Creating Income from Franco-Nevada

To say that the gold mining sector has underperformed over the last 3-4 years is a significant understatement. The sentiment in the group has never been more negative as some darling gold miners have lost more than 90% of their value. Yet, in that environment, one gold company has been able to stand strong like the Rock of Gibraltar – Franco-Nevada.

Franco-Nevada is a gold-focused royalty company. Instead of developing and operating mines, they focus on a diversified portfolio of royalties from highly favourable properties. This has allowed the stock to materially differentiate itself. There unique business plan, has over the last few years been tested against some the most perilous market conditions, and the company has thrived. This includes the stock testing all time new highs at the start of the 2015 year.

While I am not interested in cheer-leading the stock, it was solely my objective to differentiate Franco-Nevada from the overwhelmingly negative sentiment overshadowing the entire gold and silver mining sector.

While virtually flat on the year in regards to performance, the stock has experienced considerable volatility having traded as high as $74.00 and as low as $50.00. At its current price of $58.75, the stock is sitting pretty close to the mid-point of its year range. From my perspective, this is a perfect stock for investors seeking covered call income. The stock has proven to be able to weather the storm and continue to deliver to investors. At the same time, the volatility offers the potential for covered call income worthy of consideration.

In the example:

• Investor buys 1000 shares of Franco-Nevada at $58.75 for $58,750.00.
• Investor sells 10 April $60 strike covered calls for $5.60 or $5,600 in cash proceeds.

What has the investor accomplished?

The investor has generated a 9.53% cash flow for the obligation to potentially have to sell the stock at $60.00 over the next 6 months. That is close to a 20% annualized premium. While the risk of an early exercise is a possibility, the investor is likely to enhance that income return with the 1.90% dividend the company pays annually.

In addition, if the stock was to decline while the investor is holding it, the stock would need to decline below $53.15 in order for the investor to be in a loss, when taking the premium income into consideration.

If the investor was to be exercised and the stock was sold at $60.00,the investor would have realized a 11.66% realized gain in just 6 months.

In today’s market environment, where it is hard to find any safe haven, or any sound income, a covered call on Franco-Nevada may be a respectable consideration.