Wheaton Precious Metals — Incorporating Salobo Q222 operating results

Ahead of Wheaton’s Q222 results, which are scheduled for release on 11 August, we have revised our short-term financial forecasts to reflect the following developments:

In addition, we have reduced our medium-term nominal gold prices for FY23 and FY24 by 7.6% and 3.9%, to US$1,749/oz and US$1,818/oz, respectively.

In the light of these changes, Edison has updated its quarterly estimates for WPM for Q2–Q422 as follows:

Our basic EPS forecast of US$1.16/share for FY22 compares with a consensus forecast of US$1.37/share (source: Refinitiv, 26 July 2022), although we suspect that the consensus figure does not yet fully reflect the recent declines in precious metals prices (or, alternatively, that it assumes a swift rebound to the status quo ante). In this context, it is worth noting that Edison’s gold and silver price forecasts for the remainder of the year are now US$1,717/oz and US$18.64/oz, respectively, which are those prevailing at the time of writing (cf US$1,835/oz and US$21.30/oz previously).

On 5 July, Wheaton announced that it had entered into a definitive agreement with Hecla Mining to terminate its silver stream over Alexco Resource’s Keno Hill Silver District for US$135m in Hecla shares, upon the occasion of the takeover of Alexco by Hecla (subject to shareholder, regulatory and other approvals, but otherwise ‘friendly’ in nature). As a consequence, subsequent to the closing of the transaction, Wheaton will own c 5.6% of Hecla's outstanding share capital, albeit the exact number will only be calculated immediately before the closing date.

While in effect selling a silver stream runs contrary to Wheaton’s normal business plan of acquiring precious metals streams, it demonstrates WPM’s ability to remain flexible in matters of value and to strategically identify opportunities both inside and outside its portfolio that create value for its shareholders.

Wheaton originally paid an upfront consideration of US$50m on its purchase of the Keno Hill stream in October 2008. Although the terms of the agreement were subsequently amended and the value of the stream was also subsequently impaired, in 2015 Wheaton estimated a fair value less a cost to sell (FVLCS) of the stream of US$33.4m. In its FY21 annual report, it estimated a total carrying value for its Canadian silver interests (of which the Keno Hill stream may be considered a subset) of US$28.1m. Both these estimates suggest that, upon closing (presumably in Q3), Wheaton will recognise a profit in excess of US$100m on the sale of its stream. For now, we are declining to include this in our forecasts in Exhibit 2 and Exhibit 9 on account of its ‘exceptional’ nature.

Analysed with respect to future cash flows, Edison estimates that Wheaton has sold for a consideration of US$135m a stream that had an NPV10 of US$109.7m (at output rates that Alexco was not yet achieving). Stated alternatively, we calculate that Hecla’s internal rate of return on its purchase will be 3.06% (absenting any practical mining considerations from the purchase of the stream), which is very similar to the 2.809% yield to maturity currently available from the US 10-year Treasury bond in US dollar terms (source: Bloomberg, 26 July 2022).

In this case, the sale also positions Wheaton to continue to have one of the strongest balance sheets in the industry (see the ‘Financials’ section, below). Note that, for the purposes of our forecasts, we have removed any production contribution from Keno Hill to Wheaton from 1 July 2022.

WPM is a multi-asset company that has shown a willingness and desire to buy streams in the past to maintain production and maximise shareholder returns. As a result, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY22, in the case of WPM (as with other major gold producers, such as Newmont and Endeavour), we discount forecast cash flows back over five years from the start of FY22 and then apply an ex-growth terminal multiple to forecast cash flows in that year (ie FY26) based on an appropriate discount rate.

In this case, our estimate of WPM’s ‘terminal’ pre-financing cash flow in FY26 has reduced slightly from US$2.90/share to US$2.81/share (not least as a result of the exclusion of Keno Hill production and sales), as shown below:

Assuming 4% growth in nominal cash flows beyond FY26 (ie 0% growth in real cash flows) and applying a discount rate of 9.0% (being the expected long-term required nominal equity return), our terminal valuation of the company at end-FY26 is US$58.42/share (cf US$59.98/share previously), or C$75.27/share, which, when discounted back to FY22 in combination with intervening cash flows, results in a valuation at the start of FY22 of US$42.15/share, or C$54.30/share. However, this valuation is inherently conservative in that it is based on the assumption of zero growth in (real) cash flows beyond FY26. This is inconsistent with the gold price, which has risen at a compound average annual growth rate of 7.6% per annum since 1968 and at a simple average annual growth rate of 9.7% per annum:

It is also inconsistent with WPM’s longer-term historical performance, wherein operational cash flows have increased at a compound average annual growth rate of 23.2% pa for the 16 years between FY05 and FY21, while its operational cash flows per share have increased at compound average annual growth rate of 15.8% pa.

Stated alternatively, we can say that WPM’s current share price of C$41.82 discounts a long-term compound annual average growth rate in cash flows per share of 2.4%, which is no more than the compound average annual increase in US consumer prices from 1991 to the end of 2021.

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 30.1x current year basic underlying EPS, excluding impairments (cf 27.9x Edison or 23.7x Refinitiv consensus FY22e – see Exhibit 7).

Applying this 30.1x multiple to our EPS forecast of US$1.98 in FY26 (cf US$2.06 previously) implies a potential value per share for WPM in that year of US$59.75 or C$76.98. However, the graph above suggests that the investing environment post-2017 has been able to support an enhanced WPM multiple relative to earlier years. We would ascribe this observation to macro-economic uncertainty and loose monetary policy combining to create a supportive environment for precious metals prices. As such, we believe that a multiple of 38.6x (the average of FY18–21) may still be supported in the event of a return to favour of precious metals and precious metals stocks. In this case, applying a 38.6x earnings multiple to our updated EPS forecast of US$1.52 in FY23 (cf US$1.72 previously) implies a potential value per share for WPM in that year of US$58.65 or C$75.56. Even at such share price levels however, a multiple of 38.6x would still put WPM’s shares on little more than a comparable multiple relative to that of Franco-Nevada (see Exhibit 7, below).

From a relative perspective, it is notable that WPM is cheaper than its peers on 69% (25 out of 36) of the valuation measures observed in Exhibit 7 regardless of whether Edison or consensus forecasts are used:

In this context, it is worth noting that Edison forecasts imply that WPM’s EPS, DPS and cash flow will increase in FY23 and FY24 (relative to FY22), not least under the influence of the company’s increasing production profile. By contrast, consensus forecasts appear to indicate that the market expects WPM’s EPS and cash flow to be broadly unchanged in FY23 and FY24 relative to FY22, implying that it is either not expecting any production/sales increase, or that the degree of any production/sales increase will be offset by an approximately equal and opposite move in precious metals prices.

At 31 March, WPM had US$376.2m in cash on its balance sheet and no debt outstanding under its US$2bn revolving credit facility. As such (including a modest US$2.7m in leases), it had US$373.5m (US$0.83/share) in net cash overall after generating US$210.5m in operating cash flow during the quarter and consuming US$66.1m in investing activities.

In FY22 we estimate that WPM will generate US$780.0m from operating activities (cf US$913.7m previously), before consuming US$382.9m in investing activities (excluding any effect from its sale of the Keno Hill stream) in the form of instalments relating to the acquisitions of the Santo Domingo, Blackwater, Goose, Curipamba and Marathon streams and paying out a forecast dividend of US$270.8m to leave it with net cash of US$484.5m as at end-FY22.

In FY23, we now forecast that it will generate US$1,008.6m from operating activities (cf US$1,102.5m previously), before consuming US$1,099.4m in investing activities, including significant instalments relating to Salobo III, Rosemont, Kutcho and, potentially, Fenix. On this basis, we estimate that WPM will end FY23 with net cash of US$108.3m on its balance sheet, before resuming its upward trend once again.