Silver Wheaton: Still A Buy?

| About: Silver Wheaton (SLW)

Summary

SLW trades at its 52-week high but more upside is possible going forward as the company is set to report strong Q2 earnings.

SLW’s production will rise around 26% year-over-year in the second quarter, while silver prices are anticipated to rise 2.25%, which will enable it to beat the top line forecast.

SLW’s cash operating margin per silver ounce will be $12.57 in Q2, assuming silver prices of $16.77/ounce, allowing it to post $170 in cash operating margins.

SLW’s cash operating margins will rise almost 47% year-over-year in Q2, thereby enabling it to beat the bottom line forecast that calls for an EPS increase of just $0.01/share.

Silver Wheaton (NYSE:SLW) shares have gone from strength to strength this year, rising more than 110% and currently trading close to 52-week highs. Looking ahead, I believe that Silver Wheaton will be able to sustain this strong stock price momentum as it is on track to deliver robust second-quarter results in a couple of weeks. In this article, we will see why investors should continue to stay long Silver Wheaton shares going into earnings.

Silver Wheaton will beat expectations

Investors should note the fact that the expectations from Silver Wheaton are already set high. I'm saying this because the company is anticipated to post top line growth of 23.4% in the second quarter to almost $203 million. In my opinion, Silver Wheaton should not find it difficult to beat this estimate as both its revenue and production will grow at an impressive pace.

For instance, Silver Wheaton's production in the second quarter should increase impressively on a year-over-year basis. This is because the company forecasts total production of 54 million silver equivalent ounces in 2016, and of this, it had already achieved 12.7 million ounces of production in the first quarter. This means that over the remaining three quarters of the year, Silver Wheaton should ideally produce around 13.8 million ounces of silver equivalent to meet its target.

Now, in the year-ago period, the company's silver equivalent production stood at 10.9 million ounces. Therefore, if Wheaton manages to achieve its run rate forecast for 2016 production in the second quarter, its production will rise over 26% year-over-year. More importantly, Silver Wheaton has a track record of selling almost all of the silver that it produces.

For example, in the first quarter, the company's silver sales were 12.8 million ounces, which was slightly higher than production, while in the year-ago period as well, its silver equivalent sales were 10 million ounces, again close to the amount that it produced.

This means that for calculation's sake, we can assume that Silver Wheaton will be able to sell the entire silver that it produces. Now, in the second quarter of 2016, the average traded price of silver was $16.77/ounce. This is higher than the average silver price of $16.40/ounce prevalent in the second quarter last year. Therefore, on a year-over-year basis, silver prices will rise 2.25%.

Given this increase in silver prices, I won't be surprised if the company is able to outperform the top line estimate. This is because Silver Wheaton's production could grow 26% in the second quarter, while prices are expected to rise 2.25%.

Therefore, this combination of higher prices and production could put the company well past the 23.4% growth in production that analysts are forecasting. More specifically, if Silver Wheaton sells 13.8 million ounces of silver equivalent at a price of $16.77 an ounce, its top line in the second quarter will come in at $231 million, way higher than the analyst forecast of $203 million.

The bottom line growth will be even more impressive

Since Silver Wheaton is a streaming company, its costs are usually consistent since it enters into streaming agreements with miners for a fixed fee after paying an initial down payment. As a result, Silver Wheaton's cash costs for each ounce of silver have remained at around $4 an ounce over the past four years, as shown below:

Click to enlarge

Source: Silver Wheaton

Now, assuming that Silver Wheaton's costs this year remain consistent at $4.20 for each silver ounce, the company's cash operating margin for each silver ounce produced will come in at $12.57 an ounce, assuming the silver prices of $16.77 an ounce in the second quarter.

Thus, for its entire production of 13.8 million ounces, Silver Wheaton's cash operating margin in the second quarter will come in at around $170 million. In comparison, the company's cash operating margin in the year-ago period stood at $11.62 per silver equivalent ounce. This means that Silver Wheaton had generated cash operating margins of $116 million in the second quarter of 2015. Therefore, due to a combination of higher prices and increased production, Silver Wheaton's cash operating margin will increase by almost 47% on a year-over-year basis.

As such, I won't be surprised to see if Wheaton manages to beat the bottom line forecast since analysts call for the company's earnings to increase by just a cent on a year-over-year basis.

Conclusion

Thus, driven by higher production and strength in the silver market, Silver Wheaton is well-prepared to deliver strong revenue and earnings growth. So, investors should continue to hold the stock going into earnings since it is capable of delivering more upside in the light of strong results.

Disclosure: I/we 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.