The Vancouver-based Silver Wheaton (SLW), which helps finance mining projects in exchange for the right to buy future silver production at a discounted price, reported second quarter EPS of $0.21 slightly below consensus estimates of $0.25. The earnings miss was largely attributable to lower-than-expected sales, as the company added ounces to its produced but not delivered position.
SLW's unique business model provides investors with a highly-levered play on silver and gold prices. Moreover, the company's fixed cost structure and strong liquidity position warrants premium valuation relative to its peers.
One of the key strengths of SLW's business model is the low predictable cash costs for both silver and gold production. In 2Q13, the company had average cash costs of $4.14 per ounce and $391 per ounce for silver and gold respectively. SLW's costs are among the lowest in the precious metal industry and are the reason SLW is able to generate significant cash flows at current commodity prices.
On a recent conference call with investors and analysts, SLW noted that the long-term expectations are still pretty bullish for the silver and gold than the recent price performance of the metals is suggesting. However, the company noted that it will avoid making investment decisions in a volatile time and would wait for prices to stabilize before making any big capital decisions.
Silver Wheaton's liquidity position remains strong. The company recently entered into a $1 billion non-revolving term loan with a 3-year term (extendable by 1 year) to repay outstanding balances on its facilities. The company now has $36 million in cash, plus additional liquidity from an undrawn $1 billion revolving credit facility.
Pascua Lama Delay Weighing On An Otherwise Strong Company
SLW recently negotiated its contract with Barrick Gold (ABX) and extended the deadline by another year to 2016. If ABX fails to deliver on its terms of the contract, SLW will have the right to terminate the contract and be entitled to the return of its $625 million upfront cash payment, less credits for silver delivered. However, Pascua Lama represents an important asset that the company acquired in 2009 and given the significant value of the mine, it is unlikely that SLW would walk away from the project. The company remains in close contact with ABX and remains confident in Barrick's ability to bring this low cost world-class mine in production on time.
Modified Dividend Policy
Silver Wheaton has a dividend yield of 1.5%. The company smoothed its dividend policy and will now pay dividend based on 20% of the average operating cash flow generated in the last 3 quarters. With its modified dividend policy, the company is trying to mitigate some of the volatility in the amount of the quarterly dividend. The next quarterly dividend of $0.10 will be paid on Sept. 12 to shareholders of record on August 30, 2013.
Investment Thesis and Conclusion
We have a buy rating on SLW. After outperforming for many years, Silver Wheaton is suffering from bearish market sentiment the industry is facing. However, SLW's business model allows for a low operating leverage and ability to withstand lower commodity prices.
The Canadian company continues to have one of the strongest organic production growth profiles in the precious metals industry, with over 65% growth anticipated in the next five years organically. SLW's unique business model provides investors with a highly-levered play on silver and gold prices. Moreover, the company's fixed cost structure and strong liquidity position warrants premium valuation relative to its peers. The Vancouver-based company has also begun to benefit from the ramp-up of production at its various silver streaming partner companies, and although the delivery on Pascua Lama has now been delayed it should also receive sales growth from its Latin American mine.
SLW is looking at strong year-end results. The company has 5 million silver equivalent ounces which are produced but not delivered and the company expects miners to speed up the delivery of ounces for a strong year-end finish which would boost sales. Silver Wheaton's stock is up more than 50% after dropping to YTD low of $17.75 in June. In August alone the stock is up 19% and we expect the stock to continue to outperform its peers in the gold and silver industry.
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