Franco-Nevada Corp (FNV) 2012 Q3 法說會逐字稿

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to Franco-Nevada third quarter 2012 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the conference over to Stefan Axell, Manager of Investor Relations.

Thank you, Steve. Good morning, everyone. We are pleased that you have joined us today for the Franco-Nevada Q3 2012 financial results overview, as well as a discussion on our recent Weyburn Net Royalty Interest acquisition.

Accompanying our call today is a presentation which is available on our website at Franco-Nevada.com, where you'll also find our full MD&A and financial results.

On the line we have David Harquail, President and CEO, as well as Sandip Rana, our CFO, who will discuss our Q3 2012 results, and Geoff Waterman, our COO, who will discuss the Weyburn NRI transaction.

In addition, we have most of our management team to answer any questions during the Q&A period.

Before we begin formal remarks regarding our Q3 results and our Weyburn transaction, we would like to remind participants that some of today's commentary may contain forward-looking information. In this respect, we refer you to our detailed cautionary note regarding forward-looking statements, on slide 2 of our presentation.

I will now turn the call over to Sandip Rana, our CFO, to discuss Q3 results.

Thank you, Stefan. Good morning, everyone. Thank you for taking the time to join us on our call to discuss the company's financial results for the 3 and 9 months ended September 30th, 2012.

With respect to our financial results, as you will seen from the press release issued yesterday after market close, the company had another solid quarter. Our overall royalty and stream operations continue to perform well. The company again surpassed the $100 million mark in revenue for the quarter. Revenue was lower at $105.2 million for third quarter of 2012, when compared to $113.3 million for third quarter of 2011. But overall production of attributable gold ounces to Franco-Nevada from our royalty and stream properties was not significantly different from our expectations for the quarter and for the 9 months ended September 30th, 2012. On a year-to-date basis, revenue was $312.9 million, compared to $292.7 million a year ago, a 6.9% increase.

With respect to pricing, average commodity prices were generally lower in the quarter, with the average gold price being $1,655 per ounce, compared to $1,700 per ounce in third quarter of 2011, a decrease of 2.6%. However, for the 9 months ended September 30th, 2012, the average gold price was higher by 8%, at $1,652 per ounce, compared to $1,530 per ounce for the 9 months ended September 30th, 2011. The decrease in average gold prices in the quarter, along with lower stream ounces delivered, led to a decrease in gold revenue in the quarter. Gold revenue of $79.9 million was lower by 8.2% for the quarter ended September 30th, 2012, compared to prior year.

As mentioned, the company received less stream ounces partly due to the absence of a minimum ounce requirement from Ezulwini, which is not in place in 2012. However, this lower stream revenue was partially offset by higher revenues from other properties such as Timmins West, Subika, and Edikan, all of which are acquisitions made by the company, as well as organic growth from our portfolio of assets, such as the Musselwhite NPI, Hemlo NPI, and Tasiast, as they all began generating revenue.

PGM revenues have decreased from $16.5 million in third quarter of 2011, to $15.8 million in third quarter of 2012. The decrease is due to lower average platinum and palladium prices. With respect to the pricing, platinum averaged $1,500 per ounce, down 15.3% from $1,771 per ounce in third quarter of 2011, and palladium prices averaging $1,613 ounce, down 18.7%.

From a production standpoint, the company did receive an increased number of ounces from our Sudbury operations. However, as we receive gold equivalent ounces from our Sudbury assets, the lower PGM prices do have an impact on the number of gold ounces the company does receive.

For the 9 months ended September 30th, 2012, total revenue was $312.9 million, compared to $292.7 million a year ago, a 6.9% increase. The increase is due to a combination of the higher average gold prices for the 9 months, increased production from certain properties, such as Gold Quarry, Bald Mountain, and Golden Highway, as well as the organic growth mentioned with Musselwhite, Hemlo, as well as Duketon.

For the third quarter of 2012, net income was $52 million, or $0.36 per share, compared to $44.1 million, or $0.35 per share in 2011. Although revenue was lower quarter-over-quarter, the company benefitted from lower cost of sales, lower depletion, and the reporting of the mark-to-market adjustment on [investments held], resulting in higher overall net income.

For the 9 months ended September 30th, 2012, net income was $135.7 million, or $0.95 per share, compared to $98.6 million, or $0.80 per share in 2011, a 19% increase.

The company does use certain non-IFRS measures, which management believes provide a better measure of performance.

For the 3 months ended September 30th, 2012, adjusted EBITDA was $86.2 million, or $0.59 per share, compared to $92.3 million, or $0.73 per share in the third quarter of 2011. The reduction in adjusted EBITDA is a result of the lower revenue realized in the quarter. On an adjusted net income basis, it was $45.3 million for the 3 months ended September 30th, 2012, or $0.31 per share, compared to $39.8 million, or $0.31 per share in the prior year.

As the company has 45 revenue-generating royalties and streams, the impact of production fluctuations at royalty and stream properties are not as significant as they once were. The company is much more diversified.

Turning to slide 5, we illustrate revenue by commodity growth of the portfolio. As can be seen from the chart, revenue in all categories, gold, PGM, and other, have seen growth over the last 4 years, with gold revenue showing the largest overall increase. In Q1 2009, gold revenue was approximately $20 million. For third quarter of 2012, gold revenue is approximately $80 million, an increase of 300% during this period. When combining gold revenue with PGM revenue, precious metals revenue comprise 91% of total revenue for the third quarter of 2012, which is consistent with Q3 2011 and Q2 2012.

As you can see on the chart, there are some fluctuations in results for certain quarters, but this is due to timing of when certain NPIs and minimums are recognized for accounting purposes.

Turning to slide 6, you can see that the company's achieved annual revenue growth each year, with significant increases in 2010, and 2011. For the 9 months ended September 30th, 2012, revenue has again shown growth, increasing by 6.9% compared to 9 months ended September 30th, 2011.

One of the key advantages that we like to stress in our business model is scalability. Our costs have increased over the last few years, as you can see on slide 7. The increase is due to the addition of streams to our business, in particular the Palmarejo, Sudbury Base, and MWS streams. In general, you have to pay the $400 per ounce for each ounce of gold delivered, which after a period time is adjusted for an inflation factor. This has led to the increase in cost of sales line item. However, the increase is far outweighed by the increase in revenue. And even more impressive is how corporate administration costs have remained fairly constant. Corporate administration costs continue to be less than 5% of revenue.

As you turn to slide 8, the geographic revenue profile continues to be lower risk, with 81% of revenue being from North America, with Canada being the largest contributor. The other portion has increased with the additions of MWS, Ezulwini, and Edikan, and the [start of] the Tasiast and Subika royalties, as certain pay [of] thresholds have been met.

Also, please note that the diversification by asset is also expanding, with revenue being sourced from more and more properties, resulting in the company being less economically dependent on certain royalties as it once was. This will continue to grow as our advance-stage royalties begin to provide revenue. The company now benefits from 45 revenue-generating mineral assets.

Slide 9 provides a reconciliation of net income earned in Q3 2011, to net income generated in Q3 2012. The positives for the change include lower depletion due to the mix of assets generating revenue, the MWS and Ezulwini assets of higher book values, and with the lower revenue generated, the result was lower depletion.

There's lower cost of sales due to a reduction in the stream ounces delivered, in particular the minimum from Ezulwini, which is not in place this year, and other income adjustments, which include the mark-to-market adjustment on warrants held as an investment. Offsetting these positives was the reduction in overall revenue discussed earlier, and a one-time gain recognized in 2011, on the sale of investments. The end result is an increase in net income from $44.1 million in Q3 2011, to $52 million in Q3 2012, and an increase in adjusted net income from $39.8 million a year ago to $45.3 million this quarter.

And now I will pass it over to Geoff Waterman, our Chief Operating Officer. Geoff manages our Oil and Gas Division, and he will speak to the Weyburn acquisition we announced yesterday.

Thank you, Sandip. Please turn to slide 11. Yesterday, Franco-Nevada announced that it had entered into a purchase and sale agreement to acquire an 11.7% net royalty interest in the Weyburn Unit for CAD400 million, with a closing date on or about November 30th. For clarification, a net royalty interest is similar to a mineral net profits interest, as royalty payments are net of operating and capital costs.

We like the Weyburn Unit. Franco acquired its initial interest in the Weyburn Unit in 1995. A 1.15% working interest was added earlier this year, and this net royalty will add to Franco's 2.26% working interest and 0.44% overriding royalty interest. The Weyburn Unit is located 129 kilometers southeast of Regina Saskatchewan, and encompasses approximately 53,000 acres. The unit was formed in 1963, and is the third largest conventional oil pool in the western Canadian sedimentary basin.

The Weyburn Unit is operated by a proven and experienced operator, Cenovus Energy. Current production is 26,000 barrels per day. And as noted in Cenovus' 2011 AIF, investment in undeveloped reserves is projected to continue for well over 40 years.

Please turn to slide 12. As previously stated, we like the Weyburn Unit. This net royalty increases Franco's interest in one of the largest conventional oil pools in Canada, and will provide immediate cash flow from a proven operation. Historically, the margins on the net royalty have ranged between 40% and 50%. This net royalty will add approximately 1,400 net margin barrels per day to Franco's current 2,100 barrels of oil equivalent production per day. Net margin barrels are the barrels equivalent to the net royalty received after all operating and capital cost deductions, based on the price received for Weyburn Unit production.

The Weyburn Unit produces medium sour crude between 28 and 32 degree API, with approximately 2% sulfur.

We expect that this will approximately double revenues from the oil and gas portfolio and have an even larger impact on the oil and gas portfolio's EBITDA, as the revenues from this royalty are equivalent to EBITDA. This net royalty will add significantly to the proven and probable oil and gas reserves and extend the reserve life from 12 to 18 years. The cost of these additional reserves is CAD16.53 per barrel.

Going forward, Franco expects Weyburn Unit production to increase annually, peaking in 2020, at around 30,000 barrels per day. Under the current enhanced oil recovery program, the Weyburn Unit is expected to be in production until 2050. However, there is opportunity for increasing recoveries beyond that expected from the current enhanced oil recovery program.

An expansion of this oil recovery program, which ship peak oil production out beyond 2020, and production from the Weyburn Unit would continue past 2050. The Weyburn Unit is a world-class asset with long-life reserves, and Franco believes that the addition of this net royalty interest will be the right balance to Franco's portfolio.

I'd now like to turn the call over to David Harquail. David.

Thank you, Geoff. Just for some historical perspective, Geoff Waterman was with us in the original Franco-Nevada back in '95, when we bought our first interest in Weyburn. He has been ably managing our oil and gas interests ever since and is now our Chief Operating Officer.

We have a lot of continuity with the Weyburn assets, and that's why I'm so confident in this investment.

Our Oil and Gas Division is probably one of the least appreciated strengths of Franco-Nevada. Some analysts on Franco have been applying low multiples on our oil and gas assets, typical of traditional oil and gas working interests that deplete very quickly. However, royalties on [unitized] long-duration assets, which Geoff has just described are worth substantially more.

Oil and gas has been a very good business for Franco-Nevada, and we're delighted to have this opportunity to add to one of our favorite assets. We will highlight the strengths of our Oil and Gas Division in our next investors day.

Now that we have effectively doubled our Oil and Gas Division, and assuming we do nothing else, we expect our previous metals revenues will in the near term be closer to 80% of overall revenue. That assumes current commodity prices. As our Detour, Subika, and ultimately Cobre Panama gold revenues begin generating, we expect to see growth in the precious metals percentage of overall revenues.

We are looking at further acquisitions, and our focus is now back towards new precious metal opportunities.

On slide 14, there's an update of our available capital for more acquisitions. We still have over a billion dollars in available capital. We have what we need. You can also see that we have not levered our balance sheet, and have substantial additional credit capacity. We believe Franco-Nevada can be regarded as an investment grade credit.

Finally, we are just approaching the fifth anniversary of the IPO of the current Franco-Nevada. In those 5 years, we've announced 5 successive dividend increases and have almost quadrupled the value of the share price. I regularly get challenged that a 1.3% yield is too low. We like to remind investors about the capital appreciation in the value of their shares which has impacted the yield. We also like to point out that anyone who bought us at the IPO is now getting close to a 5% yield on their cost base. This is very good for a gold investment. We are very happy that many of those IPO investors are still with us and have profited with us.

Last night in the US, watching the Obama win, they were chanting 4 more years. Here at Franco, I'm going to have our management team chant 5 more years. And we're just delighted that it's been -- it's a great ride, and we expect more to come.

So with that, all of the management team that's here, we would be very happy to take any of your questions.

(Operator Instructions) David Haughton from BMO.

Thank you, David, and the team for the update there. With the Weyburn acquisition, my understanding is that although it closes at the end of November, the royalty is effective from the first of October. Is that correct? So you get the full benefit in this quarter?

Yes, that is correct, David.

And previously you had a revenue guidance of $4.30 to $4.60. Are you prepared to give us a guide now that Weyburn is in the mix?

David, Sandip here. The company still anticipates that overall 2012 revenue will be at the low end of its previously provided guidance range of $4.30 to $4.60.

Okay. Even with the contribution of Weyburn?

Yes.

And I heard your conversation about [firepower] and where you're positioning. But do you see that there's scope for more non-gold acquisitions? And if more oil and gas opportunities came your way, how would you feel about that?

David, we've always guided the Street that we see ourselves primarily as a gold-focused royalty and stream company. We feel that if we went below 80%, it would cause concern to a good part of our investor base. So we're not completely ruling out other deals, but we would have to demonstrate to the marketplace that we can quickly get above 80%.

So right now our focus is on other investment deals. I'd rather precious metal deals. My preference is to build up our percentages like we did before, and then as we get over weighted in precious metals, then be more opportunistic on the oil and gas deals. But if we see another non-previous deal that looks really good, I'll just have to have Paul Brink work doubly hard to get that precious metals revenues up as well.

I'm sure that Paul would love to do that hard work.

He's working hard. And unfortunately, he's not here with us today, but I could get him to speak to it. But I think the best thing for us right now is to do another precious metals deal. That would give us more capacity on the non-precious.

And that also speaks to another point. I know that you've got a diversified portfolio, some 45 or so producing mineral assets. But Palmarejo still represents, at this stage, 20% of your revenue mix. Do you feel comfortable or uncomfortable with such a large exposure to a single asset?

Well, obviously, you know we do try to diversify at additional assets. With Palmarejo, we are fortunate that we have this annual minimum in place, a minimum of 50,000 ounces per year, which should go on for another 4 years. So as our other properties, the Detour and the Cobre Panama come on stream, the percentage will decrease for Palmarejo.

And, David, the other thing to remember too, is on a stream, they tend to be -- we report them on a gross basis. So on an EBITDA basis, the proportion of our EBITDA from Palmarejo is smaller, so we do have to pay that $400 an ounce.

Thank you. That's it for me.

(Operator Instructions) Cosmos Chiu with CIBC.

Thanks for taking my call. Got a few questions here. Maybe the first question's for Geoff. Can you walk me through? I guess at Weyburn, it's going to be a medium grade, slightly sour oil. I think in the past it's always been the price realized would be at a discount to WTI. Is that still holding true? And how should we look at it?

Yes, Cosmos, there is a quality differential because of the grade of the oil in the sulfur content. Our benchmark is actually the Edmonton Lake posting because the fact that it's a Canadian oilfield, and it's currently running, our average this year is about $8 a barrel, and if you look historically, WTI and the Edmonton Lake posting, when you factor in foreign exchange, pretty well equal. Earlier this year we had a differential between the Edmonton Lake and WTI. But currently Edmonton Lake is, let's see, it's about $4 above WTI currently.

Okay. And, Geoff, the $8 per barrel, that's a discount?

Yes, that's the quality differential because of the lower grade of the oil and the sulfur content.

And that reflects like the last past 5 years average.

Yes.

Yes.

And then just want to confirm, Weyburn's pretty much 100% oil, right?

It is 100% oil.

Okay. And what's the tax treatment [behind] -- from Franco's perspective on this acquisition? Is it one of those structures where your taxes will be lower in the first few years until your $400 million acquisition cost has been recovered?

No. So the taxes, it's considered [cost piece], so we'll get a 10% declining balance tax deduction each year. So we will be taking a deduction in 2012, of 10% of the acquisition price.

Okay. So it's a 10% kind of straight-line depreciation?

Declining balance.

Okay. And then maybe moving on to the quarter here. The Subika number that we saw in Q3, is that for the full quarter sort of or is it -- when did it kind of come on in terms of the royalty?

It came in partway through the quarter, but we actually haven't gotten a full detail on it yet. So that's something we'll be able to guide better on. But we just don't know how much of the quarter it represented. We only have a royalty on part of the [Ahoffel] property of Newmont. So we'll chase up those details. We only got that sort of late in the quarter.

Okay. And then, David, I don't know if you can comment on the South African situation here. I know both MWS and Ezulwini have been impacted. My understanding is that maybe the labor situation at MWS is a little bit better on a relative basis. I don't know if that's true. And in terms of Ezulwini, the 30-day shutdown, was that in Q3 or is that going to go into Q4? And I guess overall we know there will be impact in Q4. But to the best of your knowledge, how much longer could it be impacting your royalty.

Well, the more significant one is Mine Waste. And we were talking to them just a couple weeks ago, and they already had 2 of the 3 lines back up. So I haven't had a confirmation on the third line, but we knew it was back to at least two-thirds. They haven't yet gone to any of the higher grade dumps on the Anglo side, which is where our royalty now applies to as well. So they're still mining from the lower grade first germanium dump.

So actually, we're quite optimistic on that asset. It seems to be in strong hands with Anglo. There's still some upside to perform. And we're not too worried to the extent that it was impacted temporarily with the labor interruptions.

Ezulwini is a different story. They're taking a longer term shutdown. I think Gold One Management Team is having a hard look at that operation, combined with the labor issues. I think part of their negotiating position is they're taking an additional 30-day hiatus which will impact mostly into our fourth quarter. And I think there's a reasonable chance they might extend it longer because there is this ongoing negotiation. Gold One's had especially problematic challenge, not so much at their Cooke operations, but at another operation in South Africa. And so I think they're trying to send the right messages to their overall labor union.

Nice aspect about this one is that we have a very long-term tenure on this property. We feel very secure about it. We're not as concerned about the near term. But it could have an impact on our fourth quarter numbers. But it's not a big number for us at this stage.

Last year we had the benefit of a minimum guarantee royalty. We always knew they were never going to be close to the minimum this year, so we've always budgeted a much smaller number. [Bit] disappointing, but it's not that material an asset for us right now.

Okay. Great. Thank you.

Greg Barnes with TD Securities.

Geoff, to make this simple, do we just take the net margin barrels of 1,400 a day, I guess it is, multiply that by oil price minus the discount?

Yes.

That would give us the revenue net to Franco?

Correct, before tax.

Thank you.

So, Greg, in a way, we're trying to do with oil and gas what we've done with our royalty assets, where we talked about royalty equivalent units. And so we're going to keep expanding that, because we actually want to get out of the commodity forecasting business, because we're, I think, one of the few companies that guides on revenues. And we want to start guiding on barrels or royalty equivalent units of ounces, so that we can be maybe a little even more accurate in terms of the guidance provided to the Street.

Just one further question. You have some warrants coming due next year, I believe, that should bulk up the balance sheet cash wise too.

Yes. So they're due, I believe June of next year. And the exercise price is just over CAD64 a share.

Canadian?

Canadian, yes.

And how many?

4.5 million roughly.

Great. Thank you.

Paolo Lostritto from National Bank Financial.

Good morning. In the past we've used the decline rate on the Weyburn oilfields of about 5%. Now that this represents a larger portion of your revenue, just wanted to get kind of what your thinking is on the decline rates on that field.

So going forward, if we look at our forecast, or the production forecast for the unit, we see it increasing due to the implementation of the balance of the current EOR program, enhanced oil recovery program. And as I said in my presentation, we're expecting production to increase through 2020 to approximately 30,000 barrels a day for the unit, and thereafter, without any further enhanced oil recovery program in place, we would see declines running at 3% to 5%.

Okay. Thank you.

Brian MacArthur from UBS.

Good morning. I just want to go back a little bit to what Greg was asking. You have the price. You have a discount and obviously we have operating costs and royalties, whatever, we have to take off. But then given this increasing production, does the capital change over time as well or can we assume that's sort of linear historically? I'm just trying to figure out whether that's going to have a negative impact on the downside.

With request to capital, I guess you could equate it to as our production is increasing, that's due to the capital that's being deployed and a balance of the enhanced oil recovery program. So you could go on and say that's a -- model that out linearly. And then once that recovery program, once the capital's been fully deployed there, we'd see a significant drop off in the capital being expended on the project. Of course, if the unit goes into a second phase EOR program, then we'll see additional capital going towards that.

So, Brian, the easy way I look at it, as a layman, is that it's actually been a pretty steady capital contribution all the way through.

Right.

Each time they decide to do another program, they just sort of tag it on to the expiry of that first capital program. So right now we have a capital program that takes us for the expansion to 2020, but they actually start decreasing spending in the next few years. So we could see a substantial -- if we decide, for instance, not to do another capital program, we'd actually see a substantial step-up on the cash flow from this asset. So it's an upside too. Except we would like to have this a long-term asset, so we wouldn't mind them actually reinvesting the cash flow. But we don't expect it to be substantially any higher than what we're experiencing right now. We believe we're at peak capital expenditures on this project at this stage.

Perfect. That helps. So just to get it clear, all that I was worried about is just, let's say an event you don't want to happen, have the oil price drop to 60 or 50, your margins will compress, but they probably wouldn't reinvest as fast, so you don't get caught on that sort of equation.

And that's exactly what's happened on this one. They've never really had a cash call to working interest partners on this, because what they do is they do manager their capital programs when times are tougher, they just slow down on the capital expansion.

As I stated in my presentation, I've been involved with this since 1995, with this unit. Our initial interest was a 1.1% working interest. And in 17 years, given the ups and downs in oil prices, it's never been cash flow negative.

Great. And maybe just -- you made another interesting comment, I thought. We talk about forecasting of revenues in oil, keeping it over a percentage of revenue. And obviously, that whole revenue percentage is a little bit on how we account all the time between streams or, in this case, the revenue's coming in at an EBITDA level, as I understand it, not 100% level. If we look at this asset -maybe you can't comment on this - what sort of percentage increase in, say a long-term NAV basis would this have been relative to where we are before? Because it looks pretty attractive, even on a long-term basis, so the relative percentage might even go up, if you see what I'm saying.

Brian, you're spot on. This is very accretive for us. We can buy oil and gas assets at much higher accretion numbers than we can precious metal assets. So if you look at it from day one, absolutely. It's just we don't have the same expiration optionality as we do with our gold assets. And we probably think gold prices maybe have even more potential longer term than oil prices.

But NAV accretion, what is the percentage of our overall NAV, we've definitely evenly higher stepped up our proportion of oil and gas NAV with this transaction. We think we've gotten it at a terrific price. We think good things come to people when they are able to write checks.

Okay. Great. Thanks very much, David.

I'm showing there are no further questions at this time. I'll turn it back to Mr. Axell.

Thank you, Steve. I want to remind investors that our full-year 2012 results are expected to be released on March 19th, 2013, with a conference call scheduled for the following morning. Thank you for joining us today and your continued interest in Franco-Nevada.

Ladies and gentlemen, this does not conclude today's conference call. You may now disconnect.