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Franco-Nevada Rides on Oil & Gas as Candelaria Grades Drop

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On Oct 8, we issued an updated research report on Franco-Nevada Corporation FNV. Though lower grade at Candelaria mine will weigh on its gold production in 2018, it will be offset by strong performance in its Oil & Gas portfolio’s performance on the back of higher oil prices and increased production from the newly added U.S. assets.
Lower Grade at Candelaria to Drag Down 2018 Production
In November 2017, Lundin Mining Corp. (LUNMF - Free Report) announced an updated mine plan to address localized pit wall instability. While decreased grades were expected in 2018, the impact on gold and silver production was greater than anticipated. Consequently, Franco-Nevada revised its GEO production to 440,000-470,000 GEOs from mining assets in 2018 from the earlier mining asset guidance of 460,000-490,000 GEOs. Even though production is expected to recover in 2019, the processing of lower grade material at Candelaria is anticipated to continue for the remainder of 2018. The lower guidance is disappointing as the company’s top-line will not benefit from rising metal prices.
Momentum in Oil & Gas Portfolio to Aid 2018 Results
The second quarter was robust for Oil & Gas with revenues soaring 137% on stronger oil prices and increased production from the newly added U.S. assets. The company is beginning to realize embedded growth of these U.S. assets. Backed by better-than-expected contribution from its previously acquired U.S. assets and stronger oil prices, Franco-Nevada now projects generating $65-$75 million in revenues from oil & gas for 2018, higher than the previous expectation of $50-$60 million.
Cobre Panama: A Catalyst Despite Near Term Uncertainty
The company has so far invested $886 million of its $1 billion commitment for the Cobre Panama project. It plans to fund the balance by 2018-end. As of the second-quarter end, the project was 76% complete. Phased commissioning of the project is scheduled to commence in 2018. Cobre Panama is expected to contribute 25% of the company’s NAV and is a key catalyst. Until actual gold and silver starts coming in from the project, it is not clear how well the mine will produce. 
Strategic Relationship with Continental Resources: A Key Catalyst
In August 2018, Franco-Nevada announced that it has entered into a strategic relationship with Continental Resources, Inc. to acquire Oil & Gas mineral rights in the SCOOP and STACK plays of Oklahoma — two of the most economic and attractive plays in North America. Franco-Nevada will make an upfront payment of $220 million for the acquisition of existing mineral rights owned by a subsidiary of Continental. It has also committed, subject to satisfaction of agreed upon development thresholds, to spend up to $100 million per year over the next three years to acquire additional mineral rights through a newly-formed company.
This represents a new business development opportunity for Franco-Nevada. It gets an acquisition vehicle, which provides the ability to acquire assets at the grassroots level or directly from individual owners. This is a segment of the market previously inaccessible to Franco-Nevada due to a lack of staff or resources to carry out these smaller-scale acquisitions. More importantly, Franco-Nevada benefits from the operator's drill plans, along with their knowledge of local land title and geology.
Poised Well for the Long Term
Franco-Nevada strives to generate 80% of revenues from precious metals over long-term horizon which includes gold, silver and PGM. With around 86% of revenues earned from precious metals in the first half of 2018, the company has the flexibility to consider diversification opportunities outside of the precious metals’ space and increase exposure to other commodities while maintaining its long-term target.
Further, Franco-Nevada appears to be on a promising long-term trajectory thanks to a healthy portfolio of streaming and royalty agreements put in place years ago. With more mines coming online in the next several years, it will benefit from higher levels of precious metals sales as well as higher prices. The company maintains solid growth outlook till 2022, forecasting production in the range of 565,000-595,000 GEOs. Furthermore, Franco-Nevada’s balance sheet remains debt free.
Shares of the company have lost 20% in the past year, compared with the industry’s decline of 24%.
Franco-Nevada currently carries a Zacks Rank #3 (Hold).
Stocks to Consider
Some better-ranked stocks in the same sector include KMG Chemicals, Inc. KMG and CF Industries Holdings, Inc. CF. While KMG Chemicals sports a Zacks Rank #1 (Strong Buy), CF Industries carries a Zacks Rank #2 (Buy).
KMG Chemicals has a long-term earnings growth rate of 28.5%. The company’s shares have surged 39% over the past year.
CF Industries Holdings has a long-term earnings growth rate of 6%. Its shares have gained 61% in the past year.
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