Will Silver And Silver Wheaton Trade Up?

Includes: SLV, SLW
by: Lior Cohen

The recent third-quarter financial reports from Silver Wheaton Corp. (NYSE:SLW) came out this week, on Nov. 5. The company's quarterly revenues and operating earnings declined during the quarter compared to the parallel quarter in 2011. The drop in sales was mostly due to a delay in delivery. Its operating profitability increased slightly compared to the second quarter of 2012, but was slightly lower than the operating profitability in third quarter of 2012. Let's examine the recent developments in the silver market and the third-quarter results of Silver Wheaton.

During November, the prices of silver and Silver Wheaton slightly decreased: Shares of Silver Wheaton declined by 2.4%, and in comparison the price of silver decreased by 0.9%. iShares Silver Trust (NYSEARCA:SLV) also fell by 0.8%. The chart below shows the developments in the price of silver, Silver Wheaton and the S&P 500 index normalized to Jan. 3, 2012. As seen below, shares of Silver Wheaton have outperformed the price of silver and the S&P 500.

Click to enlarge images.

Silver Is on the Rise, But Will This Rally Last?

The price of silver -- and by extension other silver-related assets, including Silver Wheaton -- rose in the past couple of days. This rally, however, might be short-lived as it may have been halted by the recent presidential elections. Back in the 2008 elections, the price of silver hiked during the elections by nearly 9.2% (between Nov. 5 and Nov. 7, 2008). As you well know, past performance is no indication of future performance. Nonetheless, if the rise in the price of silver was a reaction to the presidential elections, it could result in a correction in the next few days as was the case back in November 2008.

Beside the bullion market's apparent reaction to the U.S. presidential elections, many bullion investors are looking toward the U.S. government's next step in tackling the fiscal cliff. If President Obama and Congress won't be able to reach a compromise, this could result in an automated $600 billion in tax increases and spending cuts that will come into effect at the beginning of 2013.

In the meantime, the Fed isn't likely to sit on the sidelines without intervening in the financial markets. The Fed already launched QE3 back in September. The FOMC is concerned about the aftermath of the fiscal cliff. It is plausible for the Fed to introduce additional monetary actions to help jump start the economy and compensate for the ramification of the spending cuts and tax increases. In such a case, there might be another rally in the price of silver in the months to follow.

Silver Wheaton's Third-Quarter Reports

According to its third-quarter financial report, Silver Wheaton's operating profitability rose to 75% compared to the second quarter of 2012, but declined compared to the same quarter in 2011. The company's total revenues declined by 19.9%, compared to the second quarter of 2012 and by 12.9% compared to the parallel quarter in 2011. Silver Wheaton's revenues from Silver fell by 14.7% compared to the third quarter of 2011. The drop in sales was mostly due to price changes and the fall in the amount of silver (in ounces) the company had sold: During the third quarter, the company's silver sales (in ounces) declined by 0.2% compared to the third quarter in 2011, and the realized price of silver declined by nearly 14.5%. Compared to the previous quarter, however, the company sold 29.5% less silver (in ounces) while the price was 7% higher.

The chart below presents the developments in the company's operating profitability and the quarterly changes in the average realized price of silver. As seen below, the company's operating profitability has increased in the recent quarter, which coincided with the moderate gain in the price of silver.

The sharp drop in sales was mostly due to delays in delivery: In the 777 mine, nearly 0.7 million of silver equivalent ounces weren't delivered by the end of the third quarter. If the company were to sell this amount, its revenue would reach nearly $21.8 million (based on the third-quarter realized price of silver). Given an estimated 75% operating profitability, the operating profit would have increased in the third quarter by nearly $16.2 million. The Yauliyacu mine also had a delay in delivery of nearly 1.2 million of silver equivalent ounces. The total delayed amount comes to almost 2 million ounces; if this amount were completely sold in the third quarter, it would have resulted in an 11% increase in sales compared to the second quarter of 2012 and a 20.7% rise compared to the third quarter of 2011.

If the company cuts its current 5.2 million of payable silver equivalent ounces by the next quarter, this could lead to a sharp increase in the company's revenues and earnings in the fourth quarter. The company's recent financial reports might not have shown growth in sales as many had anticipated, but since the drop in sales was mostly due to timing issues and not a fundamental shift, the company's stock is likely to remain robust.

For further reading, see "Gold and Silver Outlook for Nov. 5-9."

Disclosure: I 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.

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