The mining industry presents substantial risks to the companies that operate in it. Though some mines have much greater payoffs in production than expected, other sites that look extremely promising can turn out to be relative duds. Companies like Franco-Nevada (NYSE: FNV) however, avoid many of the risks of precious metals mining because they're in the business of streaming -- making deals that provide up-front financing to mining companies. Such arrangements provide them fairly secure payouts, while leaving the actual miners on the hook with regards to project operations. Nevertheless, there are risks on both sides of streaming agreements, and Franco-Nevada's recent commitment to add further exposure to the Cobre Panama open-pit project on the Caribbean coast west of Panama City shows just how important the massive mine could be to the streaming specialist's future success.
What is Cobre Panama and why is it important?
Cobre Panama is one of the world's largest porphyry deposit extraction projects under construction, with exposure to copper, gold, and silver. Franco-Nevada has been involved with Canadian mining company First Quantum Minerals on the project since late 2015. Under the terms of the streaming deal they signed then, Franco-Nevada committed to provide up to $1 billion in capital, maintaining a 1-to-3 ratio in relation to First Quantum's share of the capital costs of developing the project. As of the end of 2016, Franco-Nevada had already contributed $462 million, and expected to lay out between $200 million and $220 million in 2017.
First Quantum expects that total investment in Cobre Panama will amount to nearly $5.5 billion. It hopes the project will come online in 2018, and forecasts that the mine could produce 320,000 metric tons of copper by 2019, a result that would push First Quantum into the ranks of the top half-dozen copper producers in the world.
For Franco-Nevada, the value of Cobre Panama will not reside in the copper that will be its largest output. Porphyry copper deposits also contain gold and silver, which are mined as byproducts. Under Franco-Nevada's streaming agreement, it will obtain the majority of the gold and silver Cobre Panama produces at far below market value, though the exact amounts it will be be able to purchase at those discounts won't be known until proportions and volumes of copper produced are established. The streamer has estimated that it should get rights to about 86% of precious metals attributable to First Quantum; future streams will be defined by a fixed percentage of gold and silver within the mine's copper concentrate.
What Franco-Nevada just did with Cobre Panama
The $1 billion commitment that Franco-Nevada made to Cobre Panama turns out not to be the end of the story. Earlier this month, Franco-Nevada announced that it will purchase an additional precious metals stream from the project for $178 million. The deal came as First Quantum acquired an additional 10% stake in Cobre Panama from one of its former joint-venture partners. As a result, Franco-Nevada will be able to buy up to 300,000 ounces of gold and 4.8 million ounces of silver at just 20% of their spot prices. Beyond those amounts, the prices will rise to 50% of spot, giving First Quantum plenty of incentive to maximize production from the mine.
Franco-Nevada took some steps to ensure it can handle any additional risk. The company reserved the right to syndicate as much as a third of the transaction amount to outside parties, a move that many financing companies use in order to spread out asset-specific risks. Whether it will actually do so remains to be seen, but just having the ability is a positive.
What to expect from Franco-Nevada
Franco-Nevada recently said that it sees relatively few opportunities in the precious metals space. That has motivated it to switch its focus toward the energy sector, with recent deals to obtain royalty interests in oil and gas projects offering what Franco-Nevada sees as better chances for greater profit.
Still, investors should expect Franco-Nevada to take advantage of mining opportunities as they arise. For a project that the company already has confidence in, Franco-Nevada has demonstrated its willingness to take on added risk in order to maximize long-term reward for itself and its shareholders.
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