Michael Jalonen – Bank of America/Merrill Lynch
Now we’re moving on to Silver Wheaton. We have Gary Brown, the Senior VP and Chief Financial Officer to make the presentation, and this continues our streaming side, focusing now on the silver streams. Gary, you guys just made a transaction also.
Great, thanks Mike, and it’s always a pleasure to speak at this conference, thanks for the invite back, and thank you for taking time out of your schedules to learn a little bit more about Silver Wheaton, and why we believe it represents the best investment vehicle out there to gain long-term exposure to silver.
Our vision is to become the premier silver focused streaming company out there and to provide shareholders with high quality long-term exposure to precious metals while at the same time offering mine owners with an attractive capital.
Just a quick refresher on what silver streaming is. Essentially in return for an upfront payment, Silver Wheaton acquires the rights to a certain percentage of silver that is produced from a specific mining asset and we make an additional downstream payment for every ounce of silver that’s delivered to us. Effectively, we view the upfront payment as being reflective of the value of the silver contained in the ore body and the production payment is intended to compensate the mining company for extracting what we consider to be our silver on our behalf.
The model works primarily because the silver is worth more to us and our shareholders than it is our counterparties. So we can structure deals that create value for both our shareholders and the mining company’s shareholders, so creating a win-win type structure. That’s the primary reason that the counterparties tend to subscribe to streaming as a form of capital but there is a host of other reasons, one of which is the flexible nature of the form of capital that we provide without – there is no fixed repayment terms under these streaming arrangements and so we take operating risk alongside with the mining company which really in these times of uncertain economic climates results in a form of capital that’s very attractive.
Who is Silver Wheaton? Well, Silver Wheaton is the largest of the metal streaming and royalty companies by market cap and we are the second largest silver company in the world by market cap. We are the largest silver company in the world by resource base and we not only have the largest resource base but the highest quality resource base with over 800 million ounces coming in the form of proven and probable reserves. Based upon our 2012 silver production guidance, we expect to produce just under 26 million ounces silver which sets us as the second largest silver producer of this year.
We have interest in 21 different mining assets, 17 of which are operational and four of which are in the development stage. Those are located in nine different countries and our arrangements with 14 different counterparties. So the portfolio of assets that we have is well diversified not only operationally and geographically but also by counterparty. And they are very high quality assets that underlie these streams and we measure quality by the – where those operations fall and the respective cost curves and the life of the mine remaining. And if you look at our 2012 to 2016 forecast production, about 80% of our production comes from mines that operate in the lowest quartile, which means that they can withstand virtually any commodity price cycle and continue operating for profit. And the life of the mines underlying our assets are also very long, with over half of 2012 production coming from mines that have over 15 years of mine life remaining, and that only gets better over time with over 70% of our production in 2016 coming from mines that have over 15 years of mine life remaining.
That high quality portfolio of assets is highlighted by two cornerstone assets, one is the 25% life of mine silver stream that we have relative to GoldCorp’s Penasquito asset located in Mexico and the other one is the 25% life of mine silver stream relative to Barrick’s Pascua Lama operation which is currently being built in straddles Chile and Argentina. Penasquito is expected to deliver about 7 million ounces of silver production to Silver Wheaton’s account over the life of mine and has been operational since 2010, and the Pascua Lama mine is expected to have first production in the middle of 2014 and will deliver about 9 million ounces to Silver Wheaton’s account for the first five years of production. Until that time we receive 100% of the silver produced from three currently operating mines of Barrick’s, which generate about 2.5 million ounces of silver production for our account per year. Barrick recently announced that there was a delay in initial start-up of Pascua Lama by a year which doesn’t really negatively affect us at all because of the – we will continue to receive silver from these other three operating mines until Pascua Lama satisfies a completion test.
And we just recently added to our high quality portfolio of assets with the deal that we struck with Hudbay. It was announced in early August and it is a deal that involves us receiving 100% of the silver from the currently operating 777 mine and 100% of the gold from that mine until the later of 2016 or when Hudbay completes Constancia, which time the gold stream will drop down to 50%. We also obtained 100% of the life of mine silver production from Constancia, an asset under development in Peru. We are paying $750 million for those two streams, $500 million will be paid upon the closing which is imminent and $250 million will be paid in two tranches; the first tranche will be paid to Hudbay once they have invested $500 million into Constancia and the second tranche of $125 million will be made once Hudbay has invested $1 billion into Constancia. And Constancia’s estimated CapEx is about $1.5 billion currently and that includes 15% contingency. So we are quite comfortable with that CapEx figure.
The production payments that we are making under these contracts is $5.90 for each ounce of silver that’s delivered and $400 for each ounce of gold. The $5.90 is $2 higher than what we have traditionally set as our production payments for silver, and that’s just really reflective of the increasing costs being experienced across the industry in OpEx.
There is, as I mentioned, a completion guarantee associated with Constancia. So Hudbay has to demonstrate that Constancia can operate at 90% of nameplate capacity by the end of 2020 and they are expecting to bring that mine online in late 2014. So we don’t anticipate that they will have any trouble satisfying that. Again to the extent that they are delayed beyond 2016 in meeting this completion test, we continue to receive 50% of the gold from the 777 mine. So we feel that that type structure really aligns both Hudbay’s and Silver Wheaton’s interest in getting Constancia up and running.
The deal was very accretive on every possible measure that has been validated by all sell-side analysts. The mines underlying these streams are – again meet the characteristics of the mines that we are interested in investing in. They are relatively long life assets that have low-cost production; 777 falls into the lowest quartile while Constancia falls into both the 26 percentile. So it’s just barely into the second quartile of its respective cost curve. So very low cost operations.
The deal, because we are taking gold from 777, increases our exposure to gold from about 5% of revenues in 2012 to 2016 to about 15% of revenues over that period. I think we’ve been clear before that we are not averse to layering in some gold into the portfolio to the extent that we can do it in an accretive fashion, we still are very much focused on the silver space but will not turn away opportunities just because they involve some level of gold exposure.
The Hudbay deal did increase the diversification of our asset base. As you can see here, based upon our 2016 forecast of production by mine, the combination results in about 14% of our expected production in 2016, which reduces our reliance on any of the other assets. That high quality portfolio of diversified assets that we’ve got exposure to is expected to generate about 28 million ounces of silver production in 2012, growing to 48 million ounces of silver equivalent production in 2016.
So, why invest in Silver Wheaton? Well, the first and foremost, you need to want to increase your exposure to silver and there is really three ways that you can increase that – to get exposure to silver, you can invest in the silver mining company, you can invest in a silver bullion or an exchange-traded fund that invest in bullion or you can invest in Silver Wheaton. As you can see from this chart, the lion’s share of investable dollars are – have been going into the ETFs over the last 12 months. But we believe there are a number of characteristics associated with Silver Wheaton that should allow us to garner a greater percentage of those investable dollars.
If you first compare us to silver mining company, it’s really the fixed cash cost associated with our model that sets us apart, it insulates us from any CapEx overruns, it insulates us from any OpEx creep and those – both of those are being experienced across the mining industry currently. We are not exposed to any ongoing exploration costs and we have no exposure to remediation costs. The model allows us to have a great diversity of assets and it’s a very tax efficient structure that we have. So by investing in Silver Wheaton, you get all the upside that you would expect from investing in a silver mining company with very strong downside protection.
If you look at the percentage of our revenues that are generated from the sale of silver before the Hudbay deal, we were about 97% based upon 2011 production; that’s dropping down to about 85% after the Hudbay deal. That still sets us as the highest of the silver companies out there. This chart really drives home the strength of the model. You can see that since the inception of the company in 2004, our cash cost per ounce of silver delivered is – has remained virtually constant at about $4 and we know that based upon the current portfolio that it will remain at about that level until the end of the contract lives. So you can see how that allows investors to participate directly in any increase in the price of silver.
We have a very diversified portfolio, certainly relative to any of the other major silver producers out there with exposure to 21 different assets, 17 of which are producing and four of which are in development and there is really none of the other silver companies that compare.
So we think we represent a better investment vehicle than investing in a silver mining company. How we stack up against the exchange-traded funds? Well, we both provide primarily silver exposure but again we think there is a number of characteristics associated with Silver Wheaton that set us apart. First, we provide leverage to the price of silver. Over the last three years, the price of silver has risen by almost 100% whereas our share price has increased by over 225% and our cash flow per share has increased by well over 400%. Some of that performance premium comes from our ability to close accretive transactions for our shareholders but part of it comes from the model itself where we don’t pay fully for the silver upfront, we defer a portion of the payment until delivery, which creates leverage.
You get exposure to exploration and expansion upside by investing in Silver Wheaton where you do not get that by investing in exchange-traded funds. You can see here, this shows a summary of how our resource base has grown from inception to where it is today but you can see here that about 16% of our resource growth has come from exploration upside. The majority comes from acquisition and that is another element that you get when you invest in us, you’ve got a team of individuals that’s demonstrated great track record for closing accretive transactions. This chart really drives that home. You can see that at the inception of the company, we had about 1.5 ounces of silver underlying each one of our shares and today, we have almost 5 ounces of silver underlying those shares. The majority of that growth has come again through accretive acquisitions.
And if you thought we are running out of runway in the silver space, we would argue differently. This chart breaks down silver production annually from 2011 through 2016 and even with our portfolio growing to 48 million ounces of silver under production, that only represents 6% of what we consider our target market. Our target market is the byproduct market, silver produced as a byproduct of either a base metal operation or a gold operation. We are happy to talk to silver companies about doing silver streams with them although they tend to be more attached to their silver credits than the byproduct producers. Again, our portfolio only represents 6% of that target market. So we believe there is still a lot of room for us to grow by focusing on silver.
And prior to the Hudbay deal, it had been two years since we closed the transaction. We just inserted this slide into our presentation to explain partially why there has been such delay. The last deal that we had done was the Rosemont deal and you can see here what we have done is mapped out the spot price of silver relative to the long-term analyst consensus price. You can see that it deviated significantly in between the Rosemont deal and the Hudbay deal but we are back down to a level where the pricing expectations of our counterparties are much more reasonable and allows us to conclude transactions that are accretive for our shareholders. I think we’ve demonstrated an enormous amount of discipline by not having transacted in the interim.
We certainly are positioned well to take advantage of any opportunities that present themselves. At June 30, we had $1.1 billion of cash on hand. We have $400 million revolving credit facility which is completely untapped. We have virtually no debt. We have one more payment that’s due to Barrick which will be made this month for $137.5 million. Then, when you layer on the Hudbay deal, it will reduce our cash balance by $500 million to start and then there is another $250 million that will pay likely early in 2013, the first $125 million will go out and likely in Q3 timeframe, the second $125 million will go out. We are also generating in the neighborhood of $160 million to $190 million of cash flow from operations per quarter. So again, we feel we are well positioned to act on any opportunities that present themselves without having to raise additional capital.
Finally, with an investment in Silver Wheaton, you get a dividend yield, something that you won’t get by investing in an exchange-traded fund. We currently payout 20% of the prior quarter’s operating cash flow in the form of a dividend and we believe that unique policy is what investors are looking for. Because of our fixed cash cost structure, it provides investors with effectively direct exposure to any increases in the price of silver. Our dividend will increase as our organic growth profile comes to fruition. It’s very sustainable because it’s based upon operating cash flow, so it can be maintained in virtually any silver pricing environment.
Net-net is we think we provide a better investment vehicle than exchange-traded funds provide and are better investment vehicle than investing in silver producers. This last chart really just drives that home. We are the only silver company out there that outperformed the price of silver since the inception of the company and we did that by significant margin.
So, our thesis is that if you like silver, you should love Silver Wheaton. The cost certainty that we provide, the high quality portfolio of assets that we provide you exposure to, we have great ability to grow the company in this environment and we provide a dividend yield. And with that, Mike, I am running out of time but I think we may have time for one more or two questions.
Michael Jalonen – Bank of America/Merrill Lynch
Yes, definitely. So if any questions, let me Gary, you are the definitely the right guy to ask. A reoccurring question I get on Silver Wheaton, which is one you’ve received a million times. I am sure you know what’s coming. The tax issue, the people keep saying what’s going to happen there with the CRA review, sort of just wondering what your view is.
Sure. The Canadian Revenue Agency has initiated an audit of our taxation years 2005 through 2010. This is the first time that they’ve come in, although CRA auditing the company the size of Silver Wheaton is a completely routine and expected process. We would expect to be audited annually moving forward. This just happens to be the first time that they are looking at the company. We don’t anticipate that review will result in any material adjustment to our filing position for those taxation years.
It’s important to understand that the way we’ve structured the company is really no different than the way any Canadian company would structure themselves having both Canadian operations and international operations. We will ultimately pay Canadian taxes on the Canadian operations and we won’t pay Canadian taxes on the profits from our international operations.
Right now the CRA is in information-gathering mode. They don’t commit to any type of timeline as far as when they believe they will be finished. I would hope that by the end of 2012 that they are finished but given the unique nature of our business model and the number of years under audit, I wouldn’t be surprised if that gets delayed until sometime next year.
I think that the market is discounting our stock price because they believe that there is significant risk of challenge here. I don’t believe that that’s warranted. It’s not just management, it’s of the opinion that we should withstand this type of scrutiny but we have a host of advisors, legal and accounting advisors reviewing the structure. If there was any significant risk of us paying Canadian, we’d have to reflect that in our financial statements and we have no liability accrued for Canadian taxes other than the liability for the profit on the Canadian operations.
Michael Jalonen – Bank of America/Merrill Lynch
Okay, thank you for that answer. I think we are out of time. So if you could join me to thank Gary and Silver Wheaton for the presentation.
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