Seeking Alpha
Research analyst, long/short equity, tech
Profile| Send Message|
( followers)  

Silver Wheaton (NYSE:SLW) will declare its annual and fourth quarter results this week. Last quarter, the company reported a 13% year-over-year increase in revenues to $161.3 million while net income declined by 11% year-over-year to $119.7 million. Although it reported a steep jump in production to 7.7 million equivalent ounces of silver due to the addition of production from Hudbay’s 777 mine, sales amounted to only 5.1 million ounces due to the timing of deliveries. Therefore, the sale of 2 million ounces of silver should be recognized in future quarters. We expect part of that to be reflected in sales for the fourth quarter, thus boosting the quantity of shipments in that period. (Silver Wheaton Reports Record Quarterly Production Results, Silver Wheaton Press Release)

Any upside in the price of silver benefits Silver Wheaton which buys silver from mining companies at fixed prices under long-term contracts but sells it at market prices. Since average silver prices have been higher compared to the third quarter and sales are expected to be higher as mentioned above, we expect higher sequential revenues and profit margins in the fourth quarter. The reason for higher prices in the fourth quarter could have been investment demand driven by apprehensions over the fiscal cliff situation. Prices have moderated since then. [1]

Business Model

Silver Wheaton signs long-term purchase agreements with mining companies (typically gold and copper mining companies) that produce silver as a by-product. The company has the right to purchase all or a portion of the silver production at a low fixed price for an upfront payment pursuant to any agreement. This gives it an edge over conventional mining companies as it does not incur any kind of operational losses in volatile market conditions. Moreover, since the company does not own any of the mines, it does not incur any operational and capital costs associated with production.

Deal With Vale

The most notable activity in the last few months was Silver Wheaton’s deal with Vale to acquire its gold production from the Sudbury and Sabobo mines.

The company will pay Vale $1.9 billion in cash, plus 10 million Silver Wheaton warrants with a strike price of $65 and a term of 10 years. Of the $1.9 billion, $1.33 billion will be paid for 25% of the gold output from the Salobo mine in Brazil and $570 million for 70% of the gold output from the Sudbury mine in Canada. In addition, Silver Wheaton will pay the lesser of $400 or market price for each ounce of gold produced, subject to a 1% inflation related adjustment after 2016 for Salobo. The deal is valid for 20 years.

The agreement with Vale will add an average of 110,000 ounces of gold per year over the next 20 years (5.9 million silver equivalent ounces). It will cause the share of gold in Silver Wheaton’s revenues to rise from an average 12% to a peak value of 25% over the next five years. Silver Wheaton now forecasts 33.5 million ounces of silver equivalent production (including 145,000 ounces of gold) in 2013. In 2017, it forecasts 53 million ounces of silver equivalent production (including 180,000 ounces of gold). (Silver Wheaton Acquires Gold Streams From Vale’s Salobo And Sudbury Mines, Silver Wheaton Press Release)

You can check the impact of the new silver stream on Silver Wheaton’s Trefis price estimate in the following graph and modify it using your own expectations and check the impact it will have on the company’s valuation.

Some concerns have been raised that the net present value (NYSE:NPV) for the Vale deal doesn’t look attractive at today’s gold prices and that the deal is essentially a bet on gold prices rising much higher than today’s levels. We are interested in listening to Silver Wheaton’s management discuss the issue if a question is raised to this effect on the conference call. [2]

CEO Randy Smallwood recently said that he is looking to close more deals in 2013 at the right valuation. The company has around $1 billion to spend on more deals. We will be looking for any further comments in this regard. [3]

We have a price estimate for the company of $38 which will be revised after the earnings results.

Notes:

  1. 1 Year Silver Prices, Silver Price
  2. Silver Wheaton’s Bad Big Deal, Seeking Alpha
  3. Silver Wheaton chief would be ‘surprised’ not to close more deals this year, Mining Weekly

Disclosure: No positions

Source: Silver Wheaton Earnings: Production, Vale Deal And Guidance In Focus