Franco-Nevada Corporation's (NYSE: FNV) adjusted EBITDA was up just under 1% in 2018. That sounds like pretty dismal performance until you consider that the streaming and royalty company's precious metals production fell roughly 10% last year. Rising gold and silver prices weren't the reason for the uptick in revenue, however. It was increased production in the company's expanding energy business. That shows the value of diversification, but here's the worrying takeaway hidden in the big-picture numbers at Franco-Nevada.
A temporary downturn
Before getting into the energy space, it is important to note that Franco-Nevada's gold equivalent ounce production in 2018 was impacted by material production shortfalls in Latin America. To put a number on that, in the fourth quarter, this segment saw production fall roughly 30% year over year. Production from the rest of the regions in which it operates was mostly flat. Within Latin America, shortfalls at two of its mine investments, Candelaria and Guadalupe-Palmarejo, were the main drags.
These are basically expected to be temporary setbacks. Management described Candelaria (which is one of the company's big three mines, accounting for around 10% of adjusted EBITDA) as a timing issue. Production is expected to turn around in 2019 as the mine begins processing higher-quality ore. Guadalupe-Palmarejo was down because there was less production from the mines on which Franco-Nevada owns streams. That's likely to continue in 2019 but is not expected to be as material to results.
Overall, Franco-Nevada is projecting an increase in production in 2019 of between roughly 4% and 11%. The main driver will be production increases from newer projects, like Cobre Panama, that are finally starting to bear fruit. All in all, last year was a rough one on the precious metals side of the business (about 87% of adjusted EBITDA) but not horrible, and there wasn't anything that was expected to turn into a lingering negative. But really, the big story in 2018 for Franco-Nevada wasn't gold and silver, it was oil.
Oil's well that ends well?
The streaming company has made the unique decision relative to peers to use the weak energy market to expand its presence in the energy sector at what it believes to be opportunistic prices. That's not out of character for Franco-Nevada, which has long invested in the space. However, the push into oil has clearly picked up steam and was a huge overall benefit in 2018, as it helped to offset the weakness on the precious metals side of things.
The company's energy revenues increased by just over 80% last year. The uptick here was the only reason that Franco-Nevada's adjusted EBITDA didn't fall year over year. Production is expected to grow in 2019 as well. Only revenue from this division is projected to be roughly flat year over year. That's a potential headwind that investors need to consider, even though the energy business is still growing. What's going on?
There are two big issues. First, 2018 performance was boosted by one-time payments, called lease bonuses. These are, essentially, lump-sum payments to Franco-Nevada from drillers that are starting up production on its land. These payments might happen in 2019, but it isn't something that management can project, so it's erring on the side of caution and assuming there are none in 2019. The next big issue, and the more important one for investors to think about, is that Franco-Nevada is projecting oil prices of $55 a barrel in 2019, down from roughly $65 in 2018.
Effectively, the company is expecting production increases will offset commodity weakness in 2019. The end result is roughly flat revenue. It's an important factor to consider, since oil can be highly volatile. Investors were reminded of this fact in the fourth quarter of 2018, when oil quickly fell into a bear market. And all oil investments aren't created equal. For example, Franco-Nevada's onshore U.S. oil benefited from a year-over-year price increase of around 6% in the fourth quarter, but the company's Canadian oil investments suffered through a massive 28% price decline. That, coupled with government-mandated production cuts, led to a 50% drop in revenues from Franco-Nevada's Canadian energy assets. Canada is a relatively small portion of the energy business at this point, but it highlights the fact that, despite the 2018 strength in oil overall, it is still a volatile commodity.
The big takeaway
Stepping back, 2018 was all about oil for Franco-Nevada. Growth in that business helped the company offset weakness on the precious metals side and was a huge net positive. However, there's not likely to be a repeat performance in 2019. Management is still excited about the long-term outlook for energy (it's projecting as much as an 85% revenue increase by 2023), but if the commodity outlook for this year plays out as expected, performance on the energy side will be flat at best in 2019. In other words, the saving grace in 2018 is set to turn into a bit of a headwind in 2019. That's not bad, it's just par for the course when dealing with commodities.
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