Silver Wheaton: The Miner To Own

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 |  Includes: SLV, SLW
by: Bill Cara

It’s not difficult for me to make a case for silver, and, if you are interested in silver, in the shares of Silver Wheaton (NYSE:SLW) versus other silver miners.

For many years through the 1990s and until quite recently, the above-ground inventory of silver (central banks and others) had been too high – now, as this chart shows, it is very low and strong demand is growing from industrial applications and from China.

Above-ground inventory chart (click to enlarge)
silver wheaton

Annual industry demand-supply chart

Of all the silver miners, Silver Wheaton is the one to hold. It is the only 100-pct pure silver company, which is going to out-perform in a rising silver price environment.

Here is a chart that compares percentage revenue of silver to total mining revenues: SLW vs. Coeur (NYSE:CDE), Pan American (NASDAQ:PAAS) and Hecla (NYSE:HL):

silver wheaton

Why is SLW the stock to own in this space? Because Silver Wheaton has been set up as a cash flow machine. All cash flow is free cash flow since the company has no capex. It is not really a miner; rather it is a mine finance house that call itself a miner for the optics involved.

In a Bull market scenario for silver, I have never seen anything like it. In other words, there is no mining company in the world that can produce over $100 million a year with seven employees.

silver wheaton

Production (as they like to call it) is 15 million oz of silver in 2006, rising to about 20 million oz in 2009, from existing contracts. But as I’ll show, the business is also growing, and the price of silver is rising too.

You can see from the Projected Operating Cash Flow chart above that cash flow is expected to be (2009e production):

• At $12/oz, about $160 mil

• At $14/oz, about $200 mil

• At $16/oz, about $240 mil

• At $18/oz, about $280 mil

I’m already on the record as forecasting $18/oz or more based on the first two charts I showed above.

If you relate that cash flow to fully diluted shares of SLW (264.5 mil, based on 220.2 mil issued and outstanding plus several million options and warrants), that would put Silver Wheaton into the $1.10 cash flow per share range by 2009.

To find maximum value, I normally price shares conservatively on the basis of six times cash flow. These shares will trade higher because there is no capex involved and almost no risk of loss due to the contracts being signed.

What is important is to be able to trade in (ie, buy when the shares are over-sold) and out (ie, sell when they are over-bought). If you can stay ahead of the Dino Kos (Federal Reserve) slash and burn trading tactics, you can rely on this stock as a wealth generator.

As most of us know, the central banks of the world are printing money faster than silver is being discovered and produced. If your portfolio stays on the right side of that trend, your wealth will increase.

Background:

How did Silver Wheaton come to be? The company started in October 2004 by Wheaton River, which soon afterwards became Goldcorp. The parent saw its 50:50 production ratio of gold versus other metals, and figured that the Bull market for gold had arrived, but there was another factor: the growing anti-hedge lobby.

So, Wheaton River management then said they didn’t want to be in the by-product (silver) business, but that was just another way of saying that they didn’t want to be seen hedging their future gold production, but saw no problem in hedging the silver production in order to give an offshoot company (Silver Wheaton) an effective business model.

In a nutshell, that is the deal here: Silver Wheaton is a reverse-hedge player to precious metal companies that wanted to hedge but knew that shareholders would not let them for gold, so silver went under the radar.

Meanwhile the producer was able to hedge partial production (ie, the silver by-product) and the revenue from Silver Wheaton would be applied to the cash cost of producing gold, which in the lingo of these producers is “lowest cash cost results in the best optics”.

This isn’t rocket science, so aggressive miners like Goldcorp, Glencore/Xstrata and Lundin have done it with Silver Wheaton. In a Bull market for precious metals, these miners are helped by the cash in hand (and available from forward contracts) that helps in their own acquisitions game, and the shareholder optics (ie, no gold hedging, and lower cash cost) also looks good.

But, many of us know, in the Bull market, hedgers always lose, and reverse-hedgers always win. By not hedging, the cash flow of the producer would have been greater.

So, I’m saying Silver Wheaton was contrived as a vehicle that would boom during a Bull market for precious metals, given that silver and gold prices are almost 100-pct correlated. And that’s why Telfer and his staff at Goldcorp sold their shares in Goldcorp and put their “retirement funds,” as McEwen calls them, in Silver Wheaton.

Silver Wheaton is in fact a no-brainer in a PM Bull market, and the senior money managers and financial advisors I have been talking to for the past year or two know that I have been saying it privately.

Of course, SLW also becomes an essential trading vehicle because whenever PM prices dip in short-term cycles, those dips are usually violent, and SLW is going to fall faster than the other PM miners.

When I discovered from Rob McEwen that Goldcorp management had sold their personal shares in Goldcorp (and go to SLW), I decided to drop Goldcorp from the Cara 100. Goldcorp is now an acquisitor, and I am concerned about the issue of shareholder value when I see excessive premiums being paid to acquire production – particularly when management has no skin in the game except share options that they quickly sell.

But silver oz will come to SLW with no dilution, no capex, etc. Hence, no brainer.

The Silver ETF (NYSEARCA:SLV) is now available and competes with SLW for the interest of risk-adverse investors who’d rather hold the bullion. But here too, I’d rather hold SLW. The iShares Silver Trust is a product that doesn't have the leverage of SLW on the upside or the protection (through contracts) on the downside.

SLW will out-perform all the silver miners and the silver ETF on way up, but also on the way down. Thank goodness this is a PM Bull market.

The Denver Gold Forum (Sept 2006) presentation shows that the company has a simple investment model: they have contracted to buy all silver production at a fixed price from three solid (long-life, low cost) mines, and they buy at a protected low price and sell at higher spot price.

I think SLW should be valued not as a miner but as a royalty company since there is no capex or miners or country risk involved and there is no financial risk if there is a shortfall of contracted production or the price declines below 3.90 (in that event, the company just don’t make profit).

The presentation slides show they partner with Goldcorp and Glencore (Xstrata) and Lundin Mining for low-cost, long-life mine production:

Luisman Mine (Goldcorp) is proven and growing producer in Mexico that has huge exploration potential without development costs to SLW… 20 yrs / all silver production @ $3.90/oz… 7 mil oz 2004 to 13 mil in 2009… Minimum oz is 220 mil and no financial risk if shortfall of production or price declines below 3.90 (just don’t make profit).

Yauliyacu Mine (Glencore) 20 yrs / 4.75 mil oz/yr @ $3.90/oz and will get 95 mil oz (71 million oz guaranteed) and no financial risk if shortfall of production or price declines below 3.90 (just don’t make profit).

Zinkgruvan Mine (Lundin Mining)

• Silver Wheaton also owns 19-pct of Bear Creek Mining.

• Leverage existing partnerships, eg, Goldcorp-Glamis. The Glamis Penasquito project is likely to be contracted to Silver Wheaton – according to the press releases.

Not to be overly cycnical, but on the final point, all that remains is for these self-serving managers at Glamis to negotiate a similar deal to the one Telfer’s group got.

That’s what these deals are all about. If you are not in the room, you are out of the deal. McEwen’s pissed because he knows the business as well as anybody in the world. I’m all for shareholder rights, but as long as the players stay on the right side of the law, you have to understand that you have to bet the jockey when you know that the jockey is betting on himself.

The bigger story here is that Silver Wheaton intends to grow through new partnerships, eg, producing mines and development projects: SLW funds in advance in return or fixed price opportunity (ptr hedges silver). Coeur d’Alene has done the same silver-streaming deal with two Australian miners, but Silver Wheaton says they too had the chance to get those deals, and passed. So, by being the biggest player in the silver industry, Silver Wheaton is going to see all or certainly most of the deals, and they’ll pick off the good ones, albeit at increasingly smaller profitability margins now that the other miners and their shareholders have come to understand what this business is all about.

Silver Wheaton is a cash flow machine, and that cash will also go into strategic investments like Bear Creek Mining. Silver Wheaton can finance small mines into production and earn the silver production. They already purchased 19+-percent of Bear Creek Mining for this purpose. Bear Creek already owns a silver resource of 300+-million oz, and management expects that figure to grow over 500 million oz. At silver prices of US$12, 14, 16, 18, 20…that is a valuable holding, particularly on a SLW fully-diluted share basis.

And the point is, management is going to do that over and over with every prospective precious metal miner that comes along with significant silver production and no worry about hedging, and they’ll negotiate their fair share of these deals.

To sum up: what I really like is the downside protection – Silver Wheaton can’t lose money if the silver price drops. They are in the financial business, not the mining business.

Certainly a worthy Cara 100 company.