Keynote: David Harquail on Franco-Nevada’s new long-life assets, succession plans

The following is an edited transcript of remarks made by Franco-Nevada (TSX: FN; NYSE: FN) CEO David Harquail at The Northern Miner’s Canadian Mining Symposium held at Canada House in London, U.K., on May 22, 2019, followed by a question and answer session. For the full audio, listen to Episode 143 of The Northern Miner Podcast.

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David Harquail: In terms of our business principles at Franco-Nevada, we’re trying to do all the good stuff in the industry, and avoid the bad stuff. We’re not a mining company, we don’t operate or build mines. We don’t even do any exploration. So, for that reason, we don’t get a lot of coverage in The Northern Miner, because it’s more of a financial business.

But over 30 years we’ve collected royalties on mining properties around the world. When I’m in New York and have to explain this to investors, the way I describe it is that our company is essentially the “Airbnb” of the gold industry. We get a little piece of a lot of different mines.

We find that royalties on great geology is really the most accretive thing you can do in the business.

We’re not financial engineers. We’re trying to expose ourselves to the exploration potential of good geology, and we describe Franco-Nevada to investors as the low-risk way to get exposure to the industry.

We try to give investors the best aspects of a gold exchange-traded fund (ETF), and the best aspects of a gold operator. The message has worked with investors, and Franco-Nevada’s market capitalization  as of yesterday was over US$14 billion [at press time on Aug. 13 it was US$17.60 billion]. So we’re just behind Newmont Goldcorp (TSX: NGT: NYSE: NEM) and Barrick Gold (TSX: ABX; NYSE: GOLD), and among the global gold companies by market capitalization.

The other thing that’s important is having a broad portfolio. And because it’s such a simple business, we can be involved in a lot of properties and manage it with few people.

We’re involved in not only producing and advanced projects, but also a lot of exploration projects. We add to these small properties every month.

If it’s good geology, we’re very patient with them, but we’re always interested in the upside.

Because we have such a broad portfolio, we’ve become a proxy of the entire gold industry, so we’re covering all stages of projects.

It’s about 370 assets that we’re administering now, and we’re doing it with 34 employees. Our properties cover 44,000 sq. km, and that’s about the size of Switzerland.

But it’s better than Switzerland, because we’re trying to do it on the right trends. So we’re trying to pick the good geology within that. It’s an advantage that it’s a simple business, and so it doesn’t cost a lot to run.

I have my past auditor here and he’ll verify the numbers, but our general and administrative (G&A) costs on a quarterly basis have been almost flat for over a decade, and that’s despite our revenues going up sixfold. So this is an absolutely scalable business.

I would love to have a thousand royalties and maybe we add one or two auditors, but we’ve got that capacity because every asset we buy is incremental, and there’s not a lot of management effort going forward.

I’m told that with our number of employees at 34, we have the highest market capitalization per employee of any company on the New York Stock Exchange, so we’ll try to maintain that.

Some of the things that have really driven our portfolio in the last few years is that we have got long-life assets. And an advantage of being in the royalty business is that we’re not restricted to just gold properties and gold companies.

What we’ve been able to do is buy gold and silver from the large porphyry gold projects and the skarn projects in Latin America. The advantage of some of these assets is that they can go for 30 to 50 years. It’s hard to find those types of assets in the gold industry.

Cobre Panama is going to make its first official concentrate shipment next month [June 2019]. This is going to be a cornerstone asset for our company. First Quantum has been developing it, and it’s still probably the largest mining development project in the world, just coming to completion right now. We’re very proud to be associated with that.

We have quality franchises here that we’re participating in: mines that are run by BHP, Glencore, Teck Resources (TSX: TECK.B; NYSE: TECK), First Quantum Minerals (TSX: FM) and the Lundins of the world. In terms of performance, you can see there’s a good, strong, linear trend … our performance was off just a bit in 2018, because there was a pit slide at our Candelaria mine in Chile, which is one of our largest cash-flow producers.

It was the first year we didn’t make guidance, but I feel like we have hit the ground running for this year.

Just a week and a half ago [in early May] we had our first-quarter release, and we had record earnings and record revenue numbers for the company.

And what we’re telegraphing right now is that this is really the start of a bunch of records, because with Cobre Panama coming, with Candelaria getting back to normal operations — and we have a lot of growth coming from our own gas assets — we expect to hit further records in the second half of this year, and through next year.

We’re one of the growth companies in the industry. It’s a very good story. I like to point out that we measured G&A as a percentage of the value of our company, because one of the things that a lot of investors buy is the gold ETF, the GLD. And to be exposed to gold through ETF, it costs you 40 basis points — 0.4% — of every year to hold that gold.

Our entire overhead is running at about 17 basis points. We’re kind of twice as efficient as a gold ETF, and we can do that with active management of these assets.

And then … there are the dividends. I listened earlier to Steve Letwin from Iamgold … and we have achieved the dream: we are a free cash flow-generating business that not only generates enough cash for dividends and growing dividends, but also to do the reinvestment. We’re self-financing going forward.

We have raised our dividend every year for the last 12 years. We just made our last announcement again 10 days ago at our annual meeting.

Anyone who bought us at our initial public offering in Canada now gets almost a 9% yield from their investment in Franco-Nevada, if they bought us 11 years ago. It just shows you the power of compounding dividends.

One of the nice things about this company is that I can’t even screw it up. If our entire management team and board gets hit by a bus … we can maintain these dividends for the next 35 years and still have billions leftover in the treasury. So I’d have to make a major mistake to screw it up at this stage.

We have got a powerful business model, and what we’re now focused on is proper succession planning to keep the DNA in order, so we can preserve this model going forward. We’ve coined ourselves as “Franco-Nevada: the gold investment that works.”

We now have 11.5 years of returns to our investors. It’s a 17% compounded annual growth rate of total return to our investors.

And this has been in a market that has been a bit of a bull, bear and neutral market for the last 11.5 years. I’m just wondering what we can do in a bull market.

So this has been a demonstration that active management … [can] outperform passive management. You can outperform the commodity, and our business model and portfolio demonstrates that.

 

Q&A session

 

The Northern Miner: The first notes I wrote down while preparing for this interview were: “One of the greatest success stories in the gold sector this millennium … in a class by itself.”

Your first-quarter results were spectacular, and then you had some big news, that the cofounder of Franco-Nevada 1.0, Pierre Lassonde, would retire next year. Could you comment on your search for a new chairman and your thoughts on succession in a company like yours?

David Harquail: What we’d been doing is this: I have been with the original Franco and the new Franco for about 32 years. It started around 1985, when we first bought that Goldstrike royalty in Nevada that made the company.

What’s important is what makes companies successful. And you can even look at Agnico Eagle Mines (TSX: AEM; NYSE: AEM), they kind of have the DNA of the founder, and there are certain things that make the company successful, so you don’t want to turn over everything all at once, and then you’ve lost that DNA.

So we’ve been very cautious in terms of trying to remember what Seymour Schulich and Pierre Lassonde did differently back in 1985, in terms of building that company in the 1980s and ’90s. And when we came back and relaunched Franco-Nevada, we tried to bring back as many of the original people as possible.

And then when we bring new people in, it’s always educating them in terms of: keep those overheads low, keep the organization focused on new investments, take care of existing investments and manage the ego of the CEO — don’t let him think he’s the master of the universe.

All of the organization is there to keep me humble. Whoever is going to be the new CEO of the company, well, we have kind of lined that up right now. We’re trying to have an organization where we’re more of a partnership than having a large ego running the company.

We’re doing all of this internally because it’s important to keep the DNA. Last year we appointed Paul Brink, who has been with me for 14 years, as the president and chief operating officer. Essentially, he’s the CEO designate, and Pierre, this year, has announced that one year from now he’ll step down as chair.

I have been going through Europe, and we’d just been marketing in the U.S. as well, to touch base with the institutions to say, “What is the proper choice going forward, and governance-wise?”

Because they’re the owners of the company, we consult with them on the choice.

I have my hand up to be the next chair of Franco-Nevada. But we have to consult with the large institutions before we make a decision later this year. We’re getting good feedback on that.

TNM: Good to hear. When you think of Franco-Nevada, you think of a superstar singer or film actor who makes it all look easy, but there’s a lot of work going on in the background. Could you comment on how you craft a royalty deal, for example, choosing between royalties, streaming or net profits, how to negotiate the deal, when to renegotiate, that kind of thing?

DH: It’s easy. The thing is the luxury we have. It’s good to remember that our very first royalty was Goldstrike. So that was a cash cow right there.

And when you have that, then you have the ability to buy things when the market dips. And because it’s such a cyclical industry, if you have got the ability to buy things when the market dips, you can buy great assets.

The only tough part is not to buy things when there’s a bull market.

We  have done our best deals when the downturn happened. For instance, [during] the global financial crisis — we did the Palmarejo–Guadalupe deal, and they’re company makers for us. We had the dip in the base metal companies from 2014 to 2016. It was BHP, Glencore, and Teck, and Freeport that were coming to us for help on their balance sheet.

We’re able to buy into their best mines and buy the gold out of those copper mines.

The other thing we have to resist is when we’re in the bull market and we’re not spending money, we’re actually piling up [cash]. Suddenly we have more than $1 billion in cash, and I get this: “Oh, you have a lazy balance sheet. Dividend it out or go buy something and accelerate your growth.”

That’s the only hard part: not spending money sometimes. What we want to do is keep that money because we want to be the only ones that can write a check on the next downturn.

Right now we have just dipped into our revolver, so we have just a bit of debt in the company, and that’s because we’re finding a lot of things to buy. So we’re countercyclical.

TNM: How much of your time is tracking existing royalties, and waiting, who knows, 10 years to buy a royalty off someone when their fortunes  maybe change, and how much of your time is spent creating royalties from scratch?

DH: Opportunity comes in waves. Because we had the base metal companies in trouble, our money and time was spent on that capital — helping them fix their balance sheets. Right now there’s not a lot of that, so we’re doing just the small exploration or early-stage projects, because we can afford to get into some of these projects early.

Just earlier this year we put $20 million in Marathon Gold’s Valentine Lake deposit in Newfoundland, because we think that’s a great orebody, and someone’s going to build that mine. We’re in early, we have a royalty.

We have just done Salares Norte with Gold Fields (NYSE: GFI). We bought the underlying ore in that project, and there’s a pre-final feasibility on it. But again, we’re absolutely confident both of these will be mines in the next five to 10 years, and we think we’re buying it at a price that even if it takes 10 years, we’re still making money on them.

We have the luxury. We can buy some of these long-dated assets beyond the time frame of most other investors because of the nature of the portfolio.

In terms of creating royalties, that’s when you’re into the mine financing and building stage. We’re really not at that stage, and I think that’s going to start happening next year.

Right now we’re spending most of our time deploying in the oil and gas industry on the U.S. side. We’re finding a lot of opportunity there, so there has been a lot of focus on that recently.

TNM: What kind of a relationship do you have with these companies after you strike the royalty deal? Is it hands off, or do you want to help out?

DH: It’s hands off, and, you know, it’s a nice thing. What I’m proud of is that in 32 years and hundreds of royalties, I have never had a lawsuit with any of the operators. We have very simple royalty contracts in Western courts of law. So no one has ever challenged them. Sometimes there’s an auditing issue … we’ll do it, but it’s very rare we ever go to an arbitration on an audit issue.

So, I think we’re seen as good partners. We help out on local community and social investments. We help fund the school program around a mine. At Detour, there was a fatality there, and so, we’re helping to fund some of the efforts to support the families who have lost their main partner.

We finance, of course, the Canadian Mining Hall of Fame. We sponsor that, and I was chair, but also the Prospectors & Developers Association of Canada Awards.

We want to help bring out the best in the industry.

TNM: On the world map of Franco’s portfolio, there are 227 exploration assets. They are obviously not material, but there’s a lot of them. What is your philosophy towards investing in juniors?

DH: Well, it’s good geology. It’s not so much the juniors, it’s: is that an interesting property? …  We can buy it, whoever owns it, because if it’s a good property, it’s going to go to stronger hands, eventually.

We were into Goldstrike before Barrick was. We were into Cobre Panama before First Quantum was.

If it’s a good orebody, it’s always going to attract a stronger operator, and so it’s the deposit itself. That’s where we have the tenure. It outlasts management teams, because those change all the time.

TNM: On a more personal note, you are a significant donor to charities, especially medical research and education. There’s the Harquail School of Earth Sciences at Laurentian University. Any reflections on this?

DH: I’m following my mentors’ footsteps. Seymour Schulich has been one of the biggest benefactors in Canada, so is Pierre Lassonde.

Our philosophy is that we don’t use the company to give money to charities. We do it with our own money. And so we just do mining-related charity in institutions. But for hospitals and universities, it has to come from your own pocket.

I have done it, but it’s actually my family. My wife and daughter are here, and we called it the Midas Touch Foundation, because if you remember, the Midas mine was where we made a lot of our money.

Our dog is named Midas, and he happens to be a Golden Retriever. So the whole family’s involved in this effort.

What I like is that Pierre has done the Lassonde mining school. I’ve done the exploration school in Sudbury because I think the biggest wealth, is not by financial engineering, it’s by finding new orebodies.

If we can have some of these kids find new orebodies in Canada, everybody’s going to win. So that’s the fun part. And I hope to get more involved in it over time.