Wheaton Precious Metals — Imperturbable

Notwithstanding a quarter in which COVID-19 related constraints continued to disrupt the industry and in which the palladium price showed notable weakness, Wheaton's Q3 financial and operational results were broadly in line with our prior expectations (see our note Honing Q321 forecasts, published on 8 October) and within the range of analysts’ forecasts, albeit towards the lower half of the range. Revenue, earnings and cash flow for the first nine months of 2021 remained at record levels. As a result, the company declared a relatively generous dividend of US$0.15/share, representing a 25% increase compared to Q420. Operationally, Antamina, Constancia, Penasquito and San Dimas all outperformed our expectations, although this was offset to a large degree by a greater than expected increase in ounces produced but not yet delivered at Salobo, which continued to suffer from COVID-19 related disruptions and accounted for 20,020oz out of a total gold under-sale of 18,292oz during the period (ie more than 100%). As a consequence, the company narrowed its annual guidance for production to 735–765koz AuE (cf 720–780koz AuE previously), consistent with the mid-point of its previous guidance, but with a slightly different mix of metals (eg more silver and other metals and less gold – see Exhibits 7 & 9).

In general, both gold and silver production during the quarter met or exceeded our forecasts. However, the extent of the under-sale of gold relative to production exceeded our expectations by 10.6koz (effectively being solely attributable to Salobo), which resulted in a US$31.0m (or 10.3%) negative variance in sales relative to our prior forecasts. This was substantially offset by a US$19.4m, or 14.1%, positive (ie lower than expected) variance in total costs, with the difference of US$11.7m effectively falling straight through to the bottom line. A summary of WPM’s financial and operating results in the context of both its results in the preceding quarters and Edison’s prior expectations is provided in the exhibit below:

Operationally, Penasquito, Antamina and Constancia all benefited from some combination of improved grades and metallurgical recoveries, while San Dimas benefited from an increase in throughput coupled with the impact of changing the silver:gold conversion ratio from 90:1 in Q321 to 70:1 in Q321. In the event, Salobo’s production was closely aligned with our prior forecast, which reflected lower grades and throughput after a slower ramp up of operations after a review in Q1 that limited mine movement. Output at Sudbury was affected by the strike that lasted from 1 June until 9 August, but has now been resolved (see our note Honing forecasts, published on 4 August). Stillwater was affected by lower grades, while Wheaton experienced an increase in both inventory held by Wheaton as well as pounds of cobalt produced but not yet delivered from operations at Voisey’s Bay

In the meantime, according to Vale’s most recent performance report, physical completion of the Salobo III mine expansion was 81% at end-Q321 (cf 77% at end-Q221, 73% at end-Q121, 68% at end-Q420, 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 H222.

While the extent of Wheaton’s under-sale of silver relative to production held close to its long-term average in Q321 (14.3% cf a long-term average of 11.9%), for gold it increased by 14.4 percentage points relative to its long-term average of 6.9% to 21.3% in Q321 – to all intents and purposes, exclusively attributable to Salobo (see our note Honing Q321 forecasts, published 8 October):

As at 30 September, payable ounces attributable to WPM produced but not yet delivered to WPM amounted to 4.1Moz silver and 81,246oz gold (cf 4.0Moz silver and 66,250oz gold as at end-June). This ‘inventory’ currently equates to 1.89 and 2.86 months of Edison’s forecast FY21 silver and gold production, respectively (cf 1.89 and 2.25 months as at end-Q221) and compares with WPM’s target 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 of gold and silver 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, where it typically refers to metal in circuit and ore on stockpiles etc.

WPM provided updated guidance for non-stock general and administrative (G&A) expenses of US$42–44m (or US$10.5–11.0m per quarter) in FY21, cf US$42-45m previously and 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. In the event, G&A expenses in Q321 were below the pro-rata quarterly rate implied by WPM’s full-year guidance for the third quarter in succession:

Compared with non-stock G&A expenses, total G&A expenses are relatively difficult to forecast, given their dependence on the price of WPM’s shares. However, a simple analysis of stock-based G&A expenses over the past eight quarters compared to the change in WPM’s share price (also in US dollars) exhibits a relatively close Pearson product moment (correlation) coefficient between the two of 0.78, which is statistically significant at the 5% level for a directional hypothesis (ie there is less than a 5% probability that this relationship occurred by random chance). The graph relating to the analysis is shown below, including its linear trendline (and with the point relating to the most recent Q321 outcome also marked).

To date, in Q421, Wheaton’s share price has increased by US$2.66, or 7.1%, leading us to believe that, all other things being equal, WPM’s stock-based G&A will be in the order of US$6.2m in Q421. That being the case, we would expect the full G&A expense for the quarter to amount to c US$17.8m, which we have incorporated into our updated financial forecasts, below (albeit with suitable caveats).

Relative to our last note (Honing Q321 forecasts, published 8 October), we have updated our financial forecasts for the remainder of the year for the following four factors, which are briefly described below:

In addition to the above developments, on 20 July, Wheaton signed a non-binding term sheet with Rio2 Ltd to enter into a precious metals purchase agreement (PMPA) in connection with the Fenix Gold project located in Chile. Under the terms of the proposed PMPA, Wheaton will acquire 6% of Fenix’s gold production until 90,000oz have been delivered and 4% of its gold production until 140,000oz have been delivered, after which the stream will drop to 3.5% for the remainder of the life of the mine. In consideration for this stream, Wheaton will pay a total upfront cash consideration of US$50m to Rio2, of which US$25m will be payable upon closing and US$25m will be payable upon Rio2’s receipt of its environmental impact assessment (EIA) for the project (subject to conditions). In addition, WPM will make ongoing delivery payments equal to approximately 18% of the spot price of gold until the aggregate value of the gold delivered less the production payment is equal to the upfront consideration of US$50m, at which point the production payment will increase to 22% of the spot gold price.

The Fenix PMPA is subject to, among other matters, the negotiation and completion of definitive documentation and therefore, for the time being, Edison has left it excluded from its financial forecasts for Wheaton. As with a number of its other streams however, once in production, WPM believes that there is ample scope for Fenix to double, treble and potentially even quadruple production relative to its initial output rates and it expects these potential scenarios to be given Rio2 management’s full consideration over the course of the next two years.

In the light of the above developments, Edison’s 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 WPM – see Exhibits 2 and 3) 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$1.35/share for FY21 is closely in line with the consensus forecast of US$1.40/share (source: Refinitiv, 5 November 2021) and towards the middle of the range of analysts’ expectations of US$1.29–1.58 per share for the period:

In the meantime, we have reduced our basic EPS forecast of US$2.05/share (previously) for FY22 to US$1.53/share (see Exhibit 12), albeit this reduction reflects only currently prevailing metals prices and nothing else. Our new estimate compares with a consensus for FY22 of US$1.62/share within a range of US$1.30–2.08/share (source: Refinitiv, 5 November 2021).

At the time of its Q420/FY20 results, WPM provided production guidance of 720–780koz AuE for FY21 and well as five-year average production guidance of 810,000oz AuE per annum and maiden 10-year average guidance of 830,000oz AuE per annum. At the same time as announcing its Q321 results however, Wheaton also took the opportunity to refine its guidance. WPM now estimates that attributable production in 2021 will be approximately 735–765koz AuE, which is in line with previous guidance, albeit achieved via a slightly different mix of metals, as shown in the table below (note that Wheaton’s longer-term guidance remains unchanged). This compares with Edison’s updated forecasts in the wake of Q321 results, as follows:

WPM’s updated five-year and 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 palladium (Pd) and US$17.75/lb cobalt (Co). Of note in this context is an implied gold/silver ratio of 72.0x, which compares with its current ratio of 75.2x and a long-term average of 61.5x (since gold was demonetised in August 1971). Self-evidently, at the standardised prices indicated, our gold equivalent production forecast of 749.4koz AuE lies well within WPM’s updated guidance range of 735–765koz AuE. Otherwise, readers will note that Edison’s (unchanged) longer-term production forecasts remain within 3.1% of WPM’s guidance for the period FY22–30.

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 H221 to improve recoveries and reduce operating costs. Production of palladium and gold at Stillwater (operated by Sibanye-Stillwater) will similarly increase under the influence of the Fill-the-Mill project at East Boulder (although the Blitz project has now been delayed by two years, to 2024, following the suspension of growth capital activities due to COVID-19).

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 at that point scheduled for H222 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 for this expansion, which WPM estimates will be c 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 WPM’s purchase of a 25% stream from Salobo 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 it paid for its original 25% stream in February 2013.

According to Vale’s Q321 performance report, the Salobo III mine expansion is now 81% complete (cf 77% at the end of Q221, 73% at the end of Q121, 68% at the end of Q420, 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 H222.

Once Salobo III has been completed, however, WPM believes reserves and resources could support a further 33% capacity increase at Salobo, from 90ktpd to 120ktpd (denoted Salobo IV). In addition to its long-term underground mining potential, WPM believes such an expansion could 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 WPM in respect of this expansion, although Vale could exercise a right to alter the timing of the incremental payment due for Salobo III.

WPM’s contract with Barrick provided for a completion test that, if unfulfilled by 30 June 2020, would result 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, 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, WPM 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 Mine Plan of Operations from the US Forest Service and a Section 404 Water Permit from the US Army Corps of Engineers (in March 2019), which was effectively the final material administrative step before the mine could start development. 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 it believed the ruling to be 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 the company could operate the mine in compliance with environmental laws. As a result, Hudbay has appealed 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 for its waste disposal plan. As per its MD&A for the year ended December 2020, final briefs relating to its appeal were filed in November 2020 and the oral hearing was completed in early February 2021, such that Hudbay expects a ruling from the Ninth Circuit in the near future. Nevertheless, as an alternative, it is also able to adapt its mine and waste plan to accommodate its waste dumps on privately owned, patented land alone, if necessary.

In the meantime, Hudbay has continued to explore in and around the area of the mine and, on 22 September, announced the intersection of additional high grade copper sulphide and oxide mineralisation on its wholly owned patented mining claims (Copper World). To date, seven deposits have been identified at Copper World with a combined strike length of over 7km. As of 30 June approximately 166 holes have been completed at Copper World, totalling over 91,000 feet, on the back of which Hudbay expects to publish an initial inferred mineral resource estimate for Copper World before the end of 2021. These mineral resources will then form the basis for a preliminary economic assessment on the project, expected to be released H122. Note, the Copper World discovery is included in Wheaton's area of interest under its PMPA with Hudbay.

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 (neither of which has yet been paid) and this production is included in our financial forecasts from FY25.

WPM reports that its corporate development team remains ‘exceptionally busy’. While the majority of deals are now reported to be with development companies in the US$100–300m range (with fewer ‘balance sheet repair’ opportunities), it is also reported there have been a number of approaches made by producing companies for transactions to fund expansion and even to fund M&A activity. In the first instance, WPM would fund any such transactions via the US$2bn available under its revolving credit facility, plus US$372.5m in cash (at end-Q321) 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 Navidad and Cotabambas, and a recently acquired 2.0% net smelter return royalty interest with the Brewery Creek mine in the Yukon in Canada.

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 (cf 29.8x Edison or 28.7x Refinitiv consensus FY21e – see Exhibit 11).

Applying this 30.0x multiple to our EPS forecast of US$2.04 in FY23 (previously US$2.06) would ordinarily imply a potential value per share for WPM of US$61.222 or C$76.27 in that year. However, the graph above suggests 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 in the event of a return to favour of precious metals and precious metals stocks (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$2.04 in FY23 implies a potential value per share for WPM in that year of US$83.03 or C$104.92 (note this analysis implicitly assumes metals prices in FY24 would be experiencing the same sort of increases relative to FY23 that they did in FY20 relative to FY19 and the average multiple would probably then contract again in FY24 as EPS ‘caught up’ with the share price). Even at such share price levels, however, a multiple of over 40.7x would put WPM’s shares on no more than par relative to Franco-Nevada (see Exhibit 11).

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 seven out of nine valuation measures, regardless of whether Edison or consensus forecasts are used. On an individual basis, it is cheaper than its peers on 75% (27 out of 36) of the valuation measures observed in Exhibit 11 if our estimates are adopted or 72% (26 out of 36) of the same valuation measures if consensus forecasts are adopted.

At 30 September, WPM had US$372.5m in cash on its balance sheet (cf US$235.4m in Q221, US$191.2m in Q121 and US$192.7m in Q420) and no debt outstanding (cf US$195.0m in Q420) under its US$2bn revolving credit facility, such that (including a modest US$3.1m in leases) it had US$369.4m in net cash overall (cf US$232.1m in Q221, US$187.7m in Q121 and US$6.0m in Q420) after US$201.3m of cash generated by operating activities during the quarter (cf US$216.3m in Q221, US$232.2m in Q121 and US$208.0m in Q420).