paid it quickly. It doesn't factor heavily into our cost of capital.

Fair enough. I think we'll take this one off-line. And then also, can you provide some color on your plant depletion year-by-year through 2020? I saw you had the longer-term outlook in your presentation, just like a rough estimate by year?

I don't have those numbers in front of me. Heiko, we can take that off-line.

Perfect. For my last question, as we consider the rest of the year, which assets do you believe could create the largest gap between your projections and the actual outcomes? In other words, is there anything specific that analysts should pay close attention to?

I think we've reiterated our guidance. So the ranges that we had provided as part of our March guidance, I think we're comfortable that our core assets will achieve those targets. In which case, it results in us meeting our guidance levels in the second half of the year.

Fair enough. I appreciate it. I'll give you guys a call back later.

Thanks, Heiko.

Next question will be from Cosmos Chiu at CIBC. Please go ahead.

Great. Thanks, Paul, Sandip. Maybe my first question is on your guidance as well. Paul as you mentioned, you're now targeting the lower end of the guidance range. If you kind of answered my question, but I just want to confirm. If I just look at your precious metals guidance, you're actually tracking pretty well. So the fact that you're targeting for total GEOs, the lower end. Is that really just due to lower kind of diversified prices, energy prices, iron ore prices? Or is that too simplistic of a way to look at it?

No, Cosmos, you're essentially correct. When we provided our initial guidance, the iron ore price we used was higher than what it has averaged so far in 2023 and what we are using going forward, which is also true for energy prices. On the other hand, the gold price is higher than what we had in our original guidance. This creates a dual impact when converting the non-gold revenue to GEOs, which is essentially the reason for guiding to the lower end.

Perfect. And then in terms of some of the corporate developments here, you talked about in your MD&A, the partnership with EMX royalties. It's not new, but at least right now, I guess, you're putting a number to it, with joint acquisitions, not huge, $5.5 million on your end. But I guess my question is, what does each of the parties bring to the table? I kind of know the answer, but I just want to confirm. And could this lead to something that's bigger down the road? Or is this really the niche in terms of smaller earlier stage royalties, utilizing, say, the technical expertise of the EMX team?

We have a good understanding of the Cosmos team and appreciate their work. It’s in our business DNA to continue pursuing smaller royalties that hold value, but our main challenge lies in prioritizing how we allocate our time. Typically, our team focuses on larger transactions. A significant advantage of this collaboration is that the EMX team is specifically targeting these smaller transactions. We do incur some costs associated with the deal, but having our capital available allows the EMX team to engage parties with greater capital capacity. The key aspect is that the gold development sector, particularly early-stage exploration, faces capital constraints. We believe we can effectively invest in this area where capital is greatly needed.

That's good to hear. Maybe one last question, more asset-specific here. Antapacay, in the MD&A, you highlighted the exploration potential here at an undisclosed location. So about 10 kilometers away from Antapaccay. Could you maybe talk a bit more about that in terms of timing, in terms of upside potential and what we could expect?

So Cosmos, let me provide some background on that property. The first mine there was Tintaya, which was operated by BHP and is a scan deposit. The second mine, Antapacay, is a porphyry deposit located along the same trend as Tintaya, although the exact site is not disclosed. The total metal value is approximately three-fourths of what's in Antapacay, but the grades are slightly higher. Glencore has been considering this project for quite a while, evaluating various versions of underground and open-pit mining. They are currently focused on gaining social license from the local communities, and once that is secured, they intend to advance the project towards development. I can't provide a specific timeline for when it might start contributing, but you can think of it this way: by the time Antapacay reaches the end of its operations, there will be a replacement deposit in place, ensuring that production continues for an extended period.

Thanks, Paul, Sandip, and team. Clearly your pronunciation is much better.

Next question will be from Martin Pradier at Veritas Investment Research. Please go ahead.

Thank you. In terms of the volumes, I look at the value volumes that were down 11%, and I was expecting more. So the question is why and what is the expectation going forward?

Sorry, volumes related to which?

Vale in iron ore volumes.

Yes. So there were two components. One is Vale. The production is usually lower in the first half of the year versus the second half of the year. So we've always guided 45% of our deals will be in the first six months and 55 in the second six months. But there was lower production at the mines themselves. And then with the lower iron ore price, it resulted in lower revenue from Vale. And then when you convert to GEOs at a higher gold price, it results in lower GEOs. So there's...

No. I'm not talking GEOs. I'm talking simply if you take the iron ore number? That's lower. It's 11% lower. And my expectation is that they would produce more.

Yes. So the revenue number, it's our best estimate at this time, right? So we don't receive a number from Vale. We're making our best estimate. So it could be a case that we'll be making an adjustment in Q3 based upon what the actual numbers come out from Vale.

And what is the expectation going forward? Because that asset was supposed to grow, and it doesn't seem to be growing much.

Yes, they have faced production challenges that we hope will be resolved. However, there is a threshold in late 2024 or early 2025 when our royalty will begin. For Franco-Nevada, we do anticipate increased production from that royalty in the future, but it won't start until the end of 2024.

Okay. The tax rate was 13%, which is lower than I expected. What should I expect in terms of tax for the year?

So the rate was lower because it's a mix of where the income is earned because we had higher stream ounces from Cobre Panama and Antapaccay. Our Barbados subsidiary was a larger contribution to our net income, which has resulted in a lower tax rate, and we had lower energy revenue, which comes out of the U.S. and Canada. Going forward, we typically guide to about a 15% effective tax rate.

Okay, perfect. Thank you very much.

Next question will be from Tanya Jakusconek at Scotiabank. Please go ahead.

Good morning, everyone. Thank you so much for taking my questions. Just wanted to follow up on Pascua-Lama, if I could. Just wanted to know, does the royalty on the gold and copper cover all of Barrick's reserves and resources on the Chilean side?

Yes, Tanya, that's right. The royalty applies only to the Chilean side of the border, but it does cover all of the current resources on that side of the border. And in fact, there's an area of interest that is broader than Barrick's property position itself.

If I were to consider Barrick's reserves and resources and take 60% because I remember that about 60% of the asset is on the Chilean side compared to 40% on the Argentine side, would that be how you viewed it when you paid $75 million for it?

Yes, you would need to review Barrick's disclosure to assess the resources on the Chilean side. Our estimate was slightly higher than that, around 80%. Therefore, when evaluating our economics, we considered approximately 80% of the resources on the Chilean side.

Okay. That's helpful. On the M&A or transaction front, Paul, should we expect to see you pursue an energy or iron ore deal before a gold deal given the current prices?

Tanya, you know our preference is always to add more precious metal. But we always say we're open to all commodities. It's driven by good deposits. So you shouldn't be surprised if you see an iron ore or an oil and gas deal. You should expect that it would be on a great deposit.

Okay. Regarding the opportunities you're considering, are we still looking at that sub-$500 million range? I'm trying to clarify if we're in the range of 100 to 350. Is that the range I should have in mind for these?

Yes. Most of what we're looking at is a modest size. So you're accurate.

100 to 300 area?

Yes.

Okay. Perfect. And then, Sandip, maybe if I could come to you to just ask about the year. So you've given us guidance that 55% of the production, obviously, pricing has an impact on the GEOs in the second half of the year. Oil and gas or the energy division to be lower in the second half? Is there anything on the gold side? Is it evenly distributed? I know Cobre Panama is ramping up. I just don't know what the timing of your sales should I be thinking even distribution on the gold side?

At this stage, yes, Tanya, I'd expect Q3 and Q4 be pretty similar. Even if Cobre Panama ramps up with a stronger Q4, there's other assets that will do better in Q3 than Q4 is just we don't have the exact detail by quarter. So I'd say essentially, they will be similar.

Okay. That’s it for me. Thank you so much.

And your next question will be from Brian MacArthur at Raymond James. Please go ahead.

Good morning. And thank you for taking my questions. Just following up on Pascua. Can I ask whether the copper royalty came with the gold royalty? And I guess where I'm going with this is whether you paid very much for the copper royalties that setback of different individuals. And really, the question then is do you see something different at Pascua where we'd be getting copper going forward? Or was most of the bid price based on assuming on the 2.7% NSR gold?

Yes. Brian, the royalty that we bought was primarily based on the value in the gold, so the 2.7% NSR at today's gold prices the copper. The small copper royalty came attached to that. We did buy it through different sellers, but each royalty had gold and copper in it. So the copper was more a tag along. We don't see as much value in the copper royalty at this stage.

Great. That's what I thought. In the second part, you mentioned a sliding scale and indicated around $800, but there were some numbers associated with the property that seemed to be scaled quite aggressively. Can I assume that it's just 2.7% above $800 if the gold price increases significantly, and that the sliding scale pertains to the lower end? Or is there a mechanism where, as we reach certain higher prices, there is an additional benefit?

The sliding scale tops out at $800 an ounce. So at today's prices and anything above $800 an ounce, it's 2.7%. And we would obviously just get the benefit of the higher gold price in that scenario.

Great. Thanks very much.

Thank you. And at this time, we have no other questions registered. Please proceed with any closing remarks or Q&A on the web.

Thank you, Sylvie. There are no questions on the webcast. This concludes our second quarter 2022 results conference call and webcast. We expect to release our third quarter 2023 results after market close on November 8, with a conference call held the following morning. Thank you for your interest in Franco-Nevada.

Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines.