- I’ll compare current operating assets, future potential assets, valuations, costs, and cash flows for Barrick Gold and gold streaming company Franco Nevada.
- Gold royalty companies have a lean business model and the appeal of constant positive cash flows, no matter the price of gold, is on their side.
- Gold miners have a history that’s better to forget after terrible investments were made in 2012 when gold prices were high, but are you investing in the past or for the future?
Two days ago, I described gold royalty, or streaming, companies and how they have outperformed gold and gold miners in the past.
Today, I want to compare the largest gold royalty company, Franco Nevada Corporation (NYSE: FNV), with the largest gold miner, Barrick Gold Corporation (NYSE: ABX), to determine which is a better investment at this point in time, a gold miner or a gold royalty company.
The two companies’ market capitalizations are pretty close with $19 billion for ABX and $14 billion for FNV. I’ll compare their current operating assets, future potential projects, valuations, costs, and cash flows.
Asset Comparison & Future Potential
FNV has royalty streams from 46 metal mines and 61 oil and gas producing assets. Additionally, it owns streams in 41 advanced mineral projects and 172 exploration projects, alongside 19 exploration projects in oil and gas. If any of these exploration projects become actual mines, FNV is going to enjoy large royalty streams in the future.
We can easily say that FNV’s portfolio is well diversified globally and in regard to future production, i.e. their royalties aren’t questionable. By the way, FNV doesn’t have to invest anything in the development of these projects.
Figure 1: FNV’s asset portfolio. Source: FNV.
ABX is also well diversified with operations mainly in the Americas, Australia, and Papua New Guinea for gold, and Saudi Arabia, Zambia, and Chile for Copper.
Figure 2: ABX’s global gold operations. Source: ABX.
The exploration side is similar to FNV with many projects and lots of optionality.
Figure 3: ABX’s potential mining projects. Source: ABX.
On exploration and future potential, we can call it an equal match between these two companies.
Margins & Production
FNV is currently selling just short of $500,000 gold equivalent ounces per year while ABX is expected to sell $5.3 million gold equivalent ounces in 2017. Thus, ABX is selling 10 times more gold than FNV which is a very big difference.
If gold prices double, ABX’s revenue from gold would go from $6.87 billion to $13.7 billion while margins would significantly increase as the costs would mostly stay fixed. By deducting 30% from the additional revenue to cover taxes and royalties, ABX’s net income would increase from the current $2.3 billion by approximately $4 billion, to $6 billion, or around 200%.
In FNV’s case, revenue would also double and go to $1.3 billion, and net income would go form the current $141 million to around $600 million accounting for 25% income tax. The increase would be much higher in percentage, but I wonder if the market would value a company with $6 billion in net income the same as one with $600 million.
ABX’s net income in the last few years has been significantly skewed due to huge impairments as the price of gold fell from $1,800 to as low as $1,100 in 2016. Nevertheless, the company has been operating cash flow positive and current operating cash flows are $2.6 billion with a CAPEX of $1.3 billion which leaves the same amount as free cash flow (price to operating cash ratio is 7.3). ABX is currently using all of its free cash flow to pay down debt and to reach a debt level of $5 billion by 2018, down from $13 billion in 2014.
Figure 4: ABX’s targeted debt levels. Source: ABX.
A free cash flow of $1.3 billion gives a price to cash flow ratio of 14.61, while the price to operating cash flow is 7.5. Price to book value is 2, and price to earnings is around 8.3. The dividend is small at just 0.6%.
As for FNV, net operating cash is $490 million which gives a 28.57 price to operating cash ratio which is much higher than ABX’s. The price to earnings ratio is 99, while the dividend is better, but still not high at 1.14%. The price to book value is 3.2.
Figure 5: Valuation comparison. Source: Author’s calculations.
On the valuation side, all the metrics apart from debt are on ABX’s side. To justify the difference in valuation, the risk has to be significantly smaller for FNV. The risk for gold miners is measured by analyzing mining costs, or in FNV’s case, streaming costs.
ABX expects all-in sustaining mining costs to be around $750 per gold ounce, and cash cost to be around $525 per ounce. In general, the company expects to be cash flow profitable at gold prices of $1,000.
Figure 6: ABX’s mining costs. Source: ABX.
As for FNV, their cash costs are around $312 per ounce which makes FNV profitable at much lower gold prices given that it doesn’t have to invest in CAPEX. However, if gold prices are much lower in the future, many miners will temporarily shut down production and thus FNV won’t receive all of its expected royalties. Therefore, I wouldn’t say that FNV is much less risky than ABX.
I dare say that there is a bubble within gold royalty streaming companies. Their success in raising their dividend, constantly being cash flow profitable, and by avoiding the huge impairments that have plagued common miners clearly created a great appeal among investors. However, that appeal will probably significantly decrease as gold miners get their act together, as they have been doing lately by lowering debt and avoiding crazy acquisitions, and as gravity pulls valuations to a rational levels.
Therefore, if you like gold royalty companies, think twice about owning them even if the business model looks wonderful. Valuations is what determines long term returns, and they are clearly on the side of common gold miners at this point in time.