If you haven't read part I of my analysis, or would like to review it as a refresher, it can be viewed here.
How To Value Silver Wheaton:
Silver Wheaton (SLW) is a silver streaming company, not a mining company. Thus, typical comparable company analyses such as P/E multiples and other relative valuation techniques are not an appropriate way to value such a unique company as Silver Wheaton. Future production and operating expenses are fairly predictable; therefore, the most appropriate way to value Silver Wheaton is by using a discounted cash flow analysis.
The following analysis will value Silver Wheaton using three different DCF variations, which are based on the following assumptions: 1) A current contract runoff with no growth, 2) Growth through 2016, which then becomes a perpetuity, and 3) A 5-year DCF with a terminal value calculation, assuming modest growth.
Current Contracts:
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The current mine agreements detailed above provide insight into estimated future production by mine. The largest mines: Pesquanito, San Dimas, and Pascua-Lama are forecasted to provide silver streams through at least 2031. These mines will provide Silver Wheaton with significant future silver streams.
Current Contracts DCF:
The current contract DCF is the most conservative valuation estimate since it assumes Silver Wheaton won't acquire any more silver streams. Silver stream forecasts don't account for additional production other than what is currently projected. Current Silver Wheaton silver streams are projected to last through 2038, with silver production peaking in 2016 at 43mm Ag equivalent oz, then tapering off as mine contracts expire. CAPEX for Pascua-Lama, Rosemont, and Loma de La Plata partially offset 2012 and 2013 cash flow.
Silver Wheaton is obligated to make these payments, but no additional CAPEX is forecasted because it is assumed that no additional silver streams will be secured. Using a discount rate of 8.9% yields a present value of $7.3B, but since Silver Wheaton has an excess cash balance of $761.6mm, we must increase their equity value to account for the excess cash on their balance sheet. In addition to excess cash, Silver Wheaton has equity investments in other companies that increase Silver Wheaton's equity value. Based on their 2011 YE financial statements, the fair value of these equity investments is estimated at $151.6mm. The estimated total value of Silver Wheaton's equity under the current contracts DCF is $8.2B, or $23.33 per share.
Growth Through 2016, Then Perpetuity DCF:
The growth then perpetuity DCF is a slightly more optimistic valuation estimate since it assumes Silver Wheaton will be able to acquire enough future silver streams to replace lost production beginning in 2017, but it remains a very conservative valuation with no future production growth past the forecasted 2016 production of 43mm Ag equivalent oz. The present value of cash flows through 2016 remains unchanged at $3.1B, as well as excess cash of $761.6mm and equity interests of $151.6mm. Beginning in 2017 operating cash flow is assumed to be the same as 2016, but it is assumed that the company will have to pay $8 per Ag equivalent oz in CAPEX for upfront consideration to replace the 43mm ounces being produced annually.
Most recently, the company has been able to purchase future silver production for approximately $4 per ounce upfront plus $4 per oz upon delivery. Due to higher long-term forecasts for silver prices, it is assumed the company's upfront consideration will have to double to $8 per Ag equivalent oz. All other costs including, production costs of $4.12 per Ag equivalent oz are included in the company's operating cash flows. Discounted back, the estimated value of Silver Wheaton's equity is $26.28 per share.
DCF With Terminal Value:
A DCF with a terminal valuation calculation is the most common DCF valuation, which assumes the company will continue to grow past 2016, although at a slower rate than their current growth rate. All calculations through 2016 are the same as the two previous valuations, including: 1) The present value of cash flows through 2016, 2) Excess cash available to shareholders, and 3) Equity interests in other companies. After 2016 it is assumed that Silver Wheaton will grow operating cash flow at a conservative 4% per year, and return on capital will decline to 15%, resulting in a required reinvestment rate of 27% of operating cash flow to maintain its growth.
The resulting FCF in 2017 is $808.8mm. Assuming a cost of capital of 8.9% and a growth rate of 4% results in a terminal value of $16.6B which has a present value of $10.9B. Adjusting for excess cash and Silver Wheaton's equity interests in other companies results in an equity value of $14.9B, or $42.05 per share.
Risks:
- Since SLW doesn't hedge their revenue is exposed to the volatile price swings of silver and gold.
- Extended delays in the Pascua-Lama project would hurt future earnings.
- An inability to obtain new productive silver streams would significantly hurt the company's future prospects.
- Natural disasters or poor weather conditions at one or more of Silver Wheaton's major partner's mines could damage or prevent continued operations for an extended period of time.
- Potential government or environmental regulation could impair profitability.
- Reserves and future production are estimates and subject to change.
- A change in the tax law or its interpretation could cause Silver Wheaton to lose the benefit of its Cayman Islands and Barbados tax shelters.
Investment Thesis:
- Silver Wheaton's market price is not factoring in any of its potential long-term growth prospects. The current stock price as of May 8th, 2012 is $26.42, which is less than a 1% variance from a conservative perpetuity valuation; assuming continual CAPEX of $8 per Ag equivalent oz (approximately double the cost of their most recent acquisition for $4 per Ag equivalent oz). The most conservative value of SLW is $23.33 per share, based on their current contracts (only 12% below its current price). Using a conservative estimate for sustainable growth after 2016 of 4% per year, and a reduced stable period return on capital of 15% values the company at $42.05 per share (59% higher than its May 8th closing price).
- Analysts are currently forecasting sales growth of 69% by 2015.
- Silver streams over the next 5 years are expected to be relatively stable since only one major mine (Pascua-Lama), and two smaller projects (Rosemont and Loma de La Plata) are scheduled to start production.
- Existing relationships with major miners like Barrick (ABX), Goldcorp (GG), Eldorado (EGO), and Pan American Silver (PAAS) should make it easier to acquire future silver streams without long delays.
- The ability to provide miners with flexible upfront capital creates a significant incentive for miners to form strategic partnerships with Silver Wheaton.
- The difference between the value of byproduct silver to a miner and a streamer like Silver Wheaton allows SLW to unlock value that a typical miner couldn't monetize.
- Being well capitalized with little debt, having $840mm in cash, and a $400mm undrawn revolver allows Silver Wheaton to purchase new silver streams without the need for new financing. A strong balance sheet also reduces the possibility of future share dilution, and helps SLW weather any downturn in the credit markets.
- Being unhedged allows SLW to take advantage of the historical trend in precious metal price appreciation, as real interest rates continue to be negative for the foreseeable future, and the Fed planning to keep interest rates at historic lows until at least late 2014.
- Strong demand from China and India create a bullish case for precious metals.
- Silver Wheaton's dividend of 20% of the prior quarters' operating cash flow shows a commitment to rewarding shareholders, and gives investors the opportunity to benefit from price appreciation of the stock, as well as future dividend increases.
- With only 25 employees, Silver Wheaton's operating expenses are minimal compared to a typical mining company.
- Having their projects well diversified geographically significantly reduces the political risk that many other miners face in more concentrated geographic locations.
- Gold miners are cheap relative to the price of gold, as currently indicated by the Gold/XAU ratio at 10.1:1.
Summary:
Silver Wheaton has secured large silver streams that will continue to pay dividends years into the future. The stock's current price isn't accounting for any future growth, or potential increases in the price of silver. If SLW can secure one or two large silver streams at reasonable prices (ideally $10 or less per oz in upfront consideration) while silver is still consolidating around the $30 level, investors could be rewarded with a doubling of the current share price without accounting for any appreciation in silver prices.
Silver Wheaton offers investors a leveraged play on silver prices with a fixed cost structure and low operating expenses. The future success of SLW as an investment will depend primarily on the future price of silver, and the company's ability to grow future production by acquiring additional silver streams at reasonable prices.
Commentary:
The appreciation potential of Silver Wheaton's stock is significant, but I believe there is another miner that offers even more upside potential for investors. My analysis of what I believe may be one of the most undervalued mid-tier miners can be viewed here.
