Will Silver Wheaton Increase Its Stakes On Pascua-Lama?
Dec. 29, 2014 11:22 AM ET
By Peter Arendas - Seeking Alpha
Silver Wheaton hasn't made a new streaming agreement for more than a year.
Pascua-Lama is a large project suspended by Barrick Gold due to huge cost overruns.
Pascua-Lama is too big and Barrick Gold has invested too much money into it not to finish it.
Gaining another silver or gold stream from Pascua-Lama would mean a huge boost to Silver Wheaton's share price.
Silver Wheaton (NYSE:SLW) lags behind its main competitors, Royal Gold (NASDAQ:RGLD) and Franco-Nevada (NYSE:FNV). While Royal Gold is up 32% year to date and Franco-Nevada is up 15%, Silver Wheaton has lost 3.5% of its value. Also the comparison of P/E ratios shows that investors are more optimistic about the future prospects of Royal Gold and Franco-Nevada.
Company Estimated P/E (12/2014)
Franco-Nevada 48.56
Royal Gold 44.70
Silver Wheaton 25.29
Source: Bloomberg.
The competitors have almost two times higher P/E ratios than Silver Wheaton. The underperformance of Silver Wheaton is usually explained as a combination of two factors:
Silver Wheaton's main focus is silver and silver is more volatile (i.e., more risky) compared to gold. Gold has lost only 2.2% of its value while silver is down by almost 19% year to date. This is why investors are more confident in investing in shares of Franco-Nevada and Royal Gold that are primarily focused on gold.
Silver Wheaton hasn't expanded its royalty portfolio for more than an year. On the other hand, Franco-Nevada and Royal Gold were more active. This is why the investors expect more growth from them, which is also reflected in higher valuations of their shares.
Both of the above-mentioned points can be resolved at once. Silver Wheaton needs to buy another stream, ideally a gold stream. Although there is a lot of projects that need to be financed right now, only a couple of them is big enough to have a meaningful impact on the valuation of a company like Silver Wheaton. Pascua-Lama owned by Barrick Gold (NYSE:ABX) is big enough. And Silver Wheaton knows Pascua-Lama quite well because it already owns a streaming agreement on a 25% share of its silver production.
Pascua-Lama and Its Future
The Pascua-Lama deposit is located in South America on the Chile-Argentina border. There are proven and probable reserves of 15 million toz of gold and 675 million toz of silver. The projected mine life is 25 years. The production during the first 5 years was expected at the level of 800,000-850,000 toz of gold and 35,000,000 toz of silver, with all-in sustaining cash costs between $50 and $200 per toz of gold. It means that the project can be highly profitable even at the current gold price. The problem is that the estimated capex grew from $1.6 billion in 2006 to more than $8.5 billion in 2014. Barrick has already invested more than $5 billion, but the decline of the gold market together with some political and environmental problems forced the company to stop the construction of the mine back in 2013.
Although the construction has been suspended, there was too much money invested for Barrick Gold to not finish the mine. The mine would be highly profitable even at the current gold price. The production of 800,000 toz of gold at all-in sustaining cash costs of $200/toz and gold price of $1200 would result in an yearly profit of $800 million. For comparison, the adjusted net earnings of Barrick Gold were $222 million in Q3 2014. It means that Pascua-Lama has the potential to significantly boost financial results as well as share value of the company.
Barrick's management surely knows this, although its comments about the restart of development are only tentative. But keeping the project conserved is expensive ($300 million in 2014 only) and it is probable that the estimated capex of $8.5 billion will rise as the years pass by. And upon of it if the mine isn't completed by the end of 2017, Silver Wheaton will have the right to terminate the streaming agreement. In this case, Barrick will be obliged to return Silver Wheaton $625 million less a credit for silver already delivered.
The above-mentioned is why Barrick claims that it will explore opportunities to improve the project's risk-adjusted returns, including strategic partnerships or royalty and other income streaming agreements. According to a government official in Argentina, Barrick Gold is in talks to form a partnership on Pascua-Lama with Zijin Mining (OTCPK:ZIJMF). Zijin Mining is the biggest Chinese gold producer and it is trying to expand its operations outside of China. Only a couple of weeks ago, Zijin Mining announced that it will acquire 9.9% of shares of Pretium Resources (NYSE:PVG) via a private placement. Whether the Chinese will make a deal with Barrick Gold or not, Barrick may need another financial infusion to complete the construction of Pascua-Lama, and Silver Wheaton has more than $1 billion to play with.
Silver Wheaton and Pascua-Lama
Silver Wheaton acquired the Pascua-Lama silver stream in September 2009. Silver Wheaton made an upfront payment of $625 million. As a result the company will receive 25% of silver production from Pascua-Lama at a price of $3.9 (or the market price if the market price is below $3.9/toz). The price of silver was $16.5/toz and the price of gold was $997/toz back in September 2009, which means that the price conditions were similar to the present ones. As such, if Silver Wheaton wants to make another streaming agreement with Barrick it should be able to reach similar terms.
Silver Wheaton should get 9,000,000 toz of silver per year during the first five years of operations. The estimated silver production of Silver Wheaton is 36,000,000 toz of silver equivalent. The current agreement may result in a 25% increase of today's production numbers. Silver Wheaton has over $1 billion of capital prepared for acquisitions of new streams, which means that it has more than enough money to reach a streaming agreement with Barrick Gold similar to the current one. It would mean a significant boost for the valuation of Silver Wheaton because:
The agreement would mean that Pascua-Lama is back on track and the markets can include the 25% growth of production into the share price.
Silver Wheaton made another deal and the business will expand.The markets should include the value of the new contract into the share price.
If the new agreement was about a gold stream instead of another silver stream, it would mean a significant diversification of the Silver Wheaton's portfolio. It should increase the valuation of Silver Wheaton (in the terms of the P/E ratio) to levels more similar to Royal Gold and Franco-Nevada.
Yes, someone can tell that the exposition against Pascua-Lama could get too big, but most of the risks can be treated in the terms of the streaming agreement (as it has done in the current streaming agreement where Barrick Gold is obliged to finish the construction by a predetermined date, or else Silver Wheaton will have the right to terminate the contract). Barrick Gold is a strong partner that should be able to fulfill its obligations. And although there were some environmental issues, it is in the interest of Argentina as well as Chile to let Barrick Gold to finish the construction of the mine, to employ the local people, and to pay local taxes.
Conclusion
Pascua-Lama is too big and Barrick Gold has invested too much money into its development to only throw it into the trash bin. Barrick Gold will be looking, and some sources say that it already is looking, for ways how to complete the mine. Pascua-Lama has a huge potential to become a major catalyst for the Silver Wheaton's share price. If Barrick Gold decides to go it alone or if it decides to bring in a new partner, the markets will attribute a higher value to the current streaming contract held by Silver Wheaton. If Barrick makes another streaming agreement with Silver Wheaton, the impact on the share price will be even stronger. It would make sense for Silver Wheaton to increase its stakes on Pascua-Lama.
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