All The More Reason To Buy Silver Wheaton

Nov.18.13 | About: Silver Wheaton (SLW)

Silver Wheaton (NYSE:SLW), the largest precious metals streaming company in the world, signs long-term contracts and pays upfront fee to miners for the right to buy all or part of a miner's production at a low fixed cost. The Vancouver, Canada based company recently announced a couple of new gold streaming deals, one with Sandspring Resources (OTCPK:SSPXF) and the other with Hudbay Minerals (NYSE:HBM). These new gold streaming agreements will add to already increasing gold contribution to SLW's total revenue. We think the increased percentage of gold in SLW's portfolio provides more stability and this increased diversification is positive for the company.

The latest of the two deals is the company's Early Deposit Gold Stream Agreement with Sandspring Resources for the Toroparu project located in the Republic of Guyana. Under the terms of the agreement SLW will pay SSPXF a total of $148.5 million, out of which $13.5 million will be paid at the closing of the agreement to complete a bankable definitive feasibility study on the Toroparu project. In return SLW will have the right to purchase 10% of the life of mine gold production from Toroparu. In addition to $148.5 million, SLW will also pay production payment of $400 per ounce, subject to 1% inflationary adjustment starting in the fourth year, or the market price, whichever is lesser.

Earlier the company announced that its 100% of the life of mine silver production from Constancia project in Southern Peru has been expanded to include gold production too. Annual attributable production from Constancia is expected to be 18,000 ounces of gold over the 16 years expected life of the mine; however, in the first five years it is expected to produce 35,000 ounces of gold on average. In 2017, this could represent an increase of 15%-20% in gold production and total annual attributable production (including gold and silver) is anticipated to increase by 45% compared to 2012 level.

Once $1.35 billion has been spent at the Constancia mine, SLW will pay Hudbay an initial consideration of 135 million and has the option to pay it in either cash or in Silver Wheaton shares. Ongoing payments will be $400 per ounce of gold with inflationary adjustment of 1% after completion or the market price, whichever is lesser. The agreement requires HBM to complete the Constancia processing plant to at least 90% of the expected throughput by end of 2016. If HBM fails to satisfy the terms of the agreement, SLW will be entitled to continued delivery of 100% of the gold production from Hudbay's 777 mine. Moreover if the test is not satisfied by end of 2020, SLW will be entitled to a proportionate return of the upfront cash consideration relating to Constancia.

Commenting on the deal, SLW's CEO, Randy Smallwood, said, "We recognized it was there when we did the original transaction with Hudbay to do the gold stream, but they had to do some additional work on the gold because most of the gold is in the Pampacancha deposit, which is a higher grade starter-type deposit."

He further said that the company continues to look for assets in the lowest half of the respective cost curves. If the project meets these cost parameters, "then we're confident the project will have enough strength to survive fluctuations in commodity prices. So that's a very important aspect of our due diligence," Smallwood said and added that he believes commodity prices are in the "bottom half of their price cycle."

We view these agreements as positive for SLW and it should partly offset the delayed growth that is expected from Barrick Gold's (NYSE:ABX) Pascua-Lama project suspension. You can read our recent article on ABX, which talks about Pascua-Lama suspension in more detail here. Coming back to SLW, these agreements with HBM and SSPXF highlight one of the main reasons why we like SLW, the company's ability to lock-in life of mine industry low cash costs. We also believe that SLW's continued diversification into gold is a long-term positive. The lower spot prices also mean that on a per ounce basis the company is paying less for streams than it was a year ago.


We have a buy rating on Silver Wheaton. SLW's unique business model provides investors with a highly-levered play on silver and gold prices. These two new gold stream agreements are positive for the company and provide SLW more stability and diversification. Silver prices can be volatile, and increasing gold exposure allows the company to stabilize revenue, particularly in a declining price environment. These kinds of deals represent a business model, which is attractive for both a streaming company like SLW and the junior exploration/development company. SLW's streaming agreements, at the cost of only a small upfront payment, provide SLW the opportunity to lock-in future growth and at the same time have the option not to proceed with the project if not satisfied with the feasibility study.

SLW's business model provides the company opportunity to generate high returns at a small initial investment. SLW has strong liquidity and cash flow generation potential and going forward the company should continue to engage in further stream agreements. SLW's business model also allows the company for a low operating leverage and ability to withstand lower commodity prices. We also believe that the company's fixed cost structure and strong liquidity position warrants premium valuation relative to its peers.

It is also important to note here that although the decision by ABX to suspend development at Pascua-Lama is not really a positive for SLW; the company has limited its downside risk by putting in place the contract to receive ongoing cash flows from three of ABX's operating mines (Lagunas Norte, Pierina and Veladero). It is also important to mention here that if ABX decides not to construct Pascua-Lama; SLW will be entitled to receive its entire initial investment of $625 million less any silver delivered up to that date.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.