Wheaton Precious Metals — In the right place at the right time

Wheaton Precious Metals acquires the right to purchase streams of precious metals from producing or near-producing mines in return for a combination of a fixed upfront payment and an ongoing payment (in US$/oz). Typically, it focuses on by-product precious metal streams as this offers the greatest arbitrage opportunity between the perceived value of the stream to the producer and the perceived value of the stream to WPM. Specifically, however, it seeks to build long-term value by entering streaming agreements with large, financially stable counterparties operating premium, high-margin projects in the lowest quartile (and certainly the lowest half) of the cost curve.

Edison has honed its EPS forecasts to 65c for FY20 (from a range of 80-130c, depending upon precious metal prices assumed) and to 113c for FY21 (cf 115c previously). Excluding FY04, WPM’s shares have historically traded on an average P/E multiple of 29.5x current year basic underlying EPS (cf 39.8x Edison or 28.9x consensus FY20e, currently). Applying this multiple to our long-term EPS forecast of US$1.13 in FY21 implies a potential value for WPM shares of US$33.38, or C$48.47, in that year (cf US$32.78, or C$43.37, previously).

As at 31 December 2019, WPM had US$104.0m in cash and US$874.5m of debt outstanding under its US$2bn revolving credit facility, such that (including a modest US$4.3m in leases) it had net debt of US$774.8m after US$131.9m of cash generated by operating activities in Q419. Relative to the company’s balance sheet equity of US$5,325.9m (cf US$5,201.4m at end-Q3), this level of net debt equates to a financial gearing (net debt/equity) ratio of 14.5% (cf 16.6% at end-Q3) and a leverage (net debt/[net debt+equity]) ratio of 12.7% (cf 14.2% at end-Q3). It also compares with a net debt position of US$865.5m as at end-September, US$1,012.8m as at end-June, US$1,057.7m as at end-March, US$1,188.2m as at end-December 2018 and US$1,261.1m as at end-September 2018. 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 late in FY21.

WPM has immediate growth potential in the form of its existing precious metal streaming agreements relating to the Salobo III mine expansion, Penasquito, Constancia, Pascua-Lama, Rosemont, Navidad, Keno Hill and Cotabambas to name a few. Aside from these, 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 856Moz in CY18 that was produced as a by-product of either gold or base metal mines (ie approximately 300Moz pa silver, compared with which WPM’s silver production of 22.5Moz in FY19 represented a market penetration rate of only 7.5%). 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 far from saturated or mature.

Our financial forecasts for FY20 are conducted at precious metals prices of US$12.00/oz Ag and US$1,479/oz Au. A ±10% change in these prices results in a ±US$0.15 (23.1%) change in our EPS forecasts.

With just one exception (Sudbury), all of Wheaton’s major mines either met or exceeded our production expectations for Q419 and, to all intents and purposes, Wheaton’s (see Exhibit 4). As a result, attributable production of gold at WPM reached a record in FY19, breaching the 400koz level for the first time ever. Record production begat record sales volumes of gold as well, although there was some evidence that sales volumes struggled to keep pace with production. Consequently, there was a (slightly uncharacteristic for the fourth quarter) increase in stocks of metals produced but not yet delivered. From a financial perspective however, underlying net earnings during the quarter were, once again, within US$1m of our prior forecasts. Otherwise, readers should note that the difference between Edison FY19 underlying EPS forecast of US$0.57 and the reported number of US$0.56 could be explained purely in terms of rounding: the reported number coming to 56.498c, rather than Edison’s 56.670c to three decimal places.

The only other significant departure from our expectations was the level of the general and administrative charge, albeit 36.4% of the total charge could be accounted for by equity settled stock-based compensation and performance share unit (PSU) accrual related to the anticipated fair value of the PSUs issued. Excluding these two factors, WPM’s general and administrative cost for the year would have been below the guided range of US$36–38m for the year as a whole.

Out of 19 mines, production at 11 (and five out of eight major assets) was in excess of our forecasts in Q4, with the outperformance generally being attributed to higher grades (eg Penasquito, San Dimas and Antamina). Once again, Salobo reported an exceptionally strong quarter, contributing its fourth highest quarterly number of ounces ever to WPM, after Q418, Q417 and Q416, albeit 16,579oz of production remained unsold at the end of the quarter (cf 10,551oz in Q319). Newmont’s Penasquito mine also reported one of its strongest production performances ever, made all the more impressive by the fact that the illegal blockade that began there on 15 September was only lifted towards the end of October:

In contrast to 11 out of 19 mines outperforming our production expectations during the quarter, only five outperformed our sales expectations, with the result that there was a 16.8% under-sale of gold relative to production and a 21.4% under-sale of silver (cf long-term averages of 7.8% and 11.7%, respectively):

As at 31 December, payable ounces attributable to WPM produced but not yet delivered to WPM amounted to 4.5Moz silver and 98,626oz gold (vs a fractionally restated 4.1Moz silver and 85,335oz gold at end September). This ‘inventory’ equates to 2.42 months and 2.92 months of FY19 silver and gold production and compares to 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 may therefore be considered to be a consequence of metallurgical recoveries in the plant.

In FY20, WPM has provided more detailed estimated attributable production guidance 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), which compares with (unsegmented) prior guidance of 750,000oz (albeit at different assumed gold, silver and palladium prices). For the five-year period ending in FY24, the company has maintained its average annual gold equivalent production at 750,000oz pa. These compare with WPM’s and Edison’s current and previous guidance/forecasts, as follows:

While Edison’s updated forecasts are within 1% of WPM’s expected range in FY20, we believe that there is upside potential to its gold production forecast at Minto, in particular, and downside risk to its silver production forecast at Constancia owing to mine sequencing ahead of its (delayed) development of the high-grade Pampacancha satellite deposit (see below).

Otherwise, 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 123x and Edison assumes that the ratio will revert to closer its long-term average of 61x from FY21. Note that, at WPM’s prices, Edison’s gold equivalent production forecast in FY20 is 704.5koz, rather than 624.4koz (which assumes a gold price of US$1,479/oz for the balance of the year and a silver price of US$12.00/oz). In addition, Edison is also expecting a production contribution from Salobo III from FY23 (albeit nothing from Rosemont).

In the medium term, silver output from Penasquito attributable to WPM is expected to recover back to its steady-state level of 7Moz as the Chile Colorado pit contributes to mill feed and grades improve once again at the main Penasco pit with mine sequencing through to 2021. It will also benefit from the development of the Pyrite Leach Project, which will add an additional 1.0–1.5Moz of silver attributable to WPM per year by recovering 48% of the silver that previously reported to tailings. At the same time, First Majestic has announced plans to increase production at San Dimas by restarting mining operations at the past-producing Tayoltita mine by the end of Q120 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 H220 in order to further improve recoveries and reduce operating costs. Production of palladium and gold at Stillwater mine will similarly increase into FY21 under the influence of the Fill-the-Mill and Blitz projects. By contrast, production is expected to remain at lower levels at Constancia, 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 for the Pampacancha deposit and expects to begin mining ore from the satellite deposit in late FY20. Nevertheless, in lieu of the delay, WPM is entitled to receive an additional 2,005oz gold per quarter from Hudbay during FY20 relative to its precious metals purchase agreement.

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 in the range US$550–650m in FY23, in return for which it will be entitled to its full 75% attributable share of gold production. Note: 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 Q419 performance report, physical completion of the Salobo III mine expansion is now 40% complete (cf 27% at the end of Q3) 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 the current time it is, to all intents and purposes, impossible for Pascua-Lama to pass a completion test on 30 June 2020, as a result of which Edison had presumed that WPM would be the recipient of c US$273.4m in FY20. Given the long-term optionality provided by the Pascua-Lama project however, Wheaton has indicated that it is unlikely to enforce the repayment of its entitlement and that it prefers instead to maintain its streaming interest in the project.

Another major project with which WPM has a streaming agreement is Rosemont copper in Arizona.

The proposed Rosemont development is located 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 will 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 (MPO) 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 commence construction work by the end of CY19, which would have enabled first production ‘by the end of 2022’. In the meantime, it commenced early works to run concurrently with financing activities (including a potential joint venture partner).

On 31 July however, the US District Court for the District of Arizona issued a ruling in the 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 that it believed that the ruling was without precedent and that 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 ten 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. In conclusion, it said that it will appeal the ruling to the Ninth Circuit Court of Appeals.

Edison estimates that Rosemont could contribute an average c US$0.11 per share (12.6%) to WPM’s basic EPS in its first nine years of operations from FY22–30 for an upfront payment of US$230m (equivalent to US$0.515/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 at least, removed any contribution from Rosemont from all of 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 856Moz in CY18 (down from 894Moz in CY15) that was produced as a by-product of either gold or base metal mines (ie approximately 300Moz pa silver vs 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 far from saturated or mature.

As a consequence, WPM reports that it is busy 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 looking to strengthen their balance sheets with mooted transactions in the >US$1bn range, which WPM would fund, in the first instance, via the US$1,125m available under its revolving credit facility, plus US$104m in cash and its proposed ATM programme (see below).

While it is difficult, or impossible, to predict potential future stream acquisition targets with any degree of certainty, it is perhaps 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 has streaming agreements with other potential producing mines, including (but not limited to) Navidad, Keno Hill and Cotabambas.

Gold is a traditional beneficiary of negative real interest rates (and therefore falling nominal interest rates, assuming constant inflation) and central bank expansion of balance sheets in the form of either quantitative easing or otherwise. From a recent high of US$1,683/oz on 6 March 2020 however, the gold price has fallen approximately 12% as it has been caught between its traditional role as a safe haven in times of crisis and liquidation and profit taking in order to make margin calls in other sections of investors’ portfolios. Its year-to-date performance of -2.7% so far during the coronavirus crisis nevertheless dwarfs the equivalent performances of its equity market rivals (eg Dow Jones -25% and FTSE100 Index -37% in US dollar terms) and it remains the only major financial and monetary asset that is not another counterparty’s liability as well as being a credible store of value and, in extremis, medium of exchange.

Edison’s nominal gold and silver price forecasts, set out in our report, Portents of economic weakness: Gold – doves in the ascendant, published in August 2019, are as follows:

While the current gold price (which accounted for 60% of WPM’s net earnings from operations in Q419) of US$1,479/oz is within 10% of Edison’s previous CY20 forecast, above, the silver price of US$12.00/oz is at a 55.1% discount to our forecast (which assumes a normalisation of the gold/silver ratio in the foreseeable future). In common with Edison’s stated practice, we use prevailing prices to generate our forecasts for the remainder of the current year, followed by long-term forecasts (above) thereafter.

WPM has provided guidance for non-stock general & administrative expenses of US$38–40m (or US$9.5–10.0m 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 PSUs and equity settled stock based compensation (see Exhibit 2). Investors should note that stock-based compensation costs and PSUs are excluded from our financial forecasts in Exhibits 8 and 12 owing to their inherently unpredictable nature.

In our update note of 18 November 2019, we stated that, our FY20 EPS forecasts ‘exist within a wide range depending on the metal prices assumed, from 80c (at spot prices) to 130c (at our higher long-term prices)’. Taking into account all of the aforementioned considerations, we have now been able to corral our forecasts for WPM for FY20, at updated metals prices to reflect the recent turmoil, by quarter, as follows:

Our basic EPS forecast of US$0.65/share for FY20 is 27.0% below the consensus forecast of US$0.89/share (source: Refinitiv, 19 March 2020) within a range of US$0.80–1.05per share – albeit we believe that this accurately reflects current circumstances in the market and, in particular, prevailing precious metals prices:

Our US$1.13 basic EPS forecast for FY21 (see Exhibit 12) compares with a consensus of US$0.88 (source: Refinitiv, 19 March 2020), within a range of US$0.76–1.15. This estimate is predicated on an average gold price during the year of US$1,509/oz and an average silver price of US$24.76/oz, which is more than double the current spot price. One of the central assumptions behind our silver price forecast is that it will, at some point, revert to the long-term correlation that it has exhibited with gold since the latter was formally demonetised in 1971. In the event that both metals remain at current levels however (US$12.00/oz and US$1,479/oz at the time of writing), we forecast that WPM would instead earn US$0.57 per share in FY21.

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 39.8x Edison or 28.9x Refinitiv consensus FY20e, currently – see Exhibit 11).

Applying this 29.5x multiple to our updated EPS forecast of US$1.13 in FY21 implies a potential value per share for WPM of US$33.38, or C$48.47, in that year (vs US$32.78, or C$43.37 previously). Note that this valuation excludes the value of 20.2m shares in First Majestic currently held by WPM, with an immediate value (19 March) of C$150.2m, or US$0.23 per WPM share.

In the meantime, from a relative perspective, it is notable that WPM is cheaper than its royalty/streaming ‘peers’ on at least 54% (13 out of 24) of the valuation measures used in Exhibit 11 and on multiples that are cheaper even than the miners themselves in at least 26% (21 out of 78) of the same valuation measures, despite being associated with materially less operational and cost risk (since WPM’s costs are contractually predetermined) – although we believe that earnings forecasts for many of WPM’s peers may not yet have caught up with current conditions in the marketplace and, in particular, prevailing precious metals prices.

As at 31 December 2019, WPM had US$104.0m in cash (cf US$151.6m at the end of Q319) and US$874.5m of debt outstanding (cf 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$4.3m in leases) it had net debt of US$774.8m (cf US$865.5m at end-Q3) overall, after US$131.9m of cash generated by operating activities during the quarter. Relative to the company’s balance sheet equity of US$5,325.9m (cf US$5,201.4m at end-Q3), this level of net debt equates to a financial gearing (net debt/equity) ratio of 14.5% (cf 16.6% at end-Q3) and a leverage (net debt/[net debt+equity]) ratio of 12.7% (cf 14.2% at end-Q3). It also compares with a net debt position of US$865.5m as at end-September, US$1,012.8m as at end-June, US$1,057.7m as at end-March, US$1,188.2m as at end-December 2018 and US$1,261.1m as at end-September 2018. 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 late in FY21.

In addition to its results, WPM announced that it intends to initiate an at-the-market equity programme that would allow 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. 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. At the moment, the programme remains subject to the negotiation of definitive agreements with Canadian and US agents, the filing of the prospectus supplement with Canadian securities regulators and the US Securities & Exchange Commission (SEC) and receipt of all of the appropriate regulatory approvals (the conditions of which are anticipated to be satisfied in April). WPM intends that the proceeds from the programme, if any, will be available as one potential sources of funding for stream acquisitions and/or other general corporate purposes, including the repayment of indebtedness. Details of the programme will be provided upon the filing of a prospectus supplement with the Canadian securities regulators and the SEC in early April and sales of shares via the programme, if any, will be made pursuant to the terms of an equity distribution agreement. Nevertheless, owing to inherent uncertainties as to price and size, for the moment, at least, Edison has excluded from its forecasts the assumption of any such issues of shares under the programme.