Wheaton Precious Metals — Q121 results preview

Wheaton’s Q420/FY20 results were provided in the context of production and sales that were already known from the company’s production update of 11 February (see Edison’s note Looking to the long term, published on 17 February 2021). Among other things, the update indicated that the normal inventory cycle experienced by WPM, whereby sales are ‘flushed through’ and ounces produced but not delivered (PBND) decline in the fourth quarter of the year, had been (perhaps not surprisingly) disrupted by the COVID-19 pandemic. This followed a quarter (Q3) in which silver inventories, in particular, increased modestly after declining sharply in Q2. By contrast gold ounces produced but not yet delivered to Wheaton declined in each of the three quarters from Q2–Q420 (inclusive). Otherwise, financial results were closely in line with our prior expectations, the only material variances being general and administrative costs, which were materially below our expectations (even on an underlying basis – see Exhibit 6), and a net interest charge that was slightly above. A summary of Wheaton’s financial and operating results in the context of both its results in the preceding quarters and Edison’s prior forecasts is as follows:

Readers will note that the tax expense for the full year does not equal the sum of the tax expenses for the individual quarters. In the case of Q120, in particular, a deferred income tax expense of US$8.4m was recognised (being primarily related to the reversal of deferred income tax assets on previously recognised non-capital and capital losses, which offset unrealised capital gains relating to the company’s long-term equity investments) and it is likely that this was subsequently reversed later in the year.

From an operational perspective, production from Sudbury, Constancia, Los Filos and Zinkgruvan was slightly below our expectations, while that from San Dimas, Antamina and Stratoni, in particular, was above (for the second quarter in succession in the cases of Antamina and San Dimas). At the same time, notably positive sales performances (relative to production) were recorded at Minto and the 777 mine. Of the six of Wheaton’s partners’ mines that were directly affected by shutdowns and suspensions earlier in the year, almost all are now at or close to full capacity:

Readers should note however that, although Los Filos production figures in the fourth quarter remained below normal levels, the cause, in this case, was an illegal blockade which caused a temporary suspension of mining activities, rather than COVID-19, and that the mine was restarted on 23 December 2020.

In the meantime, according to Vale’s most recent performance report, physical completion of the Salobo III mine expansion was at 68% at end-Q420 (cf 62% at end-Q3, 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.

Production and sales figures were already known from Wheaton’s earlier production update. As expected, the sales shortfall of 7.2% of gold ounces relative to production in Q420 was in line with the historical quarterly average since Q112. At 30% of production, the silver sales shortfall relative to production was larger than the historical average of 11.4%, although consistent with the period Q319–Q120.

As at 31 December, payable ounces attributable to WPM produced but not yet delivered to WPM amounted to 4.5Moz silver and 71,590oz gold (cf 3.4Moz silver and 75,750oz gold as at end-September and 3.2Moz silver and 79,632oz gold as at end-June). This ‘inventory’ equated to 2.35 and 2.33 months of FY20 silver and gold production, respectively (cf 1.80 and 2.51 months as at end-Q320 and 1.62 and 2.59 months as at end-Q220) 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 and ore on stockpiles etc.

In the event, silver production in FY20 exceeded the top end of WPM’s revised guidance range by 1.7% and was within the company’s original (pre-coronavirus crisis) guidance range, while gold production was within WPM’s revised guidance range and within 5.8% of its original (pre-coronavirus crisis) range. Towards the top end of the revised guidance range, gold equivalent production was therefore within 1.9% of achieving its original guidance range.

In addition to its results, WPM provided production guidance of 720–780koz AuE for FY21, updated five-year production guidance from its operations of 810,000oz AuE per annum and maiden 10-year guidance of 830,000oz AuE per annum. This compares with prior guidance of 750,000oz AuE per annum on average for the period FY20–24 (inclusive) and with Edison’s (updated) forecasts as follows:

Wheaton’s updated five-year guidance and its 10-year guidance are now based on standardised pricing assumptions of US$1,800/oz Au, US$25.00/oz Ag, US$2,300/oz Pd and US$17.75/lb Co, compared to US$1,500/oz Au, US$18.00/oz Ag, US$2,000/oz Pd and US$16.00/lb Co previously. Of note in this context is the reduction of the gold/silver ratio to 72.0x from 83.3x previously, and compared with a ratio of 69.8x currently and a long-term average of 61.5x (as implied by silver’s correlation with gold since the latter was demonetised in 1971). Readers should note that Edison’s (updated) production forecasts are 2.7% below WPM’s guidance for FY22–25 and 6.2% below its guidance for FY26–30. However, this difference is largely negated in its translation into financial results by the fact that sales have historically been recorded at a level c 8.5% below production (at prevailing prices) whereas Edison’s financial forecasts typically assume that the two are closely aligned. Moreover, our forecasts exclude (for the moment) any contribution from Santo Domingo (see below), which we expect to be in the order of 42,350oz Au per annum on average in the period FY24–25 and 25,520oz Au per annum on average in the period FY26–30.

In the short 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. 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).

Similarly, Hudbay expects gold production from its Constancia mine in Peru to increase by 263.0% in FY21 and silver production to increase by 22.3% (of which, WPM is entitled to 50% and 100%, respectively). Notwithstanding these increases, we expect production to remain at lower levels than would otherwise have been the case had the Pampacancha satellite deposit (which hosts significantly higher gold grades than those mined hitherto) been in operation for the entire 12-month period. Nevertheless, Hudbay reports that it has now received the final mining permit for Pampacancha and that it commenced pre-development activities in January with a view to pre-stripping once the one remaining individual land user agreement has been completed. Consequently, it expects to start mining at Pampacancha ‘later in 2021.’ Note that, until Pampacancha is in production, WPM continues to be entitled to receive an additional 2,005oz gold per quarter from Hudbay relative to its precious metals purchase agreement (PMPA).

On 25 March, WPM announced that it had entered into a definitive PMPA with Capstone Mining regarding the Santo Domingo project in the Atacama region of Chile. Under the terms of the proposed PMPA, WPM will acquire 100% of the gold production of Santo Domingo until 285,000oz gold have been delivered, whereupon the stream will drop to 67% of gold production for the remainder of the life of the mine. WPM will pay Capstone a total cash consideration of US$290m for the stream, of which US$30m will be payable upon closing (subject to certain customary conditions) with the remainder payable during the construction of the project. In addition, WPM will make ongoing delivery payments equal to 18% of the spot price of gold until the market value of gold 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 price of gold.

The Santo Domingo project is forecast to be a bottom cost quartile copper mine with an 18-year mine life. Attributable gold production is forecast to be 35–40koz per annum for the first five full years of production and 25–30koz for the first 10 full years, with construction commencing in late 2021 and with the first full year of production expected to be 2024.

In crude terms therefore, we estimate that WPM is acquiring an average annual positive cash flow of c US$40.5m over the first 10 years of the mine’s life for an upfront consideration of US$290m. Note that, pending final closing of the transaction, cash flows from Santo Domingo are not yet included in our WPM forecasts.

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$570–670m 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, 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 Q420 performance report, the Salobo III mine expansion is now 68% complete (cf 62% at the end of Q320, 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.

Once Salobo III has been completed however, Wheaton now believes that reserves and resources could support a further 33% capacity increase at Salobo, from 90ktpd to 120ktpd (so-called Salobo IV). Despite its long-term underground mining potential, WPM believes that such an expansion could nevertheless still be supported by output from the open pit. Under the terms of its agreement with Vale, there would be no additional payment due from Wheaton in respect of this expansion, although Vale could exercise a right to alter the timing of the incremental payment due in respect of Salobo III.

Wheaton’s contract with Barrick provides for a completion test that, if unfulfilled by 30 June 2020, resulted 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 had 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 instead opted not to enforce the repayment of its entitlement and to instead 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 response, Hudbay said that it believed the ruling to be 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 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 privately owned, patented land alone, if necessary.

Once in production, we estimate Rosemont will contribute c 16,750oz gold and 2.7Moz silver to WPM’s production profile in return for an upfront payment of US$230m in two instalments of US$50m and US$180m (of which neither has yet been paid). Note that, whereas before, we had not included Rosemont in our longer-term forecasts, we are now including it from FY25.

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$1,805m available under its revolving credit facility, plus US$192.7m in cash (as at end-FY20) 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 and Cotabambas.

WPM provided guidance for non-stock general and administrative (G&A) expenses of US$42–45m (or US$10.5–11.25m per quarter) in FY21, compared to a guided range of US$40–43m in FY20 and an actual outcome of US$38.7m (ie 3.1% below the bottom of the range), including all employee-related expenses, charitable contributions, etc, but excluding performance share units (PSUs) and equity settled stock-based compensation.

Investors are reminded that stock-based compensation costs and PSUs are now included in our financial forecasts in Exhibits 7 and 11 notwithstanding their inherently unpredictable nature.

Our updated forecasts for WPM for FY21 are as shown in Exhibit 7, 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, consistent with past practice, for the purposes of FY21 we are assuming production and sales are closely aligned and that there is little or no change in the level of ounces produced but not yet delivered. Within this context, our basic EPS forecast of US$1.51/share for FY21 is closely in line with the consensus forecast of US$1.58/share (source: Refinitiv, 26 March 2021) and towards the middle of the range of analysts’ expectations, of US$1.25–1.85 per share for the period:

In the meantime, our basic EPS forecast of US$2.05/share for FY22 (see Exhibit 11) compares with a consensus of US$1.65/share within a range of US$1.19–2.25/share (source: Refinitiv, 29 March 2021). 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. If both metals instead remain at current levels, however (US$24.61/oz Ag and US$1,718/oz Au at the time of writing), our forecast for WPM’s EPS in FY22 would moderate to US$1.58 per share and our forecast for its DPS to US$0.65/share.

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 30.0x current year basic underlying EPS, excluding impairments (vs 25.2x Edison or 24.3x Refinitiv consensus FY21e, currently – see Exhibit 10).

Applying this 30.0x multiple to our EPS forecast of US$2.07 in FY23 (previously US$1.81 in FY21) would ordinarily imply a potential value per share for WPM of US$62.07 in FY21 or C$78.03 in that year. However, the graph above suggests that the current year multiple has been on a broadly upward trend between FY12 and FY19, on which basis we would argue that a multiple in excess of 40x (as evidenced by FY18 and FY19) could be supported, not least given the fact that these years were not subject to the extraordinary trials and tribulations experienced in FY20. In this case, applying a 40.7x earnings multiple (the average of FY18, FY19 and FY20) to our updated EPS forecast of US$2.07 in FY23 implies a potential value per share for WPM of US$84.17 in FY21 or C$106.36 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 40.7x would still leave WPM’s shares at no more than on a par with Franco-Nevada (see Exhibit 10).

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 nine 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 86% (31 out of 36) of the valuation measures used in Exhibit 10 if our estimates are adopted or 69% (25 out of 36) 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 (especially in FY22 and FY23).

As at 31 December 2020, WPM had US$192.7m in cash (cf US$209.8m in Q320) and US$195.0m of debt outstanding (cf US$487.5m in Q320) 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$3.6m in leases) it had net debt of US$6.0m overall (cf US$281.4m in Q320) after US$208.0m of cash generated by operating activities during the quarter (cf US$228.1m in Q320). Relative to the company’s balance sheet equity of US$5,714.6m, this level of net debt equates to a financial gearing (net debt/equity) ratio of just 0.1% (cf 5.1% in Q320) and a leverage (net debt/[net debt+equity]) ratio similarly of just 0.1% (cf 4.8% in Q320). Self-evidently, such a level of debt is well within the tolerances required by WPM’s banking covenants that: