Wheaton Precious Metals — Continuing to beat expectations

Wheaton’s Q3 performance was characterised by a strong recovery in silver production coupled with a materially higher silver price. As expected, not all of the increase in silver production translated into increased sales owing to a process of rebuilding inventory (as measured by ounces produced but not yet delivered to Wheaton) after a period of drawdown in Q2 occasioned by coronavirus-related disruptions. Slightly unexpectedly however, there was no comparable drawdown among WPM’s gold assets, at which sales and production were closely aligned. Together, these two effects were largely responsible for a 9.9% positive variance in revenues in Q3 relative to Edison’s expectations, only partially offset by a 13.5% variance in direct costs (the disproportionately large increase in costs arising from the effect of the higher silver price on variable cost streams such as Yauliyacu and Antamina) and a 9.2% variance in depletion (see Exhibit 1). General and administrative costs were once again ahead of our expectations, although, as in Q2, almost all of the variance could be attributed to performance share unit accruals (see Exhibit 7). As a result of the overwhelming effect of the increase in sales however, net earnings exceeded our forecasts (and consensus forecasts) by 5.3% or US$7.6m. A full analysis of WPM’s Q320 income statement relative to both Q220 and our prior expectations is provided in the table below:

From an operational perspective, production at Antamina, Yauliyacu, Neves-Corvo and San Dimas materially outperformed our expectations during the quarter. Of the six of Wheaton’s partners’ mines that were directly affected by shutdowns and suspensions in Q2, four are, to all intents and purposes, operating once again at full capacity:

While lower than in Q319, production of gold at Wheaton’s flagship asset, Salobo in Brazil, was closely in line with our expectations, reflecting lower grades encountered in the orebody. Encouragingly however, there was little evidence on ongoing absenteeism during the quarter attributable to COVID-19. In the meantime, according to Vale’s Q320 performance report, physical completion of the Salobo III mine expansion was at 62% (cf 54% at end-Q2, 47% at end-Q1, 40% at end-Q419 and 27% at end-Q319) and remains on schedule for start-up in H122.

As noted previously, while sales of silver were 17.1% less than production – being approximately the amount anticipated to effect a c 20,000oz increase in inventories in gold equivalent (AuE) terms – gold sales were unexpectedly aligned with production, resulting in a negligible change in gold inventories.

As at 30 September, payable ounces attributable to WPM produced but not yet delivered to WPM amounted to 3.1Moz silver and 77,000oz gold (cf 3.1Moz silver and a fractionally restated 79,632oz gold at end-June). This ‘inventory’ equates to 1.85 and 2.45 months of FY20 forecast silver and gold production, respectively (cf 1.67 and 2.51 months as at end-Q220, as reported) and compares with WPM’s target level of two months of silver and two to three months of gold and palladium production, respectively.

Note that, for these purposes, the use of the term ‘inventory’ reflects ounces produced by WPM’s operating counterparties at the mines over which it has streaming agreements, but which have not yet been delivered to WPM. It in no way reflects the other use of the term in the mining industry itself, where it typically refers to metal in circuit (among other things) and would therefore be considered to be a consequence of metallurgical recoveries in the plant.

Prior to the coronavirus pandemic, WPM provided production guidance for FY20 of 390–410koz gold, 22.0–23.5Moz silver and 23.0–24.5koz of palladium to result in gold equivalent production of c 685–725koz (based on an assumed gold price of US$1,500/oz, an assumed silver price of US$18.00/oz and an assumed palladium price of US$2,000/oz). WPM suspended its production guidance on 1 April in response to the coronavirus crisis. As its partners’ previously furloughed mines have returned to production however, it reinstated updated guidance, as shown in the exhibit below, at the time of its Q2 results in August. Its long-term production forecast remains unchanged at 750,000oz gold equivalent per annum on average between 2020 and 2024. This compares with Edison’s current and previous forecasts, as follows:

Readers should note that the major differences between Edison’s gold equivalent production forecasts and Wheaton’s can be attributed to the ratio of the gold price to the silver price. Whereas Wheaton assumes an 83.33x ratio (based on a gold price of US$1,500/oz and a silver price of US$18.00/oz), the current ratio is closer to 77.5x and Edison assumes that the ratio will revert closer to its long-term average of 61.5x from FY21. Note that, at WPM’s prices, Edison’s gold equivalent production forecast in FY20 is 674.6koz, rather than 666.5koz (which assumes a gold price of US$1,875/oz for the remainder of the year and a silver price of US$24.18/oz). In addition, Edison is also expecting a production contribution from Salobo III from FY23 (albeit nothing from Rosemont).

In the medium term, First Majestic has announced plans to increase production at San Dimas by restarting mining operations at the past-producing Tayoltita mine and expects to ramp up production to add another 300tpd (12%) to throughput by the end of FY20. In addition, it intends to install a new 3,000tpd high-intensity grinding mill circuit and an autogenous grinding mill in Q221 to further improve recoveries and reduce operating costs. Production of palladium and gold at Stillwater (operated by Sibanye-Stillwater) will similarly increase into FY21 under the influence of the Fill-the-Mill project at East Boulder (although the Blitz project has now been delayed by two years, until 2024, following the suspension of growth capital activities owing to COVID-19).

By contrast, production is expected to remain at lower levels at Constancia in Q420, owing to delays in mining the Pampacancha satellite deposit (which hosts significantly higher gold grades than those mined hitherto). However, Hudbay reports that it has now secured the surface rights to Pampacancha and that approximately 79% of the land has been vacated and turned over to the company and that consequently it expects to begin mining ore from the satellite deposit early in FY21. Note that, in consideration of the delay, WPM continues to be entitled to receive an additional 2,005oz gold per quarter from Hudbay during FY20 relative to its PMPA.

On 5 November, WPM announced that it had entered into a definitive PMPA with Caldas Gold regarding the Marmato project in Colombia (NB WPM had already announced that it had signed a non-binding term sheet with Caldas Gold re Marmato on 22 June). Under the terms of the proposed PMPA, WPM will acquire 6.5% of the gold production and 100% of the silver production of Marmato until 190,000oz gold and 2.15Moz silver have been delivered, after which the stream will drop to 3.25% of gold production and 50% of silver production for the remainder of the life of the mine. Under the proposed PMPA, WPM will pay Caldas a total cash consideration of US$110m, of which US$38m will be payable within six months (subject to certain customary conditions) with the remainder payable during the construction of the Marmato Deep Zone project. In addition, WPM will make ongoing delivery payments equal to 18% of the spot gold and silver price until the market value of gold and silver delivered to the company, net of the per ounce cash payment, exceeds the initial upfront cash deposit, at which point it will make payments equal to 22% of the spot gold and silver price. The PMPA became retrospectively effective on 1 July 2020.

The Marmato project comprises the existing producing underground gold and silver mine in the Upper Zone, including the right to mine the lower portion of the neighbouring Echandia licence area, the existing 1,200tpd processing plant and the area encompassing the Deeps Zone mineralisation, all located within the mining licence area referred to as Zona Baja. The area has been a centre for gold production for approximately 500 years and the current mine has been in operation since 1991. As at 31 July 2019, the project’s mineral resource inventory was estimated at 5.4Moz, of which 38%, or 2.0Moz, is in the measured and indicated categories. Among other things, it has excellent infrastructure, being located adjacent to the Pan American Highway with access to Medellin to the north and Manizales to the south and has access to the national electricity grid, which runs near the property.

A preliminary economic assessment (PEA) was completed on the project in 2019 and charted a path for expansion of mining operations at the Marmato Project to encompass both the existing Upper Zone operation and a new Deeps Zone operation, which sits directly below the Upper Zone vein system. The PEA was then duly superseded by a pre-feasibility study (PFS), which was announced to the market in July 2020 and which focused on the development of the Deeps Zone mineralisation, mechanised mining using an underground long-hole stoping method, construction of a new 4,000tpd plant and new dry stack tailings storage facilities.

Wheaton’s agreement with Caldas is subject to receipt of required permits and licences, sufficient financing having been obtained and other customary conditions. On the basis of the PFS however, we have calculated the following potential cash flows to WPM based on the first 10 years of mining at Marmato (out of a total of 14) as follows:

In crude terms therefore, WPM is acquiring an average annual positive cash flow of c US$21m over 14 years for an upfront payment of US$110m. However, Wheaton interprets the geology of the mine to be structurally controlled and believes that there is a high probability that the system coalesces into one ore body at depth, similar to other systems in the region. Moreover, this interpretation appears to be supported by deeper drilling, which has indicated the potential for the mine to continue at depth and WPM therefore envisages the potential for multiple additional drop downs once the PFS plan has been concluded. Note that where cash flows from Marmato were previously excluded from our WPM forecasts, they are now included.

On 24 October 2018, Vale announced the approval of the Salobo III brownfields mine expansion, intended to increase processing capacity at Salobo from 24Mtpa to 36Mtpa, with start-up scheduled for H122 and an estimated ramp-up time of 15 months. According to its agreement with Vale, depending on the grade of the material processed, WPM will be required to make a payment to Vale in respect of this expansion, which WPM estimates will be US$550–650m in FY23, in return for which it will be entitled to its full 75% attributable share of expanded gold production. This compares to its purchase of a 25% stream in August 2016 for a consideration of US$800m (see our note, Silver Wheaton: Going for gold, published on 30 August 2016), the US$900m it paid for a similar stream in March 2015 (when the gold price averaged US$1,179/oz) and the US$1.33bn that it paid for its original 25% stream in February 2013.

According to Vale’s Q320 performance report, the Salobo III mine expansion is now 62% complete (cf 54% at the end of Q220, 47% at the end of Q120, 40% at the end of Q419 and 27% at the end of Q319) and remains on schedule for start-up in H122.

Wheaton’s contract with Barrick provides for a completion test that, if unfulfilled by 30 June 2020, results in WPM being entitled to the return of its upfront cash consideration of US$625m less a credit for any silver delivered up to that date from three other Barrick mines (at which point it would have no further streaming interest in the mine). Given the test was unfulfilled, we calculate that WPM has the right to an estimated US$252.3m (the carrying value of Pascua-Lama in WPM’s accounts) repayment from Barrick in FY20. Given the long-term optionality provided by the Pascua-Lama project, however, Wheaton has indicated it is unlikely to enforce the repayment of its entitlement and it prefers instead to maintain its streaming interest in the project (which was originally expected to deliver an attributable 1.7–12.0Moz silver pa, averaging 5.2Moz Ag pa, to WPM at a cost of US$3.90/oz (inflating at 1% per year).

Another major project with which WPM has a streaming agreement for attributable gold and silver production is Rosemont copper in Arizona.

The proposed Rosemont development is near a number of large porphyry-type producing copper mines and would be one of the largest three copper mines in the US, with output of c 112,000t copper in concentrate per year and accounting for c 10% of total US copper production. Total by-product production of silver and gold attributable to WPM is estimated to be c 2.7Moz Ag pa and c 16,100oz Au pa.

Rosemont’s operator Hudbay has received both a Section 404 Water Permit from the US Army Corps of Engineers and a Mine Plan of Operations from the US Forest Service. The Section 404 permit regulates the discharge of fill material into waterways according to the Clean Water Act and was effectively the final material administrative step before the mine could be developed. Subsequently, Hudbay indicated it would seek board approval to start construction work by the end of CY19, which would have enabled first production ‘by the end of 2022’. In the meantime, it started early works to run concurrently with financing activities (including a potential joint venture partner).

On 31 July 2019, however, the US District Court for the District of Arizona issued a ruling relating to a number of lawsuits challenging the US Forest Service’s issuance of the Final Record of Decision effectively halting construction, saying that:

In its reaction to the ruling, Hudbay said it believed the ruling was without precedent and the court had misinterpreted federal mining laws and Forest Service regulations as they apply to Rosemont. It pointed out that the Forest Service issued its decision in 2017 after a ‘thorough process of 10 years involving 17 co-operating agencies at various levels of government, 16 hearings, over 1,000 studies, and 245 days of public comment resulting in more than 36,000 comments’ and with a long list of studies that have examined the potential effects of the proposed mine on the environment. Hudbay also pointed out that various agencies had accepted that the company could operate the mine in compliance with environmental laws. As a result, Hudbay is appealing the ruling to the Ninth Circuit Court of Appeals, which it expects to be successful, not least as a result of there being legal precedents to its waste disposal plan. As an alternative, however, it is also able to adapt its plan to accommodate its waste dumps on patented land alone, if necessary.

Once in production, we estimate Rosemont could add an average c US$0.23 per share (14.4%) to WPM’s basic EPS in its first six years of its official 18-year life from FY25–30 for an upfront payment of US$230m (equivalent to US$0.512/share) in two instalments of US$50m and US$180m (of which neither has yet been paid). Nevertheless, in the light of the uncertainty about the timing and development of the project we have, for the moment, removed any contribution from Rosemont from our forecasts.

WPM is ostensibly a precious metals streaming company (plus one cobalt stream). Considering only the silver component of its investible universe, WPM estimates the size of the potential market open to it to be the lower half of the cost curve of the 70% of global silver production of c 837Moz in CY19 (down from 894Moz in CY15) that was produced as a by-product of either gold or base metal mines (ie approximately 300Moz pa silver versus WPM’s attributable production of 22.6Moz Ag in FY19). Inevitably, WPM’s investible universe may be further refined by the requirement for the operations to be located in good mining jurisdictions, with relatively low political risk. Nevertheless, such figures serve to illustrate the fact that WPM’s marketplace is very far from being either saturated or mature.

As a result, WPM reports that it is as busy as it has ever been on the corporate development front. Whereas potential deals in FY19 were generally reported to be with development companies in the US$100–350m range, more recent overtures are reported to have been from producing companies, especially within the base metals sub-sector, looking to strengthen their balance sheets with mooted transactions in the >US$1bn range. In the first instance, WPM would fund any such transactions via the US$1,512.5m available under its revolving credit facility, plus US$209.8m in cash (as at end-Q320) and, potentially, its US$300m at-the-market equity programme.

While it is difficult, or impossible, to predict potential future stream acquisition targets with any degree of certainty, it is possible to highlight two that may be of interest to WPM in due course for which it already has strong, existing counterparty relationships:

Otherwise, WPM also has streaming agreements with other potential producing mines, including (but not limited to) Navidad, Keno Hill (at which the operator, Alexco, has announced its intent to recommence mining operations from Q420) and Cotabambas. Note that during its most recent period in production, Keno Hill typically produced 150–200koz silver attributable to Wheaton per annum.

WPM reiterated its guidance for non-stock general and administrative (G&A) expenses of US$40–43m (or US$10.0–10.75m per quarter) in FY20, compared to a range of US$33–36m in FY19 (reduced from an earlier estimate of US$36–38m), an actual FY19 outcome of US$31.6m and guidance of US$34–36m in FY18 cf an actual outcome of US$36.7m, including all employee-related expenses, charitable contributions, etc, but excluding performance share units (PSUs) and equity settled stock-based compensation. It is notable, within this context, that WPM’s non-stock G&A expense for Q320 actually fell below this range (see Exhibit 7) and that the extent to which actual all-in G&A costs exceeded our forecasts could be entirely attributed to performance share unit accruals.

Investors are reminded that, since April this year, stock-based compensation costs and PSUs have been included in our financial forecasts in Exhibits 8 and 12 notwithstanding their somewhat unpredictable nature. Excluding stock-based effects, however, it is clear that non-stock expenses are trending towards the bottom end of (or even below) Wheaton’s guided range of US$40–43m.

Our updated forecasts for WPM for FY20 are as shown in Exhibit 8, below. The forecasts assume that operations will continue throughout the remainder of the year without major interruptions. Apart from precious metals prices, the principal remaining risk to our forecasts relates to the extent to which sales differ from production and therefore the extent to which inventory (in the form of ounces produced but not yet delivered to Wheaton) either increases or decreases during the year.

Readers should note that, whereas in Q320 we had assumed an inventory build in the order of 20,000oz gold equivalent, for the purposes of Q420 we are assuming production and sales are closely aligned for all metals as the possibility of a delayed inventory build in the gold division, in particular, is balanced by the traditional Q4 ‘flow through’ effect, whereby Wheaton’s partners prioritise concluding sales prior to the year-end. Within this context, our basic EPS forecast of US$1.177/share for FY20 (cf US$1.158/share previously) for FY20 is closely in line with the consensus forecast of US$1.14/share (source: Refinitiv, 10 November 2020) and towards the top end of the range of analysts’ expectations, of US$1.07–1.21 per share for the period:

In the meantime, our ostensibly unchanged basic EPS forecast of US$1.81/share for FY21 (see Exhibit 12) compares with a consensus of US$1.65/share (cf US$1.43/share on 9 October and US$1.20/share on 13 August) within a range of US$1.19–2.25/share (source: Refinitiv, 10 November 2020). In this case, our estimate is, once again, predicated on an average gold price during the year of US$1,892/oz and an average silver price of US$30.78/oz, which assumes, among other things, the silver price will revert to the long-term correlation that it has exhibited with gold since the latter was demonetised in 1971. In the event that both metals instead remain at current levels, however (US$24.18/oz Ag and US$1,875/oz Au at the time of writing), our forecast for WPM’s EPS in FY21 moderates to US$1.50 per share and our forecast for its DPS to US$0.63/share.

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 29.5x current year basic underlying EPS, excluding impairments (vs 38.0x Edison or 40.8x Refinitiv consensus FY20e, currently – see Exhibit 11).

Applying this 29.5x multiple to our EPS forecast of US$1.81 in FY21 would ordinarily imply a potential value per share for WPM of US$53.37 or C$69.41 in that year. However, the graph above suggests that the current year multiple has been on a broadly upward trend since FY12 and we would therefore argue that a multiple in excess of 40x (as evidenced by the last two completed years) can be supported, notwithstanding the fact that these years were not subject to the extraordinary trials and tribulations being experienced in FY20. In this case, applying a 42.0x earnings multiple (the average of FY18 and FY19) to our updated EPS forecast of US$1.81 in FY21 implies a potential value per share for WPM of US$75.98 or C$98.80 in that year and/or for as long as precious metals prices remain at higher levels and/or the current coronavirus crisis persists. Even at such elevated levels, however, a multiple of over 42.0x would still leave WPM’s shares at no more than on a par with Franco-Nevada (see Exhibit 11).

Note that neither of these valuations include the value of 17.2m shares in First Majestic held by WPM (3.0m shares having been sold during Q320), with an immediate value (10 November) of C$253.8m, or US$0.42 per WPM share.

In the meantime, from a relative perspective, it is notable that WPM has a lower valuation than the average of its royalty/streaming ‘peers’ on all of six valuation measures if our forecasts are used or all but two if consensus forecasts are used. On an individual basis, it is cheaper than its peers on at least 66% (16 out of 24) of the valuation measures used in Exhibit 11 if our estimates are adopted or 58% (14 out of 24) of the same valuation measures if consensus forecasts are adopted. Among other things, this could possibly indicate the market has more conservative precious metal pricing expectations than we do.

As at 30 September 2020, WPM had US$209.8m in cash cum-dividend (cf US$131.8m in Q220, US$126.7m in Q120 and US$104.0m in Q419) and US$487.5m of debt outstanding (cf US$640.5m in Q220, US$715.5m in Q120, US$874.5m in Q419 and US$1,017.1m at end-Q319) under its US$2bn revolving credit facility (which attracts an interest rate of Libor plus 120–220bp and now matures in February 2025), such that (including a modest US$3.7m in leases) it had net debt of US$281.4m (cf US$512.5m in Q220, US$592.7m in Q120, US$774.8m in Q419 and US$865.5m in Q319) overall, after US$228.1m of cash generated by operating activities during the quarter (cf US$151.8m in Q220, US$177.6m in Q120 and US$131.9m in Q419). Relative to the company’s balance sheet equity of US$5,551.3m, this level of net debt equates to a financial gearing (net debt/equity) ratio of just 5.1% (cf 9.5% in Q220, 11.3% in Q120, 14.5% in Q419 and 16.6% in Q319) and a leverage (net debt/[net debt+equity]) ratio of just 4.8% (cf 8.6% in Q220, 10.2% in Q120, 12.7% in Q419 and 14.2% in Q319). Self-evidently, such a level of debt is well within the tolerances required by its banking covenants that:

All other things being equal and subject to its making no further major acquisitions (which is unlikely in our view), on our current cash flow projections WPM will be net debt free early in FY21 (even after anticipated dividend payments).

WPM has filed an at-the-market equity programme that allows it to issue up to US$300m of common shares from treasury to the public, from time to time, at the prevailing market price or other prices through the Toronto Stock Exchange, the New York Stock Exchange or any other marketplace on which its shares are traded (eg the LSE). The volume and timing of distributions under the programme, if any, will be determined at the company’s sole discretion, subject to applicable regulatory limitations. WPM intends the proceeds from the programme, if any, will be available as one potential source of funding for stream acquisitions and/or other general corporate purposes, including the repayment of indebtedness. Owing to inherent uncertainties as to price and size, for the moment, at least, we have excluded from our forecasts the assumption of any such issues of shares under the programme.