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There’s More than Meets the Eye to This Gold Stock

Most gold and silver miners focus on building and running mines. Franco-Nevada Corp (NYSE: FNV), which gets the bulk of its revenues from selling gold, doesn't do that. It's actually more like a specialty finance company than a miner, and that has material implications for its business -- and for investors. Which is why one of Franco-Nevada's recent growth initiatives proves that there's much more than meets the eye to this gold stock.

Definitely a precious metal stock

Let's get one thing out of the way right up front... Franco-Nevada is most definitely a gold and silver stock. In the second quarter of 2017 just over 90% of its top line came from these two precious metals. That was heavily weighted toward gold, which accounted for 71% of revenues. Franco-Nevada has no plans to change this focus.

Image source: Getty Images

What's unique is how Franco-Nevada goes about investing in gold and silver. Unlike a company like Barrick Gold Corp (NYSE: ABX), Franco-Nevada doesn't own or operate a single mine. It provides financing to miners, which then use the cash to build or expand their mines. (That said, during the recent commodity downturn some miners used the cash to pay down debt.) In return for the up-front payment, Franco-Nevada gets the right to buy silver and gold at reduced prices in the future. This is called streaming. Franco also makes use of royalty agreements, which are roughly similar.

For example, Franco-Nevada has a royalty interest in Barrick's Goldstrike complex. This is one of Barrick's core U.S. mines and produces around one million ounces of gold a year. Barrick does all of the work running the mine, including an effort underway now to lower production costs by as much as $100 an ounce. Franco, meanwhile, does effectively nothing but collect cash. In 2016 it generated $22.9 million in revenue from Goldstrike, roughly 16% of its precious metals revenues.

ABX EBITDA Margin (TTM) data by YCharts

This is a great deal for Franco-Nevada and investors because it locks in low prices and leads to very wide margins, as the chart above shows. But unlike miners, which can have wide margins when precious metals prices are high, Franco's margins remain relatively strong even when gold and silver prices are low. Note that over the last decade Barrick's EBITDA margins fell deep into the red twice while Franco never skipped a beat. That's an advantage that investors shouldn't overlook.

Taking things to the next level

That's all interesting, but we haven't gotten to the surprising part just yet. You see, the model that Franco-Nevada uses in the gold and silver space can be used in other commodity businesses as well. For example, in the second quarter Franco generated roughly 9% of revenues from other metals... and 6% came from oil and natural gas.

What's a precious metals company doing investing in oil and gas? At first this might seem like a risky overreach, but Franco-Nevada is using the same streaming/royalty approach. So it hasn't suddenly become a wildcatter (which is what got Freeport McMoRan in trouble) -- it remains a financier. That's a business with which Franco-Nevada is extremely comfortable.

The investment, meanwhile, remains relatively small compared to its gold and silver operations. However, it adds an interesting level of diversification that other gold and silver stocks don't generally have. And the most important part of this surprising twist is that Franco is taking advantage of a weakened energy sector to build this business. That's the same tactic it uses in the precious metals space, opportunistically investing during downturns to support long-term growth.

A few of Franco-Nevada's recent energy investments. Image source: Franco-Nevada Corp

Franco-Nevada is expecting growth in this business to be pretty robust, too. In 2016 oil and gas revenues were around $30 million, but by 2021 management expects that to reach as much as $65 million. That more-than-doubling compares to a projected increase in precious metals revenues of around 16%. Clearly commodity prices will play a big role in what actually happens -- but oil and gas will not only provide diversification, but notable growth, too. Which helps explain why a precious metals company is, somewhat surprisingly, investing in oil and gas.

A little more than meets the eye

Franco-Nevada is clearly not a pure play precious metals investment. If that's what you want, then look elsewhere. However if you are looking to precious metals for diversification purposes, then Franco-Nevada should probably be on your short list. Not only does it offer exposure to gold and silver, but it has also expanded into the energy space -- and without changing its high-margin business model in a material way. That provides investors even more diversification than a gold miner like Barrick could.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.