Silver is a relatively small market that few people fully understand. However, I am very bullish on the outlook for physical silver as a store of wealth and as new uses for it in the industrial world are found I expect the price to continue rising.
Silver Wheaton was set up in 2004 and has grown to be the larger streaming company in the world. At present the company has 17 producing assets and four development assets, where in exchange for an upfront payment, it has the right to purchase all or a portion of the silver production, at a low fixed cost. Like Sandstorm, the mines are located in politically stable areas and I believe SLW is an excellent compliment as it provides a diversified low risk way to gain exposure to silver.
SLW’s attributable production in 2008 was just over 10m oz but for 2012 should be around 28m oz of silver equivalent, which includes 42,000 oz of gold and this is forecast to grow by 70% to 48m oz of silver by 2016. After the initial upfront payment has been made, SLW are not liable to any ongoing costs and they do not hedge production.
It is worthwhile highlighting some of the other key numbers. SLW is the industry leader by market cap amongst streaming and senior silver producers. It has more silver reserves and resources than any other silver company in the world and in terms of 2012 silver production it ranks second only to Fresnillo, which is expected to produce around 41m oz.
SLW have a number of low cost long life assets, including streams on Barrick’s Pascua-Lama project and Hudbay’s flagship 777 mine and Constancia project. Pascua Lima should add around 9m oz pa of silver to SLW in the first five years, with production due to start in the second half of 2014. The main attraction is that their business model provides leverage to the rising silver price whilst reducing risks faced by mining companies such as rising operational costs and increased royalty payments to cash hungry governments. As with all streaming and royalty companies, SLW benefits from exploration and expansion upside of the mine.
Given the clear advantages that SLW has, I would expect the share price to outperform Silver and most other silver stocks over the next year. SLW has stated that the predetermined price that they pay for future silver production is approximately $4.00 per ounce, with a small inflationary adjustment, ensuring that costs are fixed. Just like Sandstorm, SLW does not have to worry about the increasing cost of mining. Of course, they are reliant on the mines continuing to produce to ensure they receive the streams. As silver rises, this has a geared impact on SLW’s profits and this will led to an increase in the dividend (currently 0.8%)
Third quarter earnings were below analysts’ consensus forecasts, largely due to irregularities between ounces sold and timing of shipments. However, management are forecasting cash flow and dividends to increase in the current quarter as sales begin to catch up with production. Production in the third quarter grew to 7.69 million oz of silver, although sales increased by less than 1% to 5.14m oz. Sales fell 13% to $161.3m. Net income fell by 11% from last year’s $135 million to $119.7 million. I find the strong cash generation of the business model very reassuring. As at 30 September SLW has $555m in cash and cash equivalents and a $400m undrawn credit facility, so plenty of funds to finance new streams.
I believe SLW has exciting growth potential as the streaming market will continue to grow as an alternative method to traditional ways of financing. The majority of silver is produced as a bi-product of other commodities and there are very few pure silver mines in the world today. As a bi-product, miners are willing to sell streams on attractive terms to SLW. Most of SLW’s silver comes from mines in North and South America. Here are some of the largest and most important streams, which account for around 70% of annual attributable production.
Penasquito (Mexico) – In July 2007, SLW entered into an agreement with Goldcorp to purchase 25% of the silver produced for Penasquito for the life of the mine. It is one of the largest silver mines in the world and started producing in Q3 2010. The mine is expected to produce around 28m oz of silver annually for 22 years once at full production, of which SLW will receive 7m oz (c25% of SLW’s production).
San Dimas (Mexico) – In August 2010, Silver Wheaton amended its 2004 agreement following Goldcorp’s sale to Primero mining to life of mine. Primero will deliver 3.5m oz of silver pa and 50% of any excess, plus SLW will receive a further 1.5m oz to be delivered by Goldcorp. From the fifth year, Primero will deliver an amount equal to the first 6m oz of silver and 50% of any excess. San Dimas has been in production for over 100 years and is a low cost gold and silver producer.
777 Canada and Constancia (Peru) – In August 2012, SLW entered into an agreement with Hudbay to acquire 100% of the life of mine of silver and gold production as well as 100% from of the silver production from Constancia. SLW’s share of gold at 777 will remain at 100% until the later of end of 2016 or the satisfaction of a completion guarantee relating to Constancia, after which it is then reduced to 50% for the remainder of the mine life. The two mines will add approximately 4.9m oz of silver equivalent production and SLW has paid $500m in cash for the stream.
Yauliyacu (Peru) – This stream was signed in March 2006, when SLW entered into an agreement with Glencore to buy up to 4.75m oz of silver pa for 20 years, based on production from Yauliyacu. It is a low cost underground zinc, lead, copper and silver mine that has been running for over 100 years. SLW expects to receive between 2.5m and 4.75m oz of silver pa.
Zinkgruvan ( Sweden) – SLW entered into an agreement in December 2004 to purchase 100% of the mine life from Lundin Mining’s Zinkgruven mine. The mine is a low cost zinc-lead-silver mine that has been producing for over 150 years and is expected to produce up to 2m oz of silver pa
Minto (Canada) – In May 2009, SLW acquired the right to buy 100% of the mine life’s silver and gold production from Capstone Mining’s Minto mine. Minto is a high grade open pit mine located in the Yukon. SLW is forecast to receive over 200,000 oz of silver pa and approximately 20,000 oz of gold.
Cozamin (Mexico) – SLW acquired the right to purchase 100% of the silver production from Capstone’s Cozamin mine until 2017. Cozamin is a high grade underground copper-silver-lead-copper mine and is forecast to produce approximately 1.5m oz of silver pa.
Over the medium to long term, I am fundamentally bullish on the outlook for silver and would expect it to outperform gold in a rising market. SLW is a geared play on silver and has increased in value by 215% over the last three years compared to silver increasing by 111%. SLW shares currently trade around $36 and have traded between $23 and $41 over the last year. Despite the last quarter being weak, attributable production is forecast to rise strongly over the next 3-4 years. Over this time I would expect a number of new streams to be announced, which will then be factored in to analysts share price targets. SLW is a lower risk play than owning silver miners and operates in politically safe jurisdictions. For such a quality stock with a great track record it does not look expensive on an analysts’ consensus 2013 Price to Cashflow rating of 18x. Based on production growth and leverage to the silver price I would expect the share price to double over the next 2-3 years in a reasonable market.