Over the past four months, the stocks in the gold and silver mining sectors have fallen dramatically. This has provided an excellent opportunity to investigate companies in these sectors for investment purposes. One company worth looking at is Silver Wheaton Corporation (SLW).
Established in 2004, Silver Wheaton has quickly positioned itself as the largest precious metal streaming company in the world. The company has a number of agreements where, in exchange for an upfront payment, it has the right to purchase all or a portion of the silver and/or gold production, at a low fixed cost, from high-quality mines located in politically stable regions around the globe.
Over the past four years, Silver Wheaton has produced some excellent results. Their revenues have increased from $239 million in 2009 to $856 million in Q1 of 2013. As well the company's net earnings have increased from $118 million in 2009 to $572 million in Q1 of 2013. To support its new dividend policy where Silver Wheaton now calculates and distributes 20% of its operating cash flow, this metric has improved from $166 million in 2009 to $721 million in 2013 TTM.
On Feb. 5, 2013, Silver Wheaton announced that it has entered into a binding term sheet to acquire from a subsidiary of Vale S.A. (VALE). The agreement was for an amount of gold equal to 25% of the life of mine gold production from its Salobo Mine, located in Brazil, as well as 70% of the gold production, for a 20-year term, from certain of its Sudbury Mines located in Canada.
In the agreement, Silver Wheaton will pay Vale S.A. total cash consideration of US$1.90 billion, plus 10 million Silver Wheaton warrants with a strike price of US$65 and a term of 10 years. US$1.33 billion will be paid for 25% of the gold production from Salobo, while US$570 million will be paid for 70% of the Sudbury gold production. In addition, Silver Wheaton will make ongoing payments of the lesser of US$400 (subject to a 1% annual inflation adjustment from 2016 for Salobo) and the prevailing market price, for each ounce of gold delivered under the agreement.
According to Silver Wheaton, the acquisition will have many benefits. These benefits include immediate cash flow, increased exposure to gold, a world class partnership (with Vale S.A.) and an increased organic growth profile. The company financed the acquisition by cash on hand and an additional credit capacity.
Currently, Silver Wheaton has fifteen silver purchase agreements and four precious metal purchase agreements with fifteen mining partners around the globe. Some of these partners include Goldcorp (GG), Eldorado Gold (EGO) and Capstone Mining Corp. (CSFFF.PK).
As Silver Wheaton took on a substantial amount of debt to pay for the acquisition, it is important to look at the debt side of the company to understand if the company has leveraged itself or created any financial red flags that might be a negative signal for the investor.
In the article below, I will calculate important ratios in understanding the amount of debt and liabilities the company has incurred. From this analysis, we will understand more about Silver Wheaton's debt, liabilities and financial risk.
Total Debt = Long-Term Debt + Short-Term Debt
Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt due within one year.
- 2009 - $107 million + $29 million = $136 million
- 2010 - $79 million + $29 million = $108 million
- 2011 - $50 million + $29 million = $79 million
- 2012 - $22 million + $29 million = $51 million
- 2013 TTM - $14 million + $1.090 billion = $1.104 billion
As the stats above indicate, in Q1 of 2013, Silver Wheaton added a very large amount of short-term debt. This debt was added due to Silver Wheaton paying $1.9 billion for a streaming contract with Vale SA.
Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities are the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.
- 2009 - $513 million
- 2010 - $373 million
- 2011 - $218 million
- 2012 - $82 million
- 2013 TTM - $1.174 billion
Since 2009, Silver Wheaton has been busy purchasing streaming rights from many companies. Silver Wheaton has bought output rights from Vale SA, Hudbay Minerals Inc. (HBM) and Barrick Gold Corp.(ABX). Silver Wheaton has also bought shares in Bear Creek Mining Corp. (BCEKF.PK), which is developing silver mines in Peru, but until the recent purchase of rights from Vale SA, Silver Wheaton was reducing its liabilities.
As the company's amount of debt and amount of liabilities have increased significantly in Q1 of 2013, the next step will reveal if the company has the ability to pay them.
Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets. Meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2011 - $79 million / $2.872 billion = .03
- 2012 - $51 million / $3.189 billion = .02
- 2013 TTM - $1.104 billion / $4.400 billion = .25
Silver Wheaton currently has a total debt to total assets ratio of .25. The total debt to total assets ratio has increased significantly from the recent acquisition. As the total debt to total assets ratio has increased, this indicates that since 2011, the company has added more total debt than assets. As the number is currently below 1, this indicates that the company has more assets than total debt. Even though the number has increased, it is still quite low. This metric indicates a low amount financial risk to the company.
Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.
- 2011 - $218 million / $2.872 billion = .08
- 2012 - $82 million / $3.189 billion = .03
- 2013 TTM - $1.174 billion / $4.400 billion = .27
In looking at Silver Wheaton's total liabilities to total assets ratio over the past couple of years, we can see that the number has significantly increased in 2013. The ratio has increased from .03 in 2012 to .27 in 2013 TTM. As the number has increased, so is the risk to the company.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2011 - $2.654 billion / $2.872 billion = .92
- 2012 - $3.107 billion / $3.189 billion = .97
- 2013 TTM - $3.226 billion / $4.400 billion = .73
Compared with 2011, Silver Wheaton's debt-to-equity ratio has decreased. The ratio has decreased from .92 to .73. As the ratio is currently below 1, this indicates that shareholders have more invested than suppliers, lenders, creditors and obligators. .73 indicates a low-to-moderate amount of risk for the company. As the ratio is below 1 and considered moderately low, so is the risk for the company.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2011 - $50 million / $2.922 billion = .02
- 2012 - $22 million / $3.211 billion = .01
- 2013 TTM - $14 million / $4.414 billion = .003
Over the past three years, Silver Wheaton's capitalization ratio has decreased from .02 to .003. As the capitalization ratio decreased, this implies that Silver Wheaton has acquired less long-term debt than shareholders' equity. As this is the case, the company has more equity to support its operations and add growth. As this ratio has decreased financially this implies a decrease in risk to the company.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2011 - $626 million / $79 million = 7.92
- 2012 - $719 million / $51 million = 14.10
- 2013 TTM - $721 million / $1.104 billion = .65
Over the past couple of years, the cash flow to total debt ratio has decreased significantly. Due to the purchase in February, this ratio has dropped from 14.10 in December 2012 to .65 in February 2013. As the current cash flow to debt ratio is below 1, this implies that the company does not have the ability to cover its total debt with its yearly cash flow from operations.
Based on the five debt ratios listed above, we can see an increase in financial risk when compared to December 2012. As the debt is considered short-term, the acquisition does not show up on the long-term debt ratios. If we look at the company's debt ratios that include short-term debt, we will notice a significant increase in risk that is associated with the company. Even though there has been a large increase in debt, the overall stability of the company from this acquisition regarding its debt shows that the company has not overleveraged itself or made it hard for the company to pay back the debt.
As the price of silver (SLV) and gold (GLD) has declined significantly over the past four months, the company will have lower realized prices for their commodities moving forward than previously planned. The next step will reveal how much the company will pay for the debt incurred.
Cost of Debt
The cost of debt is the effective rate that a company pays on its total debt.
As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing.
This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.
Currently Silver Wheaton does not have any bonds issued. Until June 30th, 2013, Silver Wheaton has agreed to,"at the Company's option, amounts drawn under the Bridge Facility incur interest at either (I) LIBOR plus 1.70% or; (ii) the Bank of Nova Scotia's (BNS) Base Rate plus 0.70%."
As of May 24th, 2013 the Canadian LIBOR rate = 1.78% + 1.70% = 3.48%
Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- Current cost of Debt as of May 28th 2013 = 3.48%
Current tax rate
- 2011 - $8 million / $558 million = 1.43%
- 2012 - $15 million / $601 million = 2.50%
- 2013 TTM - $16 million / $588 million = 2.72%
2010 - 2012 3-year average = 2.72%
From 2011 - 2013, TTM Silver Wheaton has averaged tax rate of 2.72%.
Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 - Tax Rate)
The effective rate that a company pays on its current debt after tax.
- .0348 x (1 - .0272) = Cost of debt after tax
The cost of debt after tax for Silver Wheaton is 3.39%
Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
The cost of equity is the return a firm theoretically pays to its equity investors (for example, shareholders) to compensate for the risk they undertake by investing in their company.
- Risk Free Rate = U.S. 10-year bond = 2.04% (Bloomberg)
- Average Market Return 1950 - 2013 = 7%
- Beta = (Google Finance) Silver Wheaton's Beta = 1.56
Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
- 1.56 + 1.56 (7- 2.04)
- 1.56 + 1.56 x 4.96
- 1.56 + 7.74 = 9.3%
Currently, Silver Wheaton has a Cost of Equity or R Equity of 9.3%, so investors should expect to get a return of 9.3% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.
(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate, which is susceptible to daily change and Google Finance beta.)
Weighted Average Cost of Capital or WACC
The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.
As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk.
By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances.
For this calculation, you will need to know the following listed below:
Tax Rate = 2.72%
Cost of Debt (before tax) or R debt = 3.48%
Cost of Equity or R equity = 9.3%
Debt (Total Liabilities) for 2012 or D = $1.174 billion
Stock Price = $22.74 (May 28th, 2013)
Outstanding Shares = 354.61 million
Equity = Stock price x Outstanding Shares or E = $8.064 billion
Debt + Equity or D+E = $9.238 billion
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .0272) x .0348 x ($1.174/$9.238) + .093 ($8.064/$9.238)
.9728 x .0348 x .1271 + .093 x .8729
.0043 + .0811
Based on the calculations above, we can conclude that Silver Wheaton pays 8.54% on every dollar that it finances, or 8.54 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0854 plus the cost of the investment for the investment to be feasible for the company.
Debt Side Summary
All indications above reveal that Silver Wheaton has increased its financial risk when compared to 2011. Even though, all of the ratios that include short-term debt have displayed an increase in financial risk, they are still relatively low. As the ratios are still quite low, the company indicates no risk of being highly leveraged, or in any financial distress. The CAPM states that the investor needs 9.30% year-over-year over the long term to get good value on his or her money.
As Silver Wheaton added two significant gold metal streams in 2013, Silver Wheaton estimates silver equivalent production to be 33.5 million silver equivalent ounces, including 145 thousand ounces of gold. Over the next four years, Silver Wheaton predicts annual attributable production to increase over 80% compared to 2012 levels. They estimate growth to be at 53 million silver equivalent ounces, including 180 thousand ounces of gold.
As the current market for silver and gold has fallen, Silver Wheaton will have lower realized silver and gold prices in the upcoming quarters. These lower realized prices will affect earning expectations and realized earnings in the near future, which brings me back to the $1.09 billion short-term debt. In a recent article, Randy Smallwood, CEO for Silver Wheaton stated "Given Silver Wheaton's strong cash flows and relatively fixed costs, we are very comfortable with our current balance sheet and our ability to swiftly repay the outstanding debt". As Bloomberg analysts are expecting revenues of $895 million for FY 2013 and $1.1 billion for FY 2014, it should take some time to pay-off a $1.09 billion debt. On May 28th 2013, Silver Wheaton announced "the closing of a US$1 billion non-revolving term loan ("NRT Loan"), with a 3-year term, extendable by 1 year with the unanimous consent of lenders."
Over the next few years, analysts at MSN Money are predicting Silver Wheaton to have an EPS of $1.69 for FY 2013 and an EPS of $2.00 for FY 2014. Analysts at Bloomberg are estimating Silver Wheaton's revenue to be $895 million for FY 2013 and $1.1 billion for FY 2014.
Chart sourced by (FINVIZ)
The above analysis reveals that Silver Wheaton Corporation is a solid company on the debt side. It has significantly increased its debt levels over the past year but all of the ratios imply that the company is not "over-leveraged" or currently in any financial distress. Currently, they have a couple of forces working against them. They must payoff a billion dollar debt that they accumulated in the recent Vale S.A. deal and they must do this with lower realized silver and gold prices.
On the positive side, they have an excellent growth profile. As Silver Wheaton is looking to increase production by over 80% in the next four years, this should create shareholder value in the long-term.
Based on the chart above, the stock is currently on a strong downtrend. I believe patience is needed at this point. When the commodity prices finally find a bottom and when the stock price matches that movement and ultimately begins break to the upside, it should prove be an excellent opportunity to invest in a company with an excellent growth profile.