Why Silver Wheaton Is Still A Buy

Sep. 3.14 | About: Silver Wheaton (SLW)

Summary

Q2 earnings disappointed at the top and bottom lines.

While silver prices remain flat year to date and gold up only 7%, Silver Wheaton has recovered 23% after its 40% drop in 2013.

With silver equivalent production slated to grow 35% through 2018, Silver Wheaton is building a solid foundation for when precious metals rally again.

Silver Wheaton (NYSE: SLW) has had a pretty rough time over the past couple of weeks since its Q2 earnings release, sliding 8.7% from a close of $27.18 on Aug. 13 to yesterday's close of $24.85. But despite disappointing earnings numbers, including lower overall year-over-year production and missed earnings at the top and bottom lines, Silver Wheaton remains a long-term buy.

Silver and Gold Prices Weigh

While the price of silver (NYSEARCA: SLV) is about the same as it was at the beginning of the year, it fell after a spike in March and has seen a 5.4% decline in the last month. Gold (NYSEARCA: GLD), on the other hand, has made upwards progress year to date, but is also down for the month of August. And even though there has been constant unrest all over the world over the past few months, stock markets have shown remarkable resilience, making it difficult for precious metals to rally.

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So even though Silver Wheaton increased its year-over-year production in silver equivalent ounces sold by 4%, it simply wasn't enough to offset the 14% decline in silver prices for the same period. But as you well know, silver and gold prices may have a short-term impact on Silver Wheaton's numbers, but the company is so much more than that.

Outperforming Precious Metals

While silver prices have remained flat year to date and gold has mustered just under a 7% gain, Silver Wheaton's stock has seen a 23% increase since January. In February, one of anyoption's writers actually predicted that the stock would make a nice recovery in 2014, although a 23% gain is barely more than half the 40% it lost in 2013. Of course, one of the main reasons for Silver Wheaton's strong gains is because gold and silver prices stopped their free fall after the 2013 crash.

But that's not the only reason Silver Wheaton is up on the year. The company still has a strong business model, which is based on contractual agreements to purchase gold and silver from producers such as Goldcorp (NYSE: GG), Barrick Gold Corp (NYSE: ABX) and Vale SA (NYSE: VALE) in exchange for an upfront payment. Silver Wheaton pays approximately $4 per ounce of silver and $400 per ounce of gold.

Such low costs allows Silver Wheaton to benefit from ridiculously high profit margins, while also keeping the costs relatively fixed, keeping profits safer from potential cost overruns.

So while it would be nice to see production back up in the second half of the year, the outlook for the next two years give investors enough reason to buy and hold. During the earnings release, management announced that it has made significant progress with its two main growth platforms, Salobo and Constancia.

With continued progress on projects like these two, the company has a 35% growth in silver equivalent production by 2018 pretty much locked in. So even though we don't know what silver and gold prices are going to look like, the production growth should be enough to keep investors happy, barring any overly drastic drops in precious metals.

Risks

Of course, there are risks in all of this. For example, if gold and silver prices don't recover significantly over the coming years, the catalyst for value growth won't be nearly as strong. And if prices drop, that only makes the uphill climb steeper.

Although with the global geopolitical situation being the biggest current indicator of the drive for precious metals demand, conflicts in Iraq, Ukraine and Syria can give silver and gold prices what they need to grow as other markets struggle.

Another risk is the fact that Silver Wheaton has no ability to manage at the mine level, so if any stoppages occur due to conflicts, political disruptions or other form of slowdown could postpone some of the revenue streams expected over the short term.

Tied to this, since Silver Wheaton is a "banker" of silver and gold rather than a miner, the company relies heavily on the management and execution of other companies. So there are certainly things outside the company's control, but barring anything catastrophic, the risk should be small.

Conclusion

While Silver Wheaton's Q2 numbers weren't impressive, the stock remains a buy. The company has proven it can remain viable with sagging precious metals prices, outperforming them significantly YTD. Even if gold and silver prices continue to stay low over the coming months, Silver Wheaton is laying a solid foundation for when silver and gold do regain some of their lost luster.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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