Streaming mining companies don’t bear the operating risks of owning actual mines. (Rick Wilking/Reuters)
Unless you’re a risk-taking contrarian, you’re likely giving mining stocks a wide berth. The S&P/TSX Global Mining Index is down 30% since 2010, and there are no signs of a rebound. Surprisingly, one part of the mining industry has quietly outperformed not only the sector but the overall Canadian market.
Mining royalty “streaming” companies—firms that help finance new mines in exchange for a cut of what’s produced—have posted impressive returns amid the industry’s gloom. One of the best performers has been Franco-Nevada Corp. (TSX: FNV), which has seen its stock price climb 120% over the past five years. While gold has fallen 37% from its US$1,921-an-ounce peak on September 5, 2011, Franco-Nevada’s stock rose 36% over that time. “That’s pretty startling outperformance there,” says Ryan Crowther, a portfolio manager with Franklin Bissett Investment Management in Calgary.
Though these companies are exposed to commodity prices, they have little in common with actual miners. They don’t own or operate mines and usually have only a handful of employees, meaning they have little overhead and (usually) no debt. It’s these costs that can sink a mining company in a low commodity price environment.
Here’s how streaming works: A miner needs capital to expand, so it goes to a royalty company. The company hands over, say, $100 million, in exchange for a percentage of what’s produced at a set price. Franco-Nevada, for instance, has agreements in place to buy gold from mining companies for US$400 an ounce. It then sells that gold at the spot price as it’s produced and pockets the difference. “This isn’t a mining model,” says Crowther. “It’s a low-capital-intensity business, where margins are high and a lot of the EBITDA from these businesses flows straight to the free cash flow line.”
Indeed, the business fundamentals for the streaming trade are particularly auspicious right now. Because debt and equity financing for exploration has all but dried up, companies have nowhere else to turn to get a property into production. The streamers thus have their pick of low-cost, high-grade projects and can drive a hard bargain, setting themselves up for strong earnings growth if and when commodity prices rise.
While Franco-Nevada is making less per ounce than it once was, the company has increased both the number and size of its revenue-generating interests, says Shane Nagle, an analyst with National Bank Financial. It’s a similar story with other companies in this niche.
While some of these operations appear expensive, trading around 20 times cash flow (compared with eight times for miners), Nagle figures it’s a fair price considering that all these companies do, basically, is collect cash. By contrast, after expenses, some miners have no free cash flow at all.
In choosing a streaming stock to buy, look at the companies it’s partnering with. The biggest risk is that one of the projects it’s backing shuts down. If nothing is produced, the royalty company can’t make money, says Crowther. Having diversified sources of revenue is important for the same reason.
Both Nagle and Crowther think streaming stocks have room to grow. The mining sector may look ugly, but cash-generating companies never go out of style.
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