VANCOUVER — It’s hard to find a better value-builder over the past decade than Franco-Nevada (TSX: FNV; NYSE: FNV), which essentially pioneered the royalty-stream finance model in its previous incarnation and has seen its share price rocket 362% over the past seven years to trade at one of the premier multiples in the gold space.
Since an initial public offering in December 2007 — which valued the company at $15 per share — Franco-Nevada has outperformed both gold and other gold equities, and closed near a 52-week high of $69.71 at press time.
President and CEO David Harquail’s keynote speech at the Association for Mineral Exploration BC (AME BC’S) annual Roundup conference reflected on his career and the current state of mine finance, gold prices and exploration prospects.
Harquail began with a retrospective on his 30-odd years in the business, including an anecdote about growing up when his father worked with renowned mine-finder Thayer Lindsley at the Ventures group. Harquail would cut his teeth in a similar project evaluation role with the prolific Pierre Lassonde and Seymour Schulich, and make his way through a number of iterations of Franco before finding himself at the helm of the company.
“What strikes me is that going back to that time in the 1980s I don’t think a lot has changed in the business. The distribution of mining outcomes is about the same as it has always been,” Harquail said. “Around one in twenty projects provide good returns. I think the biggest factor in determining the outcome of projects is just more sampling and drilling of the orebodies. It requires a lot of money upfront, but investors need to be cognizant of how much it does affect the outcome.”
He said that, historically, large companies like Falconbridge and Noranda understood the need for “low-quartile cost assets with long mine lives,” since the industry so often “gets the timing wrong” on commodity cycles.
The idea hinges on the fact that longer mine lives allow miners to take advantage of at least “a couple” of strong commodity cycles to produce decent financial returns. Harquail said that during the bull market of the 2000s, a lot of that “wisdom” was lost, leading to a string of poor project-development decisions, which in turn eroded investor confidence.
He argues that a lot of those poor decisions were driven by the rise of corporate governance, wherein boards of directors and management became “over-sensitive” to the demands of investors with short-term financial goals.
During the height of the commodity cycle in the mid-2000s, management teams emphasized maximized commodity leverage, net present values and production growth. That value system led to the rise of large-tonnage mega mines, which carry heightened geopolitical and developmental risk.
Fast-forward to 2015, and industry financiers are looking down the barrel of a potential long-term downturn, and demanding companies maximize cash flow returns to investors while limiting spending.
“It’s the same as the 1999–2001 downturn. The companies are doing the same things in terms of limiting brownfield exploration, high-grading mines and deferring any new development,” Harquail said. “What’s going to happen is that investors will wake up in a couple years when companies can no longer defer any capital expenditures, and ask: ‘Why weren’t you keeping development options open? What happened to the growth?’”
He added that “I’m passionate about this business and these companies, and it hurts to watch the wheels fall off because the boards are just too sensitive in trying to respond to what investors wanted. The other problem is that commodity producers have lost any control on commodity prices. I’m afraid this ‘casino market’ of commodity trading is here to stay, and that we all need to be prepared for harder and faster commodity price swings than ever before.”
And the crisis in investor confidence has led to a rise in alternate investment vehicles that provide exposure to metals without necessarily carrying the same degree of risk. Franco and peer Silver Wheaton (TSX: SLW; NYSE: SLW) have led the charge in this respect, loudly proclaiming “we don’t explore and we don’t build mines.”
Harquail noted that, based on market capitalization, investment in the gold sector is now 25% to 30% in exchange-traded funds, 10% royalty and streaming, and 60% in gold production equities.
There aren’t many companies as active in the mine finance game as Franco, which invested US$900 million last year. The company was involved in a number of major deals, including: Lundin Mining’s (TSX: LUN; US-OTC: LUNCF) purchase of the Candelaria copper mine in Chile; funding of True Gold Mining’s (TSXV: TGM; US-OTC: RVREF) Karma gold mine development in Burkina Faso; and a gold purchase and royalty agreement with Klondex Mines (TSX: KDX; US-OTC: KLNDF) at the Fire Creek and Midas properties in Nevada.
“My belief in exploration has been shaken. Honestly, if we decided to all retire today I don’t know if the market would even notice,” Harquail said. “The physical market is really a miniature influence on the gold price. The highest multiples now are not the great explorers, but on royalty and streaming companies. The market seems to have concluded that the new discoveries are not being rewarded for the dollars being invested.”
“If you make a big productivity breakthrough and discover a mining camp, there will be unlimited capital for that innovation,” he said.
“But if we just keep doing the same old thing, the market won’t finance it anymore because they’ve seen the financial outcome. Franco has tried to make exploration our business, but we can’t figure out a way to make money investing in grassroots exploration. We expose ourselves to the best exploration optionality knowing that one out of twenty will be fantastic.”