Franco-Nevada Corp (FNV) 2016 Q3 法說會逐字稿

Good morning. My name is Jody and I will be your conference operator today. At this time I would like to welcome everyone to the Franco-Nevada Corporation's third-quarter 2016 results conference call.

(Operator Instructions)

Stefan Axell, you may begin your conference.

Thank you, Jody. Good morning, everyone. I want to thank you for joining us this morning to discuss Franco-Nevada's Q3 2016 results. Accompanying our call is a presentation which is available on our website at Franco-Nevada.com, where you also find our full financial results.

Sandip Rana, CFO of Franco-Nevada, will provide a brief review of our results and Jason O'Connell, Vice President of Oil and Gas, will provide an overview of our oil and gas acquisition in the United States. This will be followed by a Q&A period. Before we begin formal remarks, I would like to remind participants that some of today's commentary may contain forward-looking information and refer you to our detailed cautionary note on slide two of the presentation.

I will now turn the call over to Sandip Rana, CFO of Franco-Nevada.

Thank you, Stefan. Good morning, everyone. Thank you for joining us this morning.

As you will have seen from the press release issued yesterday, the Company had another strong quarter with solid financial results. In fact, there were a number of financial records achieved. This is the second quarter in a row.

It is a testament to the quality and strength of our portfolio and overall success of our business model. The portfolio continues to deliver growth and generate significant cash flow with it being further enhanced in 2016 by the Antamina and Antapaccay stream transactions.

With respect to our financial results, third quarter of 2016 was another quarter of records. The Company recorded its highest amounts for gold equivalent ounces, revenue and adjusted EBITDA this quarter, which was due to a combination of higher yields received as well as stronger gold and silver prices.

Turning to slide 3, the chart illustrates the GEO breakdown by commodity for third-quarter 2016, compared to third quarter of 2015. You can see that GEOs in total have increased over 44% compared to prior year. This increase is due to increases in both gold and silver ounces received, primarily the result of the Antamina and Antapaccay transactions, but also the commencement of the Karma stream. Actual gold ounces increased 19% versus 3rd quarter 2015 while GEOs were up over 600%.

Slide 4 provides a breakdown of where the GEO growth arose when compared to third-quarter 2015. Our core gold and silver assets did produce less GEOs during the quarter, which is partially due to the timing of production and recognition of revenue by the Company. A large portion of the decrease is due to Palmarejo.

During the quarter, Palmarejo reached its 400,000 ounce minimum requirement. In a typical quarter the Company would receive 12,500 gold ounces as a minimum, and third quarter we only received approximate 4,200 gold ounces. The Palmarejo agreement is now terminated and going forward Guadalupe will begin delivering ounces under the same agreement. There is no minimum associated with Guadalupe.

In addition, Candelaria delivered less ounces to the Company than prior year. You will recall that 2015 was an abnormally high production year for Candelaria with 2016 to be more representative of what expectations are going forward. Year-over-year GEOs from Candelaria are lower, but are in line with our expectations.

The palladium and platinum assets delivered more GEOs due to better protection at the mines. The benefit was partially offset by pricing when converting platinum/palladium ounces to GEOs. Our Hemlo NPI performed well and we expect another strong performance in Q4 from this asset.

As you can see, the largest component of growth has been the acquisitions. Significant growth because of Antapaccay, Antamina and Karma. Antapaccay contributed over 22,000 GEOs during the quarter. The Karma stream started delivering gold ounces in March of this year.

We are delivered 1,250 gold ounces per month. The Company did sell 5000 gold ounces during the quarter due to the timing of when inventory was received and Antamina had a strong quarter, delivering approximately 20,000 GEOs to our account. Year-to-date the asset has delivered approximately 50,000 GEOs to Franco-Nevada, which is above what our expectations were for the full year.

As you turn to slide 5 you will see two charts on the page. The first chart highlights the average gold price and precious metals revenue for each of the last five quarters. Third-quarter 2016 continued the positive momentum for gold prices we have seen over the last few quarters.

The average silver price was also stronger at $19.62 per year -- per ounce. These higher average gold and silver prices, along with an increase in GEOs delivered, resulted in a significant increase in precious metals revenue to $161.7 million in the quarter, compared to $92.9 million a year ago.

On the bottom chart we have highlighted our oil and gas net revenue and, as you can see, the oil price has been less volatile recently. The Company did earn slightly higher oil and gas revenue compared to prior year. Production at our oil and gas royalty working interest assets has remained stable.

As you turn to slide 6 you will see the key financial results for the Company for the three and nine months ended September 30th, 2016. I will not get into the specifics, but what I would like to point out is that we have year-over-year increases for all financial metrics across-the-board with the new records highlighted by the boxes.

The increases are the results of the additions to the portfolio previously discussed in addition to the existing assets, benefiting from higher gold and silver prices during the quarter. As mentioned, the portfolio has performed very well. With a diverse portfolio, one can minimize the negative effect of any challenging assets.

As you turn to slide 7, the geographic revenue profile continues to be lower risk with 83% of revenue being generated from the Americas, with Latin America being the largest contributor. One of our core goals that we highlight is to build a diversified portfolio with a focus on precious metals. For third-quarter 2016, precious metals revenue was 94%, with 66% being from gold, 21% from silver and 7% from PGMs. The company remains diverse, with 45 revenue-generating mineral assets.

We continue to stress the scalability of our business model and believe slide 8 highlights this. As you can see, there has been a significant increase in revenue year-over-year with a slight increase in cost. Stream costs will continue to increase as the Company is delivered more stream ounces, which we consider a positive. This is been the case in third quarter as the Company sold approximately 87,000 stream GEOs.

One item, which I believe is important to highlight on this slide, is the fixed costs. These of the Company's corporate administration costs and, as you can see, they have the remained fairly constant each year regardless of the increases in revenue.

Corporate administration costs continue to be less than 4% of revenue and for third-quarter 2016, were approximately 3.5% of adjusted EBITDA. As illustrated on the chart, the Company continues to maintain very strong margin, which was greater than 82% for Q3 2016. Unlike operators, our mineral business is not directly affected by operating and capital cost escalation.

As you will recall, the Company had provided guidance earlier this year for the number of gold equivalent ounces expected to be earned in 2016, as well as the amount of oil and gas revenue that was projected. On slide 9 we provide our revised guidance. With the strong performance of our assets thus far and expected strong performance for fourth-quarter, I'm pleased to announce that we are raising our guidance. The Company now projects to receive between 445,000 GEOs to 455,000 GEOs in 2016, compared to the previous range of 425,000 GEOs to 445,000 GEOs.

In addition, we are increasing our oil and gas revenue guidance to between $25 million to $30 million, having reported approximately $20 million thus far in 2016. And now I would like to pass it over to Jason O'Connell, VP Oil and Gas, who will discuss the oil and gas acquisition announced yesterday.

Thanks, Sandip.

Turning to slide 10, we have entered into an agreement to purchase a package of royalties located in the STACK shale play in Oklahoma's Anadarko basin for a total purchase price of $100 million US. The effective date for the transaction is October 1st, and we expect to close before the end of the year.

The royalties we are buying consist of both mineral title, whereby we only underlying mineral rights, and gross overriding royalties, where those royalties are tied to underlying leases. The royalties cover an area of 16,865 acres at a royalty rate of 7.15%. However that acreage is subject to pooling and unitization by operators and the effect is that our loyalties are actually spread across a larger area, approximately 75,000 acres, but at a reduced royalty rate of about 1.6%.

The annualized revenue for the royalties as of September of this year was $3 million, however that number is expected to grow significantly as operators carry out development of the royalty acreage. The STACK is an emerging play and drilling has only recently begun on royalty lands.

Turning to slide 11. Slide 11 provide some context for the STACK play and as is meant to demonstrate its relative quality. The chart in the upper left shows horizontal rig activity in the United States by county. Blaine and Kingfisher counties, which contain the royalty acreage, are 2 of the top 10 counties by rig activity, as measured by Baker Hughes who tracks more than 250 counties across the US.

The chart on the top right also looks at drilling activity and it shows that the STACK is they only play in the US to see an increase in drilling activity since the oil price drop in 2014. While other players are at a fraction of the 2014 levels, the STACK has actually 28% more rig activity today than it did then.

Rig activity is really a proxy for quality in that operators direct more their capital to the best place. The chart on the bottom left is from Bank of America and shows US plays ranked by IRR. You can see the STACK shows very well, particularly in the over-pressured window, which has IRRs upwards of 70%. A large part of the royalty lands sit atop that over-pressured zone.

On slide 12. This slide is meant to highlight a few things. First of all, a key aspect of these royalty lands is that they are located in the core, or the sweet spot, of the Meramec formation. The Meramec is the focus formation for operators in the area at this time, and the stratigraphic column on the right shows position of the Meramec relative to other oil-bearing formations, which the royalties also have exposure to.

The map on this slide shows wells in the area, color-coded by formation. Red dots indicate wells in the Woodford formation and those wells are located mostly to the south of royalty lands. The blue dots represent wells in the Meramec formation and, as it becomes more of a focus formation the drilling is moving north toward royalty lands.

The black circle on the map represents Devon Energy's interpretation of the core of the Meramec from their marketing materials. That circle is based on slightly dated information and with new well results, some of which are highlighted here in red, it's becoming obvious that the sweet spot is expanding and will cover almost all the royalty lands. What that means is that the royalty acreage will attract a significant amount of capital from the operating companies because it is the best part of the play.

The operators active on royalty grounds are primarily Newfield, Devon and Continental, which are very large companies with a combined market cap in excess of $45 billion and good access to capital. Newfield and Devon alone have budgeted in the neighborhood of $1 billion in capital spending for the STACK this year and both have announced that they are there transitioning to full development of their acreage beginning in 2017.

Slide 13 provides our rationale for this investment. In summary, the STACK is one of the hottest plays in North America right now, with excellent economics, which is attracting a significant amount of drilling activity. The STACK is located in Oklahoma, which is a pro-oil state. It has no carbon taxes and the royalty lands are located within 100 miles of Cushing, which is the settlement point for WTI, and which means there are very minimal pricing discounts to the WTI price.

The royalty acreage sits in the core of the play and will attract more than its fair share of STACK capitol from a strong group of operators who are committed to the play. Development of the Meramec formation is ramping up and activity is expected to move onto royalty grounds as the operators fully develop their lands. The royalties have exposure, not only to the Meramec but also to several horizons at depth.

Lastly, we are investing early in a play that we believe has excellent growth potential and therefore royalty revenues are expected to ramp up significantly in the coming years. Lastly on slide 14, this shows our available capital. Franco-Nevada remains in a strong position with $1.5 billion in available capital and no debt.

With that, operator, we will turn it over for questions.

(Operator Instructions)

Your first question comes from Josh Wilson from Dundee Capital Markets.

Good morning. I guess most of my questions are for Jason. To understand that $3 million annualized September number, how many wells were currently online on your lands for your royalties?

Thanks, Josh. In that $3 million number includes about 25 producing and paying wells. As of today, there's about -- there's closer to 45 wells that have actually been drilled on royalty lands that have not yet reached pay status. So we expect as those wells come online over the course of the next few months and hit pay status, our revenue will increase significantly.

Okay. And then in terms of your expectations for full field development in 2017, what is that sort of number of producing wells look like? And your plan next year and maybe thereafter if you have any sort of insight.

It's very hard to put a specific number on the amount of wells that'll come in -- or online next year. It obviously depends on the amount of capital that the operators put to the field and also where those wells are drilled relative to royalty ground.

We expect that, because these lands are in the core of the play that we will receive more than our fair share of that capital. But we'll just leave it at the fact that revenue is expected to grow significantly, but it's hard to put an exact number how many wells will get drilled.

All right. But knowing that $1 billion is going to be spent in 2017 and assuming flat oil prices at $50 a barrel, is there any sort of range of expectations that would be reasonable? If you want from 25 wells to 45 wells within a three month or four month period, is it reasonable to see that double or triple into 2017 or is that just far too aggressive?

No, that's not too aggressive. It's -- just to put it into context, right now there are three rigs that are drilling on royalty lands. If you assume, for example, a rig will drill one hole every three months or so -- sorry, one well every month or so. And so if those wells continued to drill on royalty land for the course of the year, they would add roughly $4.5 million in revenue in that first year.

Okay, I apologize for all these questions. This is a very narrow-focused gold analyst that is having to dig into oil and gas.

I have a couple more questions just on understanding the structure. For the GORR structure, just to clarify, that is net of cost and that includes that operating cost, transfer costs and depreciation or CapEx as well?

No. There are essentially no costs cost associated with those GORRs other than a very small processing fee, which is minimal. So those GORRs are just the top line revenue royalty.

Okay. I guess that saves me asking what the cost structure will be and that is about it for all my questions. Thank you very much.

Your next question comes from Kevin Chiu from CIBC.

Good morning, guys. Congratulations on the solid quarter. I also have some questions on the oil and gas acquisition. Maybe just to clarify, is the GORR and the mineral title royalty rate 7.15%, is that a recaptured within the 1.6% royalty rate that covers the roughly 75,000 acres?

Yes, it is. So the 7.15% is the royalty rate that's actually attributable to the lease acreage that we hold. But what happens, as I mentioned, is the lands and these leases get pooled as operators drill their wells. So they get pooled with other lands and it effectively spreads out the royalty acreage to a larger area, and in doing so reduces the royalty rate sort of on a pro rata basis. So that 7.15%, yes, that is included within the 1.6% average royalty across that larger area.

Okay. I think you mentioned the acquisition is effective October 1st. So should we be expecting a catch-up in Q1 of 2017? Is that how it works?

Yes, we will be paid starting October 1st so we will receive three months of revenue for the end of the year here, which should be paid in Q1, probably.

Okay. Maybe just on a bigger picture basis, could you maybe provide a little bit of background on the acquisition in terms of if it was a competitive process and how you kind of view this commodity space in terms of future acquisitions?

It was an auction process that was being run through the banks. This was one of several opportunities that are in front of us right now. Particularly in the United States, there are some packages that are being marketed. The competition in Canada has been relatively robust over the last couple of years with people like PrairieSky, Freehold and The Pension Funds bidding on sort of larger royalty packages.

But the US competitive landscape is a little bit different in that there aren't as many strict royalty players down there now. And there are, as I said, there are opportunities that we're looking at on the fee-land side which we hope to participate in those auctions going forward.

Great, thanks very much. Appreciate it.

Your next question comes from Greg Barnes from TD Securities.

Yes, thank you. I just wanted to switch to the outperformance at Antamina. It clearly performed above your expectations. I assume the silver mineralization is associated with the zinc? I'm not sure if that's correct. And from my understanding, zinc production at Antamina next year is going to almost double, so can we expect much higher silver production at Antamina next year from your understanding?

Greg, we're -- in terms of the outlook, I think we're having we are having a fantastic year in terms of the silver production. We don't have anything to show at this stage that it will continue into next year, so I think we currently expect to be at the average. We are down visiting site in a few weeks. We hope to get a better view of why it is they have outperformed so much this year and hopefully can speak more about it than.

So you're not aware whether the zinc is -- or the silver is associated with the zinc or more with the copper or how that plays out in the deposit itself?

Mostly we get paid on the silver in the copper cons and in the lead cons. We don't get paid on the silver in the zinc cons, so I don't think that, that particularly is driving it, although as I say we hope to get a better understanding in the coming weeks.

That makes sense. Thanks, Paul.

Your next question comes from Steven Butler from JMP Securities.

Good morning, guys. Question, Paul, for you. What is driving the increase in GEO guidance for the year? Would it be predominately Antamina or is there a second asset after Antamina that drives the guidance increase?

Particularly two assets, one is obviously Antamina, which has outperformed, and the other one is South Arturo, which is the JV between Premier and Barrick, which started mining earlier this year. We -- at the time when we issued our guidance, we weren't fully aware of what was happening with the property in terms of when do we get paid out.

There was -- they pay us a minimum amount every single year of a few hundred thousand dollars, so they have to recouped that minimum. That has been recouped and so we did receive our first payment -- or delivery of royalty revenue in Q3. And now we expect some in Q4, as well. So it's between those two, the main reason for the increase in GEO guidance.

Okay, thank you. So South Arturo had $3 million of revenues in the quarter and you said here on the first page net of $3.1 million of advance royalties. So was that suggesting that the number would be $6 million or am I missing something?

Yes. So they would be able to recover the amount that they paid us over the last number of years since mining had ceased and, yes, it would have been $6 million.

Okay. And, guys, at Bald Mountain, your royalty range is all over the place but that's the way it is. 0.875% to 5% and as Kinross gets into the Vantage pit over the next couple of years, is there any -- how does the royalty landscape look like? We were down at Bald Mountain in June, that's a vast property but what would should for modeling Bald Mountain? Take the mid-point of royalties or any guidance there?

I think taking the midpoint is probably the best route to go at this stage.

Okay, Sandip. Thanks guys.

(Operator Instructions)

Your next question comes from Jorge Beristain from Deutsche Bank.

Good morning, guys. On that guidance range, could you also give us some more color as to what is driving the guidance change at Antamina?

Antamina, is just basically -- we had projected roughly 40,000 GEOs for the year and they have already surpassed it and we expect similar deliveries in Q4 and that's basically what's behind it. In terms of specifics, why they are outperforming, as Paul mentioned, we are going to go to site in a few weeks and we'll get a better understanding of the reason for the outperformance.

Okay, maybe just a big picture question. What stage of the cycle do you think that we are in related to the -- both the precious and the industrial mining metals companies in terms of deleveraging? It would seem that, on the one hand we've seen an improvement in prices, stabilization and balance sheets. So are companies still approaching you guys for new deals? And secondly, could you just comment on when you see the next generation of greenfield projects starting to go ahead?

Sure, it's Paul answering the question. And maybe as a starting point, as you know, our strategy is 80% precious metals but we would like to have diversification, much of that has been oil and gas in the past but we're also open to base and box and doing that.

In terms of the environment, you are absolutely right. Many of the seniors have completed much of their deleveraging so we see less demand on that front but I wouldn't say there is no demand. There still is some prospects although really it depends on how the market plays out to see if those come to fruition.

So the second category is in terms of gold development projects. They are -- people are moving a number of projects forward so I think there is potential over the next 12 months that we may participate in financing some new gold projects.

And then the other area that we participate in, and the transaction Jason has just completed here on the STACK is a case in point. We are starting to see good value in the other sectors and our strategy always is, if we can get better value doing oil and gas or other metals than we can in the gold sector, then we would do that. So we've seen a good range of opportunities, both precious and non-precious across the board.

Could you -- and I'm not asking for a trade secret here, but could you just maybe give us an order of magnitude of how much better you're seeing gold -- I'm sorry, oil and gas potential returns right now, vis-a-vis your more traditional gold ones? Are you talking like a 1% bump, a two percentage point bump? Could you give us some color on that?

I don't know that I could bring it down to a single number. The -- and I'd say on the non-golds there, when we say we are looking for better returns, sometimes that is in terms of quality of projects and sometimes that is in terms of multiple returns. One of the big advantages is often you can get longer-dated assets in the non-gold sector, so where we can get cash-flowing, low-cost, longer-dated assets, that's always attractive.

Then the secondary is just being able to get a multiple of the cash that you have invested. So I think the STACK play, it is an early stage play, but if everything goes right and the momentum continues on the play, we can earn many multiples of the cash that we have invested. So I think it's -- the potentials for return are very attractive.

Thanks very much.

Your next question comes from Tanya Jakusconek from Scotiabank.

Good morning, everybody. I'm just going to come back to the oil and gas. Actually, I have two questions. One is one the oil and gas and one is on the M&A. Maybe, Jason, so that I just understood this correctly, again coming from a non-oil and gas analyst. You mentioned one well hole per month, per rig and then you mentioned in the first year if one assumed the 12 -- three rigs on the property, $4.5 million in the first year per rig so if had three that would move you to about $13.5 million from the three rigs?

No, the $4.5 million was for the three in aggregate.

Okay. And then, Jason, maybe when you were looking at doing this acquisition as you would in gold you would obviously make an assumption on what you think you would have in the ground, what sort of mine life, et cetera. Could you give us a bit of color of how you thought about this to put out a $100 million?

Yes, so we do look at it the same way we would as a mining investment in that your looking at the resource in the ground. The difficult part in assessing the STACK play is that you just don't have certainty on when the wells get drilled so your profile is a little bit more uncertain.

But if you look long-term over the life of these assets, there is probably 10 years to 15 years of drilling inventory that will get drilled over time and after that you're going to have a long decline on these assets over several decades. So what that allows you is exposure to a number of oil price cycles and a very long cash flow base that over time, as Paul mentioned, we expect to see many multiples of our investment returned.

That's very helpful. And then, Paul, just coming to you if I may, when you talked about the non-gold investments, I know at one point we had looked at pool, we had looked -- looking at potash, et cetera. Are those still on the table?

In terms of the bulk sector, both the basin and bulks have been beaten up, certainly relative to gold, and so in those categories in particular if we can invest in good cash flowing assets, establish mines with long lives, those would be attractive. And so we are seeing some transactions in that category and hopefully we can bring one or two of those home in the next 12 months.

Okay, thank you very much for that.

There are no further questions at this time. I will turn the call back over to the presenters.

Thank you, Jody. We expect to release our full-year 2016 results, provide 2017 guidance, as well as issue an updated asset handbook on March 22nd of 2017, with the conference call held the following morning, and want to thank you for your interest in Franco-Nevada.

This concludes today's conference call. You may now disconnect.