Silver Wheaton: A Look Into Its Cash Flow Prospects

| About: Silver Wheaton (SLW)


SLW offers great value at discounted valuation relative to peers.

SLW can comfortably repay its $1B debt in 3 years without any financing.

Debt reduction, organic production growth, and incremental growth from continued acquisition of streaming interests are expected to produce material price upside.

Silver Wheaton (NYSE:SLW) is the world's largest silver and gold streaming company. Its share price has experienced 25% loss over the past 12 months, compared to a 20% return for the S&P 500 Index. In my view, SLW represents a solid investment for investors requiring precious metal exposure given its inexpensive stock valuation, high quality asset portfolio, and strong growth and liquidity prospects.

Let's first take a look at the stock's valuation. At ~$23, SLW trades at 15.4x consensus 2015 EBITDA estimate, 22.2x consensus 2015 EPS estimate, and 15.7x trailing operating cash flow. The valuations compare favorably to SLW's major precious metal streaming peers' as both SLW's P/E and P/OCF multiples are at significant discount to peer averages. The large discount exists despite the facts that 1) SLW generates considerably higher returns on equity and invested capital and 2) SLW's portfolio of mines/projects that generate the cash flow streams is of the best quality among its peers due to the mines' long lives (i.e. approximately 72% of production in the next 3 years will be based on mines with more than 15 years of life) and low cash costs (i.e. 88% of the company's current production is from mines with low-quartile cash costs) (see chart below). As such, the valuation discount would offer investors a solid margin of safety and act as a buffer for potential risks such as an unfavorable outcome from the CRA audit. Further, based on the view from RBC Capital Markets, SLW's current valuation implies little value being ascribed to the Pascua-Lama project which was put on hold. As such, an investment in SLW would provide investors a free call option on this world-class asset.

On the liquidity front, SLW now sits on $96M cash and has a $1B undrawn revolving credit facility. SLW now carries $1B debt which is due in 2016. Looking forward, I expect that the company is able to generate sufficient cash to repay the debt on schedule without undertaking additional financing while still being able to continue investing in silver interests. The conclusion is based on the following inputs/assumptions:

  1. In Q4 2013 earnings call, management guided an annual silver-equivalent production of 36 moz for 2014 and expects it to grow to 48 moz by 2018, representing a 7.5% CAGR. The growth is expected to be driven by higher production from Salobo and Sudbury projects and start-up of Constancia and Rosemont projects. Based on that, my forecasted operating cash flows imply a growth rate of approximately 7.5% per annum (assuming stable silver and gold prices) from 2013 to 2016.
  2. In terms of capital expenditure, an average annual spending of $170M was modeled. I view this assumption to be conservative given that I did not factor in any incremental growth from acquisition of silver interests while a majority of this spending is for that purpose.
  3. According to management's debt maturity schedule, the company will repay the $1B debt in 2016, which was modeled.
  4. In the earnings call, management also reiterated their target to payout 20% of average operating cash flow over the past 4 quarters as dividend, and I have factored that in the analysis.

Based on the above, my calculation suggests that SLW would generate an accumulated cash of $625M in 2014 and 2015, which is sufficient to plug the negative cash hole in 2016 when the company repays the debt. It is noted that the deleveraging can be achieved without withdrawal from the $1B revolver and this conclusion is based on conservative operating cash flow and capex assumptions (see chart below).

Assuming that cash balance and enterprise value stay the same by 2016 (unchanged enterprise value is unrealistic given management's production growth guidance), the deleveraging in 2016 would mean an 11% gain in equity value.

In summary, I view SLW's risk and reward to be very compelling as downside is limited by cheap valuations and solid fundamentals (assuming no material decline in silver and gold prices) while notable upside would be driven by strong organic growth of cash flows and continued investments in streaming interests. Hence, investors that need precious metal exposure are recommended to buy SLW at the current level.

All charts are created by the author, and data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.

Disclosure: I am long SLW. 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.