Wheaton Precious Metals — Exceeding guidance and expectations

Wheaton’s FY18 production outcome exceeded guidance for all of its products (namely gold, silver and palladium) to the point at which gold production and sales also achieved new annual records. Not only was gold production ahead of guidance (which was expected), but it was also materially ahead of our prior expectation, driven by a 12.2% quarter-on-quarter increase in production attributable from Salobo, in contrast to our expectation of a moderation in output from already high levels. Sales of gold also amounted to 95.6% of gold production (relative to a prior long-term average of 91.0% of production), whereas silver sales fell to 80.0% of production (relative to a prior long-term average of 89.6%), with the result that sales of gold amounted to 64.3% of WPM sales, while sales of silver amounted to just 32.8% of the total (almost exactly the reverse of the situation as recently as Q415 when silver sales were dominant). With these two effects (effectively) offsetting one another, group sales for both the year and the quarter were within US$1.2m of our prior expectations. General and administrative expenses were higher than our expectations owing to accruals relating to performance share units (which we decline to forecast); however, this was almost exactly offset by improvements in the total cost of sales, including depletion. Net interest and taxes were also modestly better than our prior expectations, such that net earnings for both the quarter and the full year were US$2.5m ahead of our forecasts. A full analysis of both WPM’s Q4 results and its FY18 results in relation to our prior forecasts, on both an underlying and a headline basis, are provided in the table below:

From an operational perspective, the star performer of the quarter was Salobo. Other assets that outperformed our expectations included Stillwater, Neves-Corvo and Aljustrel, while Penasquito and Sudbury underperformed, relatively speaking. Not only was Penasquito affected by the ongoing commissioning of the Pyrite Leach Project (PLP) during the quarter (which was expected), but also by higher than expected ore hardness, which endured beyond Q3 and adversely affected mill throughput. Nevertheless, it achieved commercial production as of 31 December 2018 and grades are anticipated to improve in FY19 (from the main Penasco pit) at the same time as the PLP adds c 1Moz gold and 44Moz silver to production over the life of the mine and c 1.0–1.5Moz silver per year, by recovering 40% of the gold and 48% of the silver that currently report to tailings.

After recording a quarter that reflected long-term averages in Q3, sales of gold and silver relative to production diverged in Q4. Sales of gold, in particular, were just 4.4% less than production (vs a long-term average of 9.0%), while sales of silver were 20.0% less (vs a long-term average of 10.4%), as shown in the Exhibit below:

As at 31 December, payable ounces attributable to WPM produced but not yet delivered amounted to 3.3Moz silver and 77,500oz gold (vs 4.5Moz silver and 77,100oz gold in September, 4.3Moz silver and 75,600oz gold in June, and 4.8Moz silver and 84,400oz gold in March). This ‘inventory’ equates to 2.17 months and 2.60 months of forecast FY18 silver and gold production respectively (vs 2.17 months and 2.60 months in Q3, 2.12 months and 2.59 months in Q218, and 2.06 months and 2.72 months in Q1) and compares with WPM’s target level of two months of annualised production for silver, and two to three months of annualised gold and palladium production.

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.

WPM has provided production guidance to the market to the effect that output of precious metals is ‘forecast to be approximately 365,000 ounces of gold, 24.5 million ounces of silver and 22,000 ounces of palladium, resulting in gold equivalent production of approximately 690,000 ounces.’ For the five-year period ending in FY23, the company estimates that average annual gold equivalent production will amount to 750,000 ounces per year. This aligns closely with both our current and prior expectations with the exception of the fact that we are also anticipating a production contribution from Rosemont (see below) from FY22.

In the immediate future, 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 with mine sequencing. 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. At the same time, mining at Constancia will start at the Pampacancha pit in FY19, which hosts significantly higher gold grades than those mined hitherto and of which WPM will now be entitled to an increased portion. The company also expects palladium and gold production at Stillwater to increase as the Blitz project ramps up to full capacity in FY21.

On 24 October, 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, if throughput is expanded above 28Mtpa within a predetermined period and, depending on the grade of the material processed, WPM will be required to make an additional payment to Vale, which WPM estimates to be in the range US$550–650m in FY23, in return for which it is entitled to its full 75% attributable share of gold production. As such, the expansion is equivalent to WPM buying a 37.5% stream for US$603m (Edison estimate), which compares to its purchase of a 25% stream in August 2017 for an estimated consideration of US$820.8m (including renegotiated warrants and cost inflation terms) and the US$900m it paid in March 2015 (when the gold price averaged US$1,179/oz) for another 25% gold stream from Salobo (see our note, Silver Wheaton: Going for gold, published on 30 August 2016).

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 870Moz in FY17 that is produced as a by-product of either gold or base metal mines (ie approximately 305Moz pa silver vs WPM’s production of 28.5Moz Ag in FY17). 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. It has the potential for up to six deals with a value in the range US$100–300m, thus fully financeable via the c US$0.81bn available to WPM under its revolving credit facility as at end-FY18.

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:

One further, major project rapidly moving closer to development is the Rosemont copper project in Arizona, after its operator, Hudbay, announced that it had received a Section 404 Water Permit from the US Army Corps of Engineers and that it expects to receive Rosemont’s Mine Plan of Operations from the US Forest Service ‘shortly’. The Section 404 permit regulates the discharge of fill material into waterways according to the Clean Water Act and is effectively the final material administrative step before the mine can be developed. The proposed mine is located near a number of large porphyry-type producing copper mines and is expected to be one of the largest 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 and we estimate it will contribute an average c US$0.135 per share 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$0.52/share) in two instalments (vs three previously) of US$50m and US$180m. Note that, for the purposes of our financial modelling, we have assumed that these instalments will be paid from WPM to Hudbay in FY20 and FY21, respectively.

WPM has forecast non-stock general and administrative expenses for FY19 in the range US$36–38m, or US$9.0–9.5m per quarter (vs a comparable forecast of US$34–36m, or US$8.5–9.0m per quarter, for FY18), including all employee-related expenses, charitable contributions etc. Investors should note that our financial forecasts in Exhibits 5 and 8 exclude stock-based compensation costs.

Taking into account the aforementioned considerations, our updated forecasts for FY19 for WPM, by quarter, are now as shown below:

Our forecast basic EPS of US$0.53/share for FY19 compares with a consensus forecast of US$0.52/share (source: Refinitiv, 22 March 2019), within a range of US$0.37–0.72 per share.

Our US$1.19 basic EPS forecast for FY20 (see Exhibit 8) compares with a consensus of US$0.63 (source: Refinitiv, 22 March), within a range of US$0.37–0.81. However, our estimate is predicated on an average gold price during the year of US$1,482/oz and an average silver price of US$25.95/oz. These are 12.4% and 66.5% above current spot prices, respectively, but are consistent with our historical practice and, in particular, assume that silver will, at some point, revert to the long-term correlation that it has exhibited with gold since the latter was demonetised in 1971. In the event that precious metals’ prices remain at current levels (US$1,318/oz Au and US$15.59/oz Ag at the time of writing), we forecast that WPM instead earns US$0.56 per share in FY20.

Excluding FY04 (part-year), WPM’s shares have historically traded on a contemporary average P/E multiple of 28.5x current year basic underlying EPS, ie excluding impairments (vs 43.6x Edison or 46.3x Refinitiv consensus FY19e, currently – see Exhibit 7).

Applying this multiple to our updated EPS forecast of US$1.19 in FY20 (vs US$1.18 previously) implies a potential value per share for WPM of US$33.97, or C$45.18 in that year (vs US$32.48, or C$42.97 previously). Note that this valuation excludes the value of 20.9m shares in First Majestic currently held by WPM, with an immediate value of C$144.4m, or US$0.26 per WPM share (priced as at 15 November).

In the meantime, from a relative perspective, it is notable that WPM is cheaper than its royalty/streaming ‘peers’ in at least 95% (23 out of 24) of the valuation measures used in Exhibit 7 and on multiples that are cheaper even than the miners themselves in at least 35% (30 out of 84) of the same valuation measures (irrespective of whether Edison or consensus forecasts are used), despite being associated with materially less operational and cost risk (since WPM’s costs are contractually predetermined).

As at 31 December 2018, WPM had US$75.8m in cash and US$1,264.0m of debt outstanding under its US$2bn revolving credit facility (which attracts an interest rate of Libor plus 120–220bp and matures in February 2024 – now a year later than previously), such that it had net debt of US$1,188.2m overall, after US$108.5m (US$0.24/share) of cash inflows from operating activities during the quarter. Relative to the company’s Q4 balance sheet equity of US$5,171.9m, this level of net debt equated to a financial gearing (net debt/equity) ratio of 23.0% and a leverage (net debt/[net debt+equity]) ratio of 18.7%. It also compares with a net debt position of US$1,261.1m as at end-September, US$863.8m as at end-June and US$547.4m as at end-March 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 in early 2021.