Wheaton Precious Metals Corp (WPM)

[Tommy]

$SLW - Silver Wheaton Corp: A Big Long-Term Investment Opportunity

http://seekingalpha.com/article/1526182-silver-wheaton-corp-a-big-long-term-investment-opportunity?source=email_rt_article_readmore

Silver is one of the most widely acknowledged stores of value since historic times. Although fiat money has taken its place in recent times, silver continues to hold much significance in our modern world. World demand for silver and its products has never been higher.

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Source: World Silver Survey 2013 and Thomson Reuters GFMS

Silver, because of its many applications, is an essential input for many companies belonging to the jewelry, solar paneling, and fabrication industries. Silver is also used for investment purposes as its price constantly fluctuates with changes in the economic variables that affect it.

Exploiting Silver's Potential - Silver Wheaton Corp (SLW)

SLW is the largest silver streaming company in the world. It has a unique business model which allows it to generate attractive returns for its shareholders. SLW engages in long-term contracts with different mining companies to purchase the silver they produce. The contract is enacted at a low price on which both the parties have mutual agreement. The mining companies in question are those that extract base metals and for them silver are a by-product of their operations. SLW pays an upfront payment to the mining companies when the contract is signed. Later on SLW also pays delivery payments to the mining company per ounce of silver delivered. The contract is beneficial for both of the parties as SLW is able to procure silver at lower rates and the mining company gets much needed capital by selling off the silver by-product of their operation. Two major mining companies that have contracts with silver streaming companies are Barrick Gold and Goldcorp.

One of the prime characteristics of silver streaming companies is that their earnings are directly proportional to the changes in the price of silver in the open market.

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Source: Y Charts

The above graph shows the 3- year percentage change in the price of SLW with the S&P Gsci Silver Index. It is very evident from the graph that SLW's performance is highly correlated with the movement in silver's price. The reason for this great correlation is explained below.

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Source: Company Presentations

The above graph shows that SLW's total cash costs per ounce of silver are fairly stable over the years. The slight increase over the years is an adjustment for inflation. This is due to the long term contracts of SLW with the mining companies as discussed before. We see that as the per ounce price of silver increased, in the 2010-2011 period, the margins for the company increased. The opposite is true when the per ounce price of silver decreased in the 2011-2012 period. Overall, the company has seen an increase in its cash operating margins.

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Source: Company Presentations

The above bar charts show the most positive financial indicators for the company in the 2010-2012 period. Revenues, operating cash flows and earnings have more than doubled in the representative period.

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Source: Company Presentations

The 1Q13 results for the company have been largely positive. The YoY increase in the production of silver equivalent products was 20%. Revenues increased by 3% on the YoY basis. This figure is the best indicator of the current performance of the company because as the operating cash margins have fallen, the company has been able offset it by increasing its sales volumes. The sales volume increased due to the increasing demand for silver from different industries which use it as an input for production. The falling market price of silver had the inevitable effect on the earnings on the company which fell by 9% on the YoY basis.

Future Outlook - SLW

SLW's future in part depends on the future of mining companies.

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Source: CPM Group silver production forecasts by source metal, company presentation

The above bar chart shows the estimated increase in base metal mining operations around the world. We can also see an increase in the number of gold mines and traditional silver mines. It is interesting to note that 70% of the silver is produced as a by-product of base metal and gold mining operations. The forecasted increase in base metal and gold mining operations is a positive sign for SLW as it will be able to increase its supply by contracting with these mining companies in the future. Therefore, we see tremendous growth potential for the companies involved in the silver streaming operations.

A possible downside to the silver streaming companies is that no credible forecast exists for the possible changes in silver prices. Historically, money supply and velocity of money have shown correlation with changing prices of silver. A detailed regression model can at best only vaguely estimate the price changes in the future. Therefore, it is highly recommended that investors should not base their expectations on changes in these two variables only.

SLW's Risk Profile

Companies that pack growth potential have exposure to mounting risks. Below we analyze how SLW manages its risks.

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Source: Company Presentations

The above graph shows that SLW ranks very favorably on the political risk spectrum. This is because most of the mining companies that provide silver to SLW operate in politically stable locations with lesser chances of downtime. This will ensure steady supply of silver to SLW in the years to come.

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Source: Company Reports, Company Presentations

Another way SLW has reduced its exposure to risks is through contracting only those mining companies that have access to long-life mines. The pie charts show that by the year 2017, up to 80% of silver supply to SLW would come from long-life mines (long life mines are those which are expected to last 10 or more years).

SLW is also protected from currency translation losses as it deals in silver. SLW has no exploration expenditures and it is able to maintain strong cash flows. All these factors reduce the risks SLW faces.

Valuation

SLW is not the only silver streaming company in world. The performance of other companies in this industry has immense effect on the share price of SLW.

Source: Company Financial Statements and Morningstar

The above table shows the valuation of SLW using the price multiples. The fair value that we get for SLW is a little higher that the last close value of its share price.

Conclusion

SLW has a winner business model which packs enormous growth potential once the silver prices start to rise again. The comparative valuation shows a small upside potential for the company signifying no immediate gains to be made on the stocks of this company. As silver prices are subject to changes, there will surely come a time in future when they start to rise again. Until then, SLW will focus on increasing its sales volume and providing solid dividends to its shareholders. Due to the above mentioned reasons, I will give a buy recommendation to the investors for a long horizon.