Wheaton Precious Metals — Forging ahead

After a strong Q419, in which all but one of its major mines either met or exceeded Edison’s production expectations, WPM’s operational performance moderated in Q120, with seven assets (out of 15 currently producing operations) outperforming our production expectations (largely in its silver division) approximately balanced by six assets underperforming (largely in the gold division). While auguring well for the future – particularly with respect to the silver division – sales, in general, struggled to keep up with production (especially in the silver division), albeit with the notable exception of Salobo, which once again recorded a material (12,369oz, or 19.8%) Q1 over-sale of metal not dissimilar to the over-sales that it recorded in Q119 and Q218. From a financial perspective, total sales were US$10.0m less than our expectations, although this was more than offset by a US$12.6m variance to the good in the total cost of sales (see Exhibit 1). Unusually, this overall positive variance to our estimates until the PBT level was itself offset by a (rare) tax charge in the income statement relating to a reversal of deferred income tax assets (which therefore had no effect on cash flows). Underlying net earnings during the quarter were within US$2.6m (or 2.6%) of our prior forecasts. A full analysis of WPM’s Q120 income statement relative to both Q419 and our prior expectations is as follows:

Within the context of the above results, it was notable that our all-in forecast for general and administrative costs was within 3.3% of the actual outcome, suggesting both that central costs for the full year are trending towards the same level as FY19 (given that our quarterly forecasts are now based on the average level of quarterly costs in FY19) and that non-stock G&A expenses are trending below the company’s guided range of US$40–43m (or US$10.0–10.75m per quarter) for the full year.

Of WPM’s eight major mines, Penasquito recorded a notably exceptional production performance, with output increasing by 40.3% or 763koz Ag compared with Q419 – 28.9% above both our expectations and the operator’s long-term guidance including the pyrite leach project – largely as a result of mining higher grades as the Chile Colorado pit contributes to mill feed and grades improve once again at the main Penasco pit with mine sequencing through until 2021. As noted previously, Salobo recorded a notably strong sales performance. In addition, higher grades contributed to a better than expected production performance (relative to our expectations) also at Antamina, although this mine was subsequently furloughed by its operator, Glencore, in mid-April and (as of 27 April) the date of its restart is still reported to be ‘uncertain’. By contrast, lower grades were encountered at Sudbury, Constancia and San Dimas, although, in the case of the latter, these were more than offset by higher throughput to result in a positive production outcome.

Since Q112, the average level of silver under-sale relative to production has been 12.4%, although this is also accompanied by a degree of volatility, with the standard deviation of under-sales amounting to 9.5 percentage points around the mean. In Q120 therefore, the under-sale for WPM’s silver division was more than one standard deviation beyond the mean, registering a 26.5% (or 1.8Moz) under-sale relative to production – the largest since Q312 – largely accounted for by WPM’s ‘other’ silver assets. In contrast, WPM’s gold division, which historically records a 7.7% average under-sale of metal relative to production (± a larger standard deviation of 19.6 percentage points about the mean) recorded a 6.0% over-sale in Q120, albeit this result was within the normal historical range:

As at 31 March, payable ounces attributable to WPM produced but not yet delivered to WPM amounted to 5.3Moz silver and 88,431oz gold (vs 4.5Moz silver and a fractionally restated 98,475oz gold at end-December). This ‘inventory’ equates to 3.17 and 2.78 months of FY20 forecast silver and gold production, respectively, and compares to WPM’s target level of two months of silver and two to three months of gold and palladium production, respectively.

All other things being equal therefore, we would expect the level of silver ‘inventory’ at WPM, in particular, to reduce to within WPM’s target range in the near future, in all probability as a result of a near-term over-sale of silver relative to 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 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). In response to COVID-19 however, on 1 April, WPM suspended its production guidance. At the time, five operating partner mines had been (or were in the process of being) furloughed, namely Constancia, Yauliyacu, Penasquito, San Dimas and Los Filos (plus Voisey’s Bay, although WPM is not scheduled to take delivery of any metal from Voisey’s until FY21). Since then, operations at Antamina have also been suspended.

For the five-year period ending in FY24, the company’s guidance was for average annual gold equivalent production of 750,000oz pa. These compare with WPM’s and Edison’s current and previous guidance/forecasts, as follows:

With respect to Edison’s forecasts, we believe that there is upside potential to our gold production forecast at Minto, in particular, and downside risk to the 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 113x 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 654koz, rather than 600koz (which assumes a gold price of US$1,691/oz for the balance of the year and a silver price of US$15.03/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 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 (all other things being equal). 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 Q120 performance report, the Salobo III mine expansion is now 47% complete (cf 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 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, Edison calculates that WPM has the right to an estimated US$273.4m repayment from Barrick 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 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 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 (15.1%) to WPM’s basic EPS in its first nine years of its official 18 year life from FY22–30 for an upfront payment of US$230m (equivalent to US$0.513/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, albeit with the caveat that COVID-19 has inevitably slowed the pace of progress. 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$1,282.5m available under its revolving credit facility, plus US$126.7m in cash and its 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. It has fallen back from a recent high of US$1,741/oz on 14 April 2020, but only by a relatively modest 2.9%. Its year-to-date performance of 11.7% (cf -2.7% in late March) so far during the coronavirus crisis nevertheless dwarfs the equivalent performances of its equity market rivals (eg Dow Jones -17% and FTSE100 Index -27% 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:

In common with Edison’s stated practice however, we use prevailing prices (ie US$1,691/oz Au, US$15.03/oz Ag and US$1,814/oz Pd) to generate our forecasts for the remainder of the current year, followed by long-term forecasts (above) thereafter. Investors should note that our long-term forecasts (above) assume an eventual normalisation of the gold/silver ratio from an unprecedented 113x currently to something closer its long-term average of 61x from FY21.

WPM has provided updated guidance for non-stock general & administrative 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 PSUs and equity settled stock based compensation (see Exhibit 2). Investors should note that stock-based compensation costs and PSUs are now included in our financial forecasts in Exhibits 8 and 12 notwithstanding their somewhat unpredictable nature.

Our updated forecasts for WPM for FY20 are as shown in Exhibit 8, below. As before, our forecasts assume that Yauliyacu, Constancia, Penasquito, San Dimas and Los Filos all remain closed for the entirety of Q220. However, these have now been joined by Antamina, from mid-April. Clearly, there exists risk associated with both the potential lifting of existing lockdowns in this respect (upside) and the imposition of new lockdown restrictions (downside). The other notable change compared with our previous assumptions relates to the terms of the San Dimas precious metals purchase agreement (PMPA). Under the terms of the San Dimas PMPA, Wheaton is entitled to an amount equal to 25% of the payable gold production plus an additional amount of gold equal to 25% of the payable silver production converted to gold at a fixed gold/silver exchange ratio of 70:1. If the gold/silver price ratio decreases to less than 50:1 or increases to more than 90:1 for a period of six months or more, however, then the 70 is revised to either 90 or 50, as appropriate. In this case, the ratio has been more than 90 for a period of six months. Consequently, from 1 April, the effective ratio has been adjusted to 90 for the purposes of the San Dimas PMPA, until such time as it reverts to between 50 and 90 for a period of six months once again, in which case the 70:1 ratio will be re-adopted.

Apart from precious metals prices, the principal remaining risk to our forecasts relates to the extent to which sales differ from production and therefore, by extension, the extent to which inventory (in the form of ounces produced but not yet delivered to Wheaton) either increases or decreases during the course of the year.

Our basic EPS forecast of US$0.859/share for FY20 is 3.5% below the consensus forecast of US$0.89/share (source: Refinitiv, 7 May 2020) within a range of US$0.78–1.03per share:

Our US$1.12 basic EPS forecast for FY21 (see Exhibit 12) compares with a consensus of US$1.02 (source: Refinitiv, 7 May 2020) within a range US$0.85-1.44 and is materially higher than the equivalent figures of US$0.88 within a range US$0.76-1.15 of mid-March (source: Refinitiv, 19 March 2020). 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 assumes, among other things, that the gold/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 remain at current levels however (US$15.03/oz and US$1,691/oz at the time of writing), we forecast that WPM would instead earn US$0.87 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 49.2x Edison or 47.4x Refinitiv consensus FY20e, currently – see Exhibit 11).

Applying this 29.5x multiple to our updated EPS forecast of US$1.12 in FY21 implies a potential value per share for WPM of US$33.08 or C$46.59 in that year (vs US$33.46, or C$47.27 previously). However, it is clearly apparent from the graph above that WPM’s current year multiple has been trading higher for some time and the last two years would suggest that a multiple in excess of 40x earnings is sustainable – notwithstanding the fact that these years were not subject to the extraordinary trials and tribulations being experienced in FY20. Even at such elevated levels however, a multiple of over 40x would still leave WPM’s shares at a discount to those of its obvious peers, as demonstrated in Exhibit 11. In this case, applying a 42.0x earnings multiple (the average of FY18 and FY19) to our updated EPS forecast of US$1.12 in FY21 implies a potential value per share for WPM of US$47.10 or C$66.32 in that year and/or for as long as the current coronavirus crisis lasts and precious metals prices (especially gold) remain elevated.

Note that neither of these valuations include the value of 20.2m shares in First Majestic currently held by WPM, with an immediate value (7 May) of C$227.1m, or US$0.36 per WPM share.

In the meantime, from a relative perspective, it is notable that WPM has a lower relative valuation than its royalty/streaming ‘peers’ on at least 58% (14 out of 24) of the valuation measures used in Exhibit 11 and based on multiples that are cheaper even than the miners themselves in at least 23% (18 out of 78) of the same valuation measures (regardless 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 March 2020, WPM had US$126.7m in cash cum-dividend (cf US$104.0m at the end of Q419) and US$715.5m of debt outstanding (cf US$874.5m at end-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$3.9m in leases) it had net debt of US$592.7m (cf US$774.8 at end-Q4 and US$865.5m at end-Q3) overall, after US$177.6m of cash generated by operating activities during the quarter (cf US$131.9m in Q419). Relative to the company’s balance sheet equity of US$5,238.2m, this level of net debt equates to a financial gearing (net debt/equity) ratio of 11.3% (cf 14.5% and end-Q4 and 16.6% at end-Q3) and a leverage (net debt/[net debt+equity]) ratio of 10.2% (cf 12.7% at end-Q4 and 14.2% at end-Q3). 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 H121 (even after including anticipated dividend payments).

WPM has initiated 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. 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 that 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, Edison has excluded from its forecasts the assumption of any such issues of shares under the programme.