Wheaton Precious Metals — Q123 in line; looking to H2

Wheaton’s financial results for Q123 were very close to both our prior expectations and (post tax) its performance in Q422. In general, production of precious metals was slightly higher than our expectations, but sales, costs and depletion were in line, as a result of an increase in ounces produced but not yet delivered to Wheaton from its streaming counterparties. As a result, the main (positive) variances between our forecasts and WPM’s actual results – in percentage terms (pre-tax) – were general and administrative costs (see page 4) and other income (predominantly interest received) to result in net earnings that were US$2.6m (or 2.5%) better than our prior expectations.

A complete analysis of WPM’s underlying financial and operating results relative to both Q422 and Edison’s prior expectations is provided in the exhibit below:

At the level of the individual mines, Zinkgruvan, Minto, Neves-Corvo, Constancia and Sudbury all outperformed our expectations in terms of production, while Los Filos, Antamina, San Dimas, Salobo and Voisey’s Bay performed in line. Penasquito reported a notable under-sale of silver, relative to production, albeit this was not entirely unexpected in the light of Newmont’s Q123 results, announced on 27 April. Compared with the prior year period, Salobo, Penasquito and Constancia experienced higher grades (albeit with lower recoveries in the cases of Salobo and Penasquito), while Constancia also experienced a higher rate of throughput. As previously announced by Vale, Salobo continued to be affected by planned and corrective maintenance, which is anticipated to continue into Q223. Antamina and Voisey’s Bay experienced lower grades compared with a year ago, albeit this too was expected.

Entering Q223:

At 14.3%, the degree of under-sale of gold in Q123, relative to production, was greater than the prior historical average of 6.6% (from Q112 until Q422). Similarly, the 23.9% under-sale of silver relative to production was greater than its prior historical average of 11.8%, indicating a degree of re-stocking by Wheaton’s counterparties in Q123 after the reverse process of ‘flushing through’ in Q422 (before the end of the financial year):

As a result, both gold and silver stocks increased, to 69,482oz and 3.2Moz, as at end-March (cf a marginally restated 62,602oz and 2.9Moz as at end-December), respectively.

Consequently, we calculate that gold and silver ounces produced but not yet delivered as at end-March now amount to 2.43 and 2.03 months of full-year production (cf 2.62 months and 1.41 months as at end-FY22), respectively, and compare with WPM’s target levels of two to three months for gold and palladium and two months for silver (see below).

At the time of its Q422 results, WPM provided guidance for non-stock general and administrative (G&A) expenses of US$47–50m or US$11.75–12.50m per quarter for FY23 (cf US$47–49m in FY22, US$42–44m in FY21 and US$40–43m in FY20), including all employee-related expenses, charitable contributions, etc, but excluding performance share units (PSU) and equity settled stock-based compensation. In the event, at US$11.5m, non-stock G&A expenses in Q123 were below the bottom of the range implied by WPM’s official guidance for the ninth quarter in succession.

Given the performance of WPM’s shares during the quarter, stock-based G&A expenses in Q123 were closely in line with our prior estimate for the quarter (as shown in Exhibit 5, below):

The analysis of stock-based G&A expenses over the past 14 quarters relative to the change in WPM’s share price (also in US dollars) continues to exhibit a close Pearson product-moment (correlation) coefficient between the two of 0.78, which remains 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) and this therefore continues to form the basis of our quarterly and full-year forecasts for G&A expenses in Exhibit 8.

At the time of its 21 February production and sales announcement, Wheaton also provided detailed production guidance for FY23 (for the first time), as well as for the five years from FY23–27 (inclusive) and the 10 years from FY23–32 (inclusive). These remain unchanged.

Following the acquisition of Sabina by B2Gold, however, the latter exercised its option to acquire 33% of the Goose stream under the terms of its precious metals purchase agreement (PMPA) with Wheaton in exchange for a cash payment of US$46m (resulting in a gain on partial disposal, inter alia, of US$5m). We have now updated our long-term production model to reflect this sale (see Exhibit 6, below). Note that both Wheaton’s guidance and Edison’s forecasts include the Marathon, Curipamba and Goose streams (but not yet the Fenix stream), but exclude the Keno Hill and Yauliyacu streams (which have now also been sold).

WPM’s updated five-year and 10-year guidance is based on standardised pricing assumptions of US$1,850/oz gold, US$24.00/oz silver, US$1,800/oz palladium and US$18.75/lb cobalt. Of note in this context is an implied gold/silver ratio of 77.1x, which compares with its current ratio of 78.8x, but a long-term average of 61.5x (since gold was demonetised in August 1971). At the standardised prices indicated, our gold equivalent production forecast of 612.7koz gold equivalent (AuE) for FY23e lies well within WPM’s guidance range of 600–660koz AuE.

Otherwise, readers will note that Edison’s medium-term production forecasts are within 5% of WPM’s guidance for the period FY23–27 and within 8% of its longer-term guidance for FY23–32. However, we regard this as within an acceptable range of variance, especially given WPM’s traditional under-sale of metal relative to production of this order of magnitude. In addition, these estimates necessarily exclude potential future stream acquisitions.

In the short term, production of palladium and gold at Stillwater (operated by Sibanye-Stillwater) will increase under the influence of the Fill-the-Mill project at East Boulder (although the Blitz project has now been delayed to 2024, following the suspension of growth capital activities owing to COVID-19). Similarly, the Voisey’s Bay underground project is ramping up to full production, while First Majestic is increasing production at San Dimas by restarting mining operations at the past-producing Tayoltita mine to add another 300tpd (12%) to throughput. In addition, it has been investigating the installation of a 3,000tpd high-intensity grinding mill circuit and an autogenous grinding mill to improve recoveries and reduce operating costs.

In the medium term, Wheaton has four projects that are progressing on their route to production:

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 at the time, depending on the grade of the material processed, WPM was to have made a payment to Vale for this expansion, subject to a 90-day completion test, which WPM estimated was to have been in the range US$550–670m in FY23–25, in return for which it was to be entitled to its full 75% attributable share of expanded gold production.

After the end of Q422 however, Wheaton and Vale agreed to amend the Salobo PMPA to adjust the expansion payment terms to provide increased flexibility for the ramp-up of the expansion, while also maintaining an incentive for Vale to maximise grade on an annual basis. The expansion payment will now be phased, with Wheaton making an initial payment once actual throughput is expanded above 32Mtpa and a second payment if actual throughput is expanded above 35Mtpa by 1 January 2031. The total cumulative payments will range from US$283m to US$552m, dependent on Vale’s timing for each of the production increases. Where before Edison had been forecasting that Wheaton would make total payments to Vale of US$552m in FY23 and FY24, we are now forecasting that it will make the whole payment (of US$530m) in FY24. In addition, Wheaton will be required to make annual payments of between US$5.1m and US$8.5m for a 10-year period following payment of the expansion payments if the Salobo mine maintains a high-grade mine plan.

These payments compare 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.

As at the end of Q123, the Salobo III mine expansion was reported to be complete:

According to Vale, the project successfully commenced at the end of 2022 and is expected to achieve full capacity in Q424. Once full capacity at Salobo III has been completed, however, WPM believes that reserves and resources at the mine could support a further 33% capacity increase, from 90ktpd to 120ktpd (denoted Salobo IV). In addition to its long-term underground potential, WPM believes such an expansion could nevertheless still be supported by open-pit mining alone. Under the terms of its agreement with Vale, there would be no additional payment due from WPM in respect of the Salobo IV expansion.

Another major project with which WPM has a streaming agreement for attributable gold and silver production is Rosemont in Arizona (now part of the wider Copper World complex).

Rosemont/Copper World is near a number of large porphyry-type producing copper mines and will be one of the largest copper mines in the United States, with initial output of c 86,000t copper per year from mined sources, accounting for c 8% of total US copper production, rising to c 101,000tpa after 16 years. Total by-product production of silver attributable to WPM is estimated to be c 1.7Moz Ag pa for Phase I, followed by c 2.4Moz Ag pa for Phase II.

The evolution of the project from Rosemont to Copper World

In March 2019, Rosemont/Copper World’s operator, Hudbay, 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 (ACOE), which was effectively the final material administrative step before the Rosemont 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).

A legal challenge, lunched in July 2019, has since delayed the project. However, Hudbay has continued to explore in and around the area of the mine and, on 22 September 2021, announced the intersection of additional high-grade copper sulphide and oxide mineralisation predominantly located on its wholly owned patented mining claims (denoted Copper World). To date, seven deposits have been identified at Copper World with a combined strike length of over 7km and, on 15 December 2021, Hudbay announced a maiden mineral resource at Copper World of 272Mt in the indicated category and 142Mt in the inferred category, both at an average grade of 0.36% copper. The mineralisation consists of both skarn and porphyry copper sulphides with a significant oxidised component along a regional fault along the west side of the Rosemont, Bolsa and Broad Top Butte deposits known as the Backbone Fault. As a consequence of this exploration, it was determined that approximately 33Mt of inferred mineral resources at the Bolsa deposit, which were previously considered to be waste in the resource pit shell used for Rosemont’s NI 43–101 feasibility study, could now potentially be converted into reserves, which would result in less waste being mined at Rosemont, thereby reducing costs and energy consumption per tonne of ore mined. In addition, the Rosemont deposit also contains oxide mineralisation that was previously classified as waste, which could be processed with the oxide mineralisation at Copper World, and it is expected that further synergies will be identified as Hudbay explores the gap between Bolsa and Rosemont. Note, the Copper World discovery is included in WPM’s area of interest under its PMPA with Hudbay.

A new development plan

As a result of these discoveries, Hudbay has adjusted its plan to develop the district. Among other things, it has now acquired a private land package totalling approximately 4,500 acres to support an operation on private lands. The initial technical studies for Copper World were incorporated into a preliminary economic assessment (PEA) investigating the development of the Copper World deposits in conjunction with an alternative plan for the Rosemont deposit, which was announced to the market on 8 June 2022, and proposed a two-phase mine development plan. The first phase of the mine plan requires only state and local permits and reflects an approximate 16-year mine life. The second phase then extends the mine life to 44 years and incorporates an expansion onto federal lands to mine the entire Rosemont and Copper World deposits. The second phase of the mine plan will be subject to the federal permitting process and the company expects that it will be able to pursue the federal permits within the constraints imposed by the courts’ most recent legal decisions if any subsequent appeals are not successful.

In this context, on 24 May 2022, Hudbay received a favourable decision from the US District Court for the District of Arizona on all issues relating to the development of Copper World, including that Copper World and Rosemont are not connected under the National Environmental Policy Act (NEPA) and, therefore, that the ACOE does not have an obligation to include Copper World as part of its NEPA review of Rosemont. The District Court also granted Hudbay’s motion to dismiss the Copper World preliminary injunction request filed by the plaintiffs in the two lawsuits challenging the Section 404 Clean Water Act permit for Rosemont on the basis that the lawsuits were moot after the company surrendered its 404 permit back to the ACOE in April 2022. The ACOE has never determined that there are jurisdictional waters of the United States on the Copper World site and Hudbay has independently concluded through its own scientific analysis that there are no such waters in the area. In this respect, Hudbay believes the District Court’s decision, together with the 12 May 2022 decision, clarifies the permitting path for Copper World, including the requirements to receive federal permits for the second phase only (ie years 16 to 44 of the project) under existing mining regulations.

PEA completed and PFS underway ahead of potential project sanctioning in 2024

Resources were reported to have expanded materially to 792Mt in the measured category, 381Mt in the indicated category and 262Mt in the inferred category at the time of Hudbay’s PEA at an average grade of 0.40% copper. In April 2022, the company commenced early works at Copper World with initial grading and clearing activities at site and, in January, it received an approved right-of-way from the Arizona State Land Department that will allow for infrastructure such as roads, pipelines and powerlines to connect the properties in the company’s private land package. Subsequent to the end of the quarter, it also announced the receipt of confirmation from the Army Corps of Engineers that its previous surrender of the Section 404 Clean Water Act permit for the former Rosemont project had been formally accepted and revoked, as requested. Clearing and grading work to prepare the Copper World site, including the construction of roads and other facilities, is continuing. In the meantime, main facility engineering has been completed and metallurgical test work is being analysed as part of concentrate leaching trade-off evaluations.

Hudbay expects to conclude a pre-feasibility study for Phase I of the Copper World project in the middle of this year. Among other things, this will focus on converting the remaining inferred mineral resources to measured and indicated status and the evaluation of many of the project’s optimisation and upside opportunities. It will then complete a definitive feasibility study as well as receiving all required state and local permits over the next 12 months, while simultaneously evaluating a variety of financing options, including a potential minority joint venture partner, prior to project sanction potentially as early as 2024. As such, Edison is continuing to forecast production from Rosemont/Copper World attributable to WPM in FY27. However, readers should note that any acceleration in the process of being granted federal permits could allow Hudbay earlier access to higher-grade areas of the orebody, especially at Rosemont. In the meantime, it is continuing exploration and technical work at site to support its feasibility studies.

In April 2022, Antamina announced a US$1.6bn investment that will lengthen the mine’s useful life from 2028 to 2036. Currently, the mine is carrying out a third and final ‘public participation’ with residents of the northern Andean region of Ancash, where the mine is located, and is awaiting a response from the local authority, Senace, regarding the company’s request to modify its environmental impact assessment to allow the mine to extend its operating life by eight years. Production and the mine’s operational footprint would remain the same and it hopes to achieve mine extension approval in the middle of this year. The mine, which is co-owned by Glencore, BHP, Teck and Mitsubishi Corp, is Peru’s largest, and the world’s second-largest, copper mine.

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 (WPM’s carrying value of Pascua-Lama) 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 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). A Chilean court ordered Pascua-Lama to close in 2020.

However, Barrick is advancing a high-level study into Pascua-Lama, which it reports to be nearing completion. The study is understood to be focusing on the fact that a substantial portion of the resource could be processed by leaching or agitated leaching, which would require only modest modifications to the circuit already built. This raises the possibility that the orebody could be developed in a different manner and Barrick’s goal is to demonstrate a viable project to both the Chilean and Argentinian governments. If successful, it would then pursue permitting options (and, in particular, water permits) and build out a new model for the project’s development, in which case an investment decision on Pascua-Lama could be forthcoming as early as 2024.

Wheaton reports that its development team remains ‘exceptionally busy’ evaluating new opportunities. In general, WPM expects to be conducting due diligence processes on approximately 10–12 projects at any one time, which it expects to narrow to three to four target projects over approximately 12 months. Most of the opportunities currently being evaluated by WPM are reported to be the precious metal by-product streams of base metal mines, although there are also reported to be some high-margin, purely precious metals mines included in the evaluation process. In the first instance, WPM would fund any such transactions via the US$2bn available under its revolving credit facility, plus the US$799.7m in cash that it has on its balance sheet (at end-Q123) 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, being:

In the light of WPM’s FY23 guidance, and recent moves in metals prices, forex rates and WPM’s share price, Edison has updated its quarterly forecasts for Wheaton for FY23 as follows:

Our fractionally improved basic EPS forecast of US$1.32/share for FY23 is 10.0% above the largely unchanged consensus forecast of US$1.20/share (source: Refinitiv, 3 May 2023), potentially indicating that the market is being reticent in incorporating the recent rises in precious metals prices into its WPM estimates. In this context, it is worth noting that our gold and silver price forecasts for the remainder of the year are US$2,000/oz and US$25.90/oz, respectively, which are those prevailing at the time of writing.

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 FY23, in the case of WPM (as with Newmont and Endeavour), we discount forecast cash flows back over four years from the start of FY23 and then apply an ex-growth terminal multiple to forecast cash flows in that year (ie FY26) based on an appropriate discount rate.

Our estimate of WPM’s ‘terminal’ pre-financing cash flow in FY26 is ostensibly unchanged at US$2.56/share (cf US$2.58/share previously), as shown below:

Readers should note that the increase in cash flows predicted in FY23 and the corresponding decline in cash flows forecast in FY24 relative to our last two notes has arisen almost solely as a result of our revised forecast that Wheaton will make a payment of US$530m to Vale in respect of the Salobo III expansion in FY24, rather than a payment of US$552m split across both FY23 and FY24.

Otherwise, 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$52.99/share (cf US$53.37/share previously), or C$71.40/share. However, readers should note that this valuation is inherently conservative in that it assumes 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 7.4% per annum from 1967 to 2022 and at a simple average annual growth rate of 9.6% per annum (as depicted below):

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 21.0% pa for the 17 years between FY05 and FY22, while its operational cash flows per share have increased at compound average annual growth rate of 14.1% pa.

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 30.4x current year basic underlying EPS, excluding impairments (cf 38.9x Edison or 42.5x Refinitiv consensus FY23e – see Exhibit 13).

Applying this 30.4x multiple to our (ostensibly unchanged) EPS forecast of US$1.78 in FY26 (cf US$1.80 previously) implies a potential value per share for WPM of US$54.06 or C$73.03 in that year.

From a relative perspective, it is notable that WPM is cheaper than its peers on at least 69% (25 out of 36) of the valuation measures observed in Exhibit 13 if Edison estimates are used or 63% (23 out of 36) of the same valuation measures if consensus forecasts are used.

Stated alternatively, were Wheaton to trade at the average multiples of its peers, we calculate that its share price in FY23 would be US$56.92, or C$76.90.

As at 31 March, WPM had US$799.7m in cash on its balance sheet and no debt outstanding under its US$2bn revolving credit facility. As such (including a modest US$1.8m in leases), it had US$797.9m in net cash overall after generating US$135.1m in operating cash flow during the quarter.

In addition, WPM has long-term investments, in the form of equity share- and warrant-holdings, in listed companies in the sum of US$309.1m as at 31 March, or US$0.68/share.

In FY23 we estimate that WPM will generate US$838.0m from (net) operating activities, before consuming US$425.9m (cf US$1,004.0m previously – lower on account of the deferral of the Salobo III payment) in investing activities and paying out up to US$272.1m in forecast dividends to leave the company with net cash of US$834.1m on its balance sheet as at end-FY23. However, investors should note that the timing of payments relating to the Salobo III, Santo Domingo, Blackwater, Goose, Curipamba, Marathon and Rosemont/Copper World streams is uncertain and inasmuch as investments are delayed, we calculate that it is possible that Wheaton could register a larger cash balance on its balance sheet by the year end. Either way, in the absence of any major new asset acquisitions, we do not expect that Wheaton will require recourse to its debt facilities in the foreseeable future (all other things being equal).