My thesis here is that Silver Wheaton (SLW) is a compelling stock to own for those investors who want exposure to the price of silver and to the potential leverage offered by mining companies without several of the risks inherent in mining companies.
Silver Wheaton is the largest publicly traded precious metals royalty and streaming company with a market capitalization of $7.88 billion. It is also the second largest silver investment next to Fresnillo (OTCPK:FNLPF).
The company is primarily engaged in acquiring silver streams. This means that it makes agreements with mining companies that produce silver whereby it agrees to pay a mining company some amount of money or to issue it a certain number of shares or warrants in exchange for the right to purchase the silver produced by that company at a particular mine at an agreed upon price for a specified length of time.
In all the company has 24 deals in place, which means that it gets it revenue from a wide variety of sources. Most of these deals are long-term and are designed to generate:
- High margin cash-flow for many years
- Leverage to the silver price
- Cost free exposure to exploration
This has been an excellent business model, with Silver Wheaton vastly outperforming the silver price, the price of most silver miners, and broad stock market indexes over the past several years. Furthermore, despite a strong long-term stock performance Silver Wheaton shares are priced well thanks to weakness in the precious metals sector.
Ultimately, as will become clear presently, I think Silver Wheaton is an excellent low-risk way to bet on the price of silver--it should do well if the price of silver remains flat, and it should do exceedingly well if the silver price rises.
What Kind of Deals Does Silver Wheaton Make?
The individual deals have different specifications, but a typical Silver Wheaton deal is characterized by the following four attributes.
First, the mine in question is not a primary silver mine. Silver is a secondary or tertiary metal. The mining company makes decisions based on various copper, zinc, or gold price scenarios, and in order to eliminate the minimally impactful yet potentially game-changing uncertainty in the silver price it makes a deal with Silver Wheaton.
Second, Silver Wheaton makes streaming deals whereby it agrees to buy silver for $3.90/ounce or the market price, whichever is lower, and there is often an "inflation" clause that allows for a slight increase in this price. With silver at $20/ounce this gives the company some leverage. It also means that the stream will almost certainly be profitable if we don't consider the company's initial cost.
Third, Silver Wheaton makes streaming deals on long-term projects. The company makes sure to point out in its presentation that the expected mine life for more than half of its projects exceeds 15 years. Furthermore, the portion of the company's production that comes from long-term mines is expected to increase over time, as the following graphs, taken from the aforementioned presentation, illustrate.
Finally, the company almost exclusively operates in the Western Hemisphere with a few European deals being the exception. Furthermore, the projects in question are often in what are considered to be safe places to mine. Most notably these include Mexico, Canada, and the United States. Argentina is an exception, and the projects in question may never go into production and as a result I have calculated the company's value with them and without them.
Lately we have seen a major change that needs mentioning. While the company still gets the bulk of its revenues from silver, there appears to be a shift towards gold. In 2013 the company made two deals for gold streams in South America and Canada. I think this shows intent on the part of management to diversify in order to become a precious metals streamer rather than just a silver streamer. While the first deal with Vale (VALE) can be explained as a situation where management saw deep value and took advantage, the second deal with Sandspring (OTCPK:SSPXF) shows a pattern.
Why Royalty/Streaming Companies?
Royalty and streaming companies are compelling investments. Unlike mining companies they have fixed costs that are generally well below metals prices and the cost of production. This means that they have high profit margins, and their profits are highly correlated to metal prices. SG&A costs are extremely low because they don't have to hire a lot of workers, or spend a lot of money on geologists or environmental lawyers.
This makes royalty and streaming companies extremely appealing compared with mining investments. The direct quantitative impact that I see is that with these advantages we can use a relatively low discount rate in valuing a royalty/streaming company's future cash-flow. A mining company really has no idea what it will cost to mine in, say, 15 years, and so I tend to use a conservative discount rate--8%-12%--in determining the value of this cash flow. I use a 3% discount rate, which is more or less in line with the 10-Year Treasury Bond to value streaming companies. This has a tremendous impact on the value of future cash-flow, especially if we go out several years. For example, $100 of cash flow 15 years from now is valued at one of the following amounts depending on the discount rate one uses.
- 0% - $100
- 3% - $64.19
- 8% - $31.52
- 12% - $18.27
With royalty companies we can justify these higher future valuations of cash-flow because their costs are more or less fixed. Silver Wheaton pays a fixed price for its silver and gold plus small inflation considerations. It has just 24 employees, which means that there is virtually no salary expense. It pays virtually no taxes because it operates through its Cayman Islands subsidiary. Finally, while there is no guarantee that any of its streaming deals will perform as expected, the company's diversification means that exceedingly strong or weak performances here and there can be smoothed out. Therefore we can be fairly certain of the company's future cash-flow as a function of silver and gold prices, and in itself this certainty is valuable.
Silver Wheaton has 24 projects, although four of them are tied up together in a unique deal with Barrick Gold (ABX), and I will detail this issue when I discuss that property below. Most of the value is in just a handful of these and this is admittedly a drawback--should there be a problem with the Penasquito mine, for instance, Silver Wheaton shares will suffer. But generally the failure of one or two projects shouldn't be an issue, and I have calculated the company's value below without counting the troublesome projects and I still arrive at a valuation that suggest that gold and silver bulls should consider owning the shares.
I am valuing the project using a 3% discount rate, a $20/ounce silver price, and a $1,260/ounce gold price. All figures are pre-tax, although, as previously mentioned, Silver Wheaton pays very little in taxes.
Penasquito is a polymetallic mine in Mexico operated by Goldcorp (GG). Silver Wheaton agreed to purchase 25% of all of the silver produced at Penasquito at $3.90/ounce, which given current estimates is about 7 million ounces over 22 years, and potentially far more should Goldcorp expand production into an underground mine there. This royalty is worth roughly $1.8 billion.
B: Los Filos
Los Filos is another Goldcorp operation in Mexico. It produces about 250,000 ounces of silver annually and is expected to do so for 14 more years. Silver Wheaton owns the right to purchase this silver at $3.90/ounce, which makes the stream worth $47 million.
C: Pascua Lama
I have been skeptical of the Pascua Lama project in Chile and Argentina given that its owner--Barrick Gold--has understated development costs and has had issues with the Chilean government. Development has been suspended and we do not know when exactly it will begin, although it will likely take a higher gold price for this to happen.
Fortunately Silver Wheaton prepared for this possibility, as the following statement from the Pascua Lama royalty website demonstrates:
As part of the original agreement, Barrick provided Silver Wheaton with a completion guarantee, requiring Barrick to complete Pascua-Lama to at least 75% of design capacity by December 31, 2015, which was subsequently extended to December 31, 2016. During 2014 and 2015, Silver Wheaton was to be entitled to the silver production from the currently producing mines to the extent of any production shortfall at Pascua-Lama, until Barrick satisfies the completion guarantee. As a result of Barrick's decision to temporarily suspend construction activities at Pascua-Lama, the Company has amended its silver purchase agreement with Barrick. The amendment entails Silver Wheaton being entitled to 100% of the silver production from Barrick's Lagunas Norte, Pierina and Veladero mines until the end of 2016 - an extension of one year. In addition, Silver Wheaton has agreed to extend the completion test deadline an additional year to the end of December 31, 2017. If the requirements of the completion guarantee have not been satisfied by the revised outside completion date, the agreement may be terminated by Silver Wheaton. In such an event, Silver Wheaton will be entitled to the return of the upfront cash consideration of $625 million less a credit for silver delivered up to that date.
Ultimately, should Pascua Lama go into production, it will produce roughly 20-25 million ounces of silver for 25 years, and Silver Wheaton is entitled to a quarter of this. Assuming the middle of this range, this comes to 5.25 million ounces of silver annually for 25 years, which is worth $1.9 billion. However in valuing Silver Wheaton we need to consider the possibility that Pascua Lama is not developed, in which case the royalty is worth just $625 million.
D: San Dimas
The San Dimas mine in Mexico is owned and operated by Primero Mining (PPP). Primero owes Silver Wheaton 3.5 million ounces of silver this year plus 50% of whatever silver is produced beyond that in exchange for $3.90/ounce. After this year the initial figure rises to 6 million ounces plus 50% of any silver produced beyond that. Thus Silver Wheaton will be entitled to 4.8 million ounces of silver this year, worth $77 million.
Going forward it isn't clear how long San Dimas will operate, but it has a 100 year history of production, as well as 150 million ounces of silver. Assuming 6 million ounces of production annually for 15 years, which is conservative, this adds $96 million in cash-flow for the following 14 years. Thus the stream is worth at least $1.2 billion, and easily more than this.
E: Hudbay's 777
Hudbay's (HBM) 777 mine is a base metal mine with gold and silver produced as a by-product in Manitoba. Silver Wheaton owns the rights to all of the silver produced here and all of the gold produced through 2016 at $5.90/ounce and $400/ounce respectively. Also after 2016 there will be a 1% annual increase in Silver Wheaton's buy-price for gold and silver. If Hudbay meets certain requirements in developing its Constancia project in Peru (on which Silver Wheaton owns another stream) then the gold royalty goes down to 50%.
The mine has a life of at least 8 years from here and it produces about 110,000 gold equivalent ounces. Through 2016 the royalty is worth $272 million. Assuming that Hudbay gets its Constancia project up and running the stream will pay about 65,000 ounces for at least five more years with the aforementioned inflation clause added. This adds $235 million to the value giving it a total value of $507 million.
Constancia in Peru is also owned by Hudbay. It is in development and expected to go into production, at least on a preliminary basis, late this year, and it will reach full capacity next year. It will operate for at least 17 years and produce several metals. Silver Wheaton has a streaming agreement to buy the silver at $5.90/ounce and half the gold for $400/ounce plus a 1% increase per year for inflation from years 5 through 17. The mine should generate 2.9 million ounces of silver annually and 60,000 ounces of gold (attributable). In all the stream is worth $858 million.
Yauliyacu in Peru is a long-life mine operated by Glencore-Xstrata (OTCPK:GLCNF). Silver Wheaton has a streaming agreement whereby it buys 4.75 million ounces of silver from the mine annually for $3.90/ounce. If it produces less in one year then Glencore makes up the difference in subsequent years. While the agreement goes through 2025 the project only has about 10 years of silver resources left. Glencore will likely increase this but I will be conservative and assume 4.5 million ounces over 10 years, which gives the project a value of $641 million.
The Salobo project in Brazil is part of a huge two project package that Silver Wheaton made last year with Vale. Salobo is a copper mine with some gold, 25% of which will be sold to Silver Wheaton at $400/ounce plus 1% added annually for inflation beginning in 2016. The project should generate 45,000 ounces for the company for the next 2 years. It will then generate an average of 60,000 ounces for at least 28 more years. The stream is worth $958 million.
The Sudbury project in Canada is expected to produce 30,000 attributable gold ounces for the next two years, and 50,000 on average for the duration of the streaming agreement. Otherwise the terms are the same as for Salobo. The stream is worth $596 million.
The Zinkgruvan project is a polymetallic mine in Sweden operated by Lundin Mining (OTCPK:LUNMF). It has an estimated mine life of at least 10 years and silver production of about 2 million ounces per year, which Silver Wheaton owns a 100% stream on and pays $3.90/ounce. This being the case the stream is worth $283 million.
Neves-Corvo is another Lundin operation. It produces copper and zinc with silver as a by-product in Portugal. It is expected to produce at least 1 million ounces of silver annually for at least the next 10 years. Silver Standard owns the right to purchase all of the silver mined here for $3.90/ounce. This stream is worth $141 million.
Cozamin in Zacatecas, Mexico is one of two projects operated by Capstone Mining (OTCPK:CSFFF) on which Silver Wheaton has a streaming agreement. This one entitles it to the approximately 1.5 million ounces of silver produced at Capstone's Cozamin mine for the next three years at $4/oz. plus inflation. Thus the deal is worth $70 million.
The Minto project is a copper mine with gold and silver produced as secondary metals in the Yukon. The Minto deal with Capstone gives Silver Wheaton the right to purchase the silver produced here at $3.90/ounce and the gold up to 30,000 ounces at $300/ounce. If more gold is produced then Silver Wheaton can buy half of the excess at the same price. The project will produce an average of 155,000 ounces of silver and 16,500 ounce of gold through 2022, which gives the stream a value of $145 million.
The Toroparu project in Guyana is a development stage project owned by Sandspring Resources. It is expected to produce an average of 225,000 ounces of gold per year for 16 years with 2016 as the first full year of production. Silver Wheaton is in the process of buying the right to buy 10% of the gold (22,500 ounces) for $400/ounce plus inflation, which gives the stream a value of $230 million.
Note that this is a recent deal and so Silver Wheaton's obligation to Sandspring does not appear on its most recent balance sheet.
The Stratoni mine in Greece is operated by Hellas Mining, a subsidiary of Eldorado Gold (EGO). Silver Wheaton has a stream on the silver mined here which is about 1.2 million ounces per year for the next two years at $3.90/ounce, although Eldorado does intend to expand it. As it stands the stream is worth $38 million.
The Rosemont copper/molybdenum/silver project is located in Nevada and is owned by Augusta Resource Corp. (AZC). it is expected to go into production in 2016, and it will produce an average of 2.9 million ounces of silver annually for at least 21 years. Silver Wheaton has the right to buy the silver produced here for $3.90/ounce, which makes the stream worth $694 million. Note that the company has a similar agreement on the gold produced at Rosemont, but Augusta has not reported that the project has any gold resources.
The Navidad project, which is owned by Pan American Silver (PAAS) is one of the largest silver deposits in the world. Silver Wheaton owns the right to buy 12.5% of the silver produced here at $4/ounce. The projects preliminary economic assessment indicates that the project can produce 275 million ounces of silver over its 17 year life, which means that on average Silver Wheaton will realize 2 million ounces of silver per year, making the stream worth $397 million. Unfortunately Pan American Silver is having regulatory issues with the already capricious Argentinian government, and there is a chance that the project will never get built. Furthermore, unlike with Pascua Lama, Silver Wheaton does not have a contingency plan should Navidad not go into production. Therefore, while this stream could generate $16/ounce on over 75 million ounces long term, there is a chance that Silver Wheaton will never see this.
R: Mineral Park Mine
Mineral Park is a copper/molybdenum/silver operation in Arizona run by Mercator Mineral (OTC:MLKKF). It has an estimated 20 year mine life with more than 500,000 ounces of silver production annually. Silver Wheaton has a streaming agreement entitling it to buy all of the silver produced here for $3.90/ounce, making it worth at least $123 million.
S: Keno Hill
The Keno Hill project is an underground mine in the Yukon owned and operated by Alexco Resources (AXU). Silver Wheaton has the right to buy 25% of the silver produced here for $3.90/ounce. It is currently producing about a million ounces but by next year the project will be producing 2.8 million ounces through 2020. Thus the stream is worth $69 million.
T: Campo Morado
The Campo Morado project in Mexico is operated by Nyrstar (OTCPK:NYRSY). It produces 1.3 million ounces of silver annually and it will do so for at least the next 10 years. Silver Wheaton owns the right to buy 75% of the silver produced here for $3.90/ounce. This makes the stream worth at least $140 million
Aljustrel is a mine in Portugal owned by a private company called I'M SGPS. It produces primarily lead and zinc but it produces over 100,000 ounces of silver annually and will do so for at least 10 years. Silver Wheaton owns the right to purchase this silver for $3.90/ounce, making the stream worth $14 million.
If we include Pascua Lama and Navidad, then the value of these royalties amounts to $10.9 billion pre-tax. The company's effective tax-rate is minimal given that it operates through is Cayman Islands subsidiary, although it still pays about 3.3%. Assuming this remains the same, the total value of Silver Wheaton's streaming deals is worth $10.5 billion.
However, we must consider a couple of contingencies; two of the projects I considered--Pascua Lama and Navidad--may have values that are considerably less than those considered. Navidad may never produce, and so Silver Wheaton's stream's value may be $0. Pascua Lama may also never produce, but Silver Wheaton's stream has a minimum value of $625 million because Barrick is currently paying silver from other projects to Silver Wheaton, and if the Pascua Lama project falls through then Barrick owes Silver Wheaton $625 minus what it is receiving from the other projects. Therefore if we assume that these two questionable projects have minimal value the sum total of Silver Wheaton's projects comes to $9.2 billion, or $8.9 billion after taxes.
If we add in the company's $48 million in working capital and subtract its $1,050 million in liabilities as of September 30th, the total value comes down to $7.9 billion, which is slightly higher than the company's current valuation.
That Silver Wheaton shares are nearly fully valued is to be expected given its relative popularity as an investment. But keep in mind that this full valuation is conservative. Pascua Lama could end up producing, as could Navidad, despite my skepticism. Furthermore, the projects in question have exploration potential, and should more metal be discovered on them, Silver Wheaton benefits on the upside without having to put forth anymore capital. In short, the $7.9 billion valuation is the result of a rather pessimistic scenario.
Silver Wheaton is an excellent investment, and an ideal way to get exposure to the price of silver, and more recently to gold as well. Silver Wheaton isn't going to give investors incredible leverage to the silver price the way that some of the higher-cost miners will, but it will generate cash-flow during the negative years, and it will still provide leverage when the price is rising.
But investing in a silver company is about more than just getting leverage to the silver price. Like with any investment, return on invested capital, growth, and returning capital to shareholders all prove to be key attributes of a quality silver investment. Silver Wheaton has performed extremely well in these categories having made incredibly valuable deals early on in its history (the value of the newer deals will take years to become apparent), it has grown its production markedly, and it pays a dividend equivalent to 20% of its free cash-flow. The growth in particular is a compelling story because it is relatively consistent and predictable.
Ultimately, I think investors who are looking for the following should take a position in Silver Wheaton.
- Exposure to silver and gold prices
- A dividend that is leveraged to silver and gold prices
- Strong, predictable growth
- A steady cost structure with high margins and limited SG&A
- A proven track record of value creation
Additional disclosure: I may initiate a long position in Silver Wheaton in the near future.