Silver Wheaton (SLW) is one of the more unusual silver companies in the world, because it is only a pure play middleman that does not own or operate its own silver mines. It has quickly become the largest metals streaming company in the world because of its ability to provide mining projects with upfront payments in return for future supplies of silver. It has secured the rights, at low fixed costs, to some or all of the silver production from 16 high-grade mines and three projects under development around the world. The company has long-term contracts with 11 major mining companies such as Barrick Gold (ABX), Goldcorp (GG) and Glencore. Some of these contracts are for fixed percentages of production or for a specific period of time or, indeed, as in the case of Penasquito owned by Goldcorp for the life of the mine.
Naturally, the single biggest determinant of the company's success is the price of silver. Though Silver Wheaton's contracts are indexed for inflation they are liable to pay the fixed amount regardless of the fluctuation in silver prices. This means that it can pocket to profit when silver prices are high, but asked to swallow the losses when prices are low. It has no say in how much silver its mining partners produce nor are they compensated if production expectations are not met. The company does not pay income taxes, because it is headquartered in the tax haven of the Cayman Islands.
Many investment experts believe that the business model that Silver Wheaton follows has its own particular strengths and weaknesses. For one thing, silver is generally produced as a byproduct of gold and copper production, and the company therefore has an indirect exposure to these other metals. It has an edge over the mining companies, because it is less likely to incur operating losses and highly volatile market conditions. Moreover, it does not incur any of the costs that are associated with extraction and production of silver. However, this very same model leaves the company highly vulnerable to silver price fluctuations with limited or no means of hedging.
For the first quarter of the current fiscal, Silver Wheaton showed encouraging results, with an 8% increase in attributable silver production over the same quarter of the previous year. Revenues were up 26% to a record $199.6 million, while net earnings increased by 20% to $147.2 million. This translates into an earnings per share of $.42 per share as against $.35 per share in the same period of the previous year. Operating cash flows increased by 29% to $163.8 million.
In late March, the Company had just under $1 billion of cash on hand in addition to which, the Company had US$400 million of available credit under its revolving bank debt facility. This puts the company in a strong position to continue its strategy of upfront payments in return for favorable long-term fixed-price silver contracts. Silver Wheaton had attributable proven and probable silver reserves of 798 million ounces which is nearly twice as much as any other silver company in the world. Silver Wheaton is the largest silver streaming company in the world. Based upon its present contracts in force, attributable production for 2012 is expected to be approximately 27 million silver equivalent ounces, including 16,500 ounces of gold. By 2016, annual attributable production is forecast to increase significantly to approximately 43 million silver equivalent ounces, including 35,000 ounces of gold. The company has also declared a second quarterly cash dividend of nine cents per share.
In considering the company as a candidate for investment, it is important to understand how the silver market operates. In addition to being a precious metal, silver is also used extensively as an industrial metal. It is used in manufacturing operations related to electronics, optics and medical equipment. It is also used in the manufacture of photovoltaic cells that are used to produce solar power. In countries like China and India, it is also used as a store of wealth. Given this background, it is difficult to see how there can be a precipitate decline in demand, especially since there are no cost effective substitutes. However, since the silver market is much smaller than the gold market, and there is a correlation between the two, prices can be volatile in the short-term. If you want to avoid the roller coaster ride that a direct investment in silver involves, an investment in Silver Wheaton is a perfectly acceptable proxy.
Because of its unique position, there is no direct competition with which comparison is possible. However if you take a look at a handful of companies such as Coeur d'Alene Mines (CDE), Hecla Mining (HL), Pan American Silver (PAAS) and BHP Billiton (BHP), the earnings multiple may make the stock look somewhat expensive. However there are other factors that you should be considering. Growth is an important consideration and if you consider the PEG ratio of 0.6, the price/earnings ratio is at a discount to the future growth. Moreover, the company has an operating margin of almost 77% compared to margins of between 40% and 50% for most of the other companies and this is due to the unique business model and not likely to be matched by mining companies.
Make no mistake, investments in precious metal companies are risky and you may choose not to touch them. In my opinion, the manner in which Silver Wheaton has set up its long-term business minimizes these risks to the investor. The long-term contracts for silver supplies at fixed prices and the bullish price trend mean that the company is extremely well-placed to take advantage of the market and grow profitably for some years to come. I strongly recommending buying Silver Wheaton today. In any case, you should certainly hold on to any existing investment that you may have because the downside is limited and it is a small risk compared to its future potential.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
