Wheaton Precious Metals — Salobo tasting sweet

WPM’s Q324 results are scheduled after the close of business in Canada on Thursday 7 November. Ahead of their release, we have adjusted our earnings forecasts for the quarter to take account of the following:

Of the six effects, the most significant is our estimate of higher gold production attributable to Wheaton from Salobo. The mine produced 46.0kt copper in Q2 and 46.6kt copper in Q3 and there is a very strong correlation (0.954 Pearson product moment correlation coefficient, quarterly, since Q316) between copper produced and gold produced attributable to WPM (as shown in Exhibit 1, below). In this case, 46.6kt Cu produced in Q3 implies gold production attributable of 65,019oz ±3,480oz and, for these purposes, we have therefore assumed that production attributable to Wheaton from Salobo in Q3 will be at the lower end of the range, at 61,539oz. Note however, that we continue to expect lower output of both copper and gold in Q4 owing to mine sequencing as it segues into lower-grade zones of the pit (as shown in Exhibit 2).

The consequence of these changes is that we have increased our revenue estimate by US$3.9m (or 1.3%), partially offset by a US$2.7m (16.7%) increase in the G&A charge to result in a US$2.7m (1.8%) increase in net earnings to US$153.9m, or US$0.339/share (as shown below):

Note that, for the purposes of the above analysis, we have shown Q224 on an ‘underlying’ basis, with the global minimum tax (GMT) attributable in Q124, but reported in Q224, adjusted back out into Q124 (which is also the basis of our ‘Implied re-stated’ Q124 numbers).

As a result, our forecasts compare as follows with respect to the consensus for the quarter:

For the group as a whole, we expect the level of silver under-sales to remain relatively high in Q3, at 17.0% of production (cf a long-term average of 12.6% since Q112), while we expect the level of gold under-sales to remain relatively close to the long-term average, at 7.2% (cf a long-term average of 7.1%):

As a result, we expect silver ounces produced but not yet delivered (PBND) to WPM to increase to c 3.6Moz and to now equate to 2.14 months of our forecast FY24 production level (cf 2.8Moz and 1.68 months at the end of Q224) – that is, broadly in line with WPM’s target level of two months for silver production. We expect gold ounces PBND to increase by 6,017oz (or 6.7%) to 95,684oz, or 3.26 months of estimated FY24 production (cf 89,667oz and 3.05 months at the end of Q124). This figure of 3.26 months of gold ounces PBND is slightly above WPM’s target levels of two to three months for gold and palladium production, but arguably sets up a rebound in Q4 when Wheaton’s counterparties traditionally flush through sales ahead of the end of the calendar (and usually financial) year-end.

At the time of its Q423 results, WPM provided guidance for non-stock G&A expenses of US$41–45m, or US$10.25–11.25m per quarter, for FY24, which represents a decline relative to US$47–50m in FY23 and US$47–49m in FY22 and is on a par with guidance of US$42–44m for FY21 and US$40–43m for FY20.

Given WPM’s share price as at the date of our last note in August, we forecast that the total G&A charge for WPM in Q3 should be US$16.3m. WPM’s share price appreciated by 16.7% in US dollar terms over the quarter, with the result that we have increased our estimate of G&A expenses to US$19.0m, of which 57% will have been attributable to non-stock-based G&A expenses and 43% to stock-based expenses.

Exhibit 8, below, shows the precise position of our stock-based G&A forecasts for Q3 relative to Wheaton’s share price movement in US dollars. Note that the error of estimation of the regression analysis is US$2.4m for any particular quarter.

On 23 October, Wheaton announced that it had entered into a definitive PMPA with Montage Gold in respect of its Koné mine in Côte d'Ivoire, which also effectively represents a full financing package for the project.

Key terms of the stream are as follows:

Montage completed, and subsequently published, an updated feasibility study on the Koné project (with Lycopodium as its lead consultant) on 15 February 2024. For the purposes of our valuation of the stream relating to the mine, we have taken ‘Year 1’ of the study to be 2027, albeit we have adjusted output such that this year entails nine months of production (being six months of ramp up and six months of commercial production). On this basis (including the terms of the stream set out above), our estimate of pre-tax cash flows attributable to Wheaton from the project in the first nine years of production (note that, according to the feasibility study, there are a further nine years beyond the end of this schedule) is as follows:

This schedule inevitably excludes any potential expansion or extension of the mine as a result of blue-sky exploration success. Nevertheless, we calculate that its pre-tax internal rate of return (IRR) to Wheaton will be 10.1% at Edison’s gold price forecast assumptions (which dip as low as US$2,023/oz in the event of real interest rates in the United States becoming positive to the tune of 4%, in line with experience in the early 1980s). At the current price of gold of US$2,692/oz – flat for the life of the mine – we calculate that the IRR of the stream to Wheaton will be 13.0%, with higher returns earlier and lower returns later.

Two days before its Koné announcement, on 21 October, Rio2 announced an expanded relationship with Wheaton whereby WPM will now provide a full financing package for the construction, development, operation, commissioning and ramp-up of the Fenix Gold project in Chile. Under the updated terms, WPM will pay Rio2 an additional upfront cash consideration of US$100m (over and above the remaining US$25m outstanding under the original stream), in exchange for which Rio2 will deliver 95,000oz of gold from the project (subject to adjustment if there are delays in deliveries relative to an agreed schedule). In addition, Rio2 has agreed to adjust the production payment for all gold ounces delivered to 20% of the spot gold price. Rio2 has a one-time option to terminate the requirement to deliver the additional gold production from the end of 2027 until the end of 2029 by delivering 95,000oz less any of the previously delivered gold ounces. Wheaton will also provide a US$20m contingent cost overrun facility for the project in the form of a standby loan facility. Lastly, Wheaton has committed to participate in a private placement of Rio2 common shares for C$5m at a price per share equal to, and concurrent with, a public offering by Rio2. 

Rio2 completed, and subsequently published, a feasibility study on the Fenix project (with Mining Plus as its lead consultant) on 5 September 2023. At the time, the feasibility study posited a ‘construction timeline of approximately 14 months from receipt of relevant permits and contractor mobilization’. Assuming that contractor mobilisation is now imminent in the aftermath of the announcement of the expanded stream terms, our estimate of incremental pre-tax cash flows attributable to Wheaton from the project in the first eight years of production (note that, according to the feasibility study, there are a further 10 years beyond the end of this schedule) is as follows:

As with Koné, this schedule inevitably excludes any potential expansion or extension of the mine as a result of blue-sky exploration success. Nevertheless, we calculate that its pre-tax IRR to Wheaton on its incremental payment of US$100m will be 13.5% at Edison’s gold price forecast assumptions. At the current gold price of US$2,692/oz – flat for the life of the mine – we calculate that the IRR on Wheaton’s incremental payment will be 19.9%, with higher returns earlier and lower returns later.

In addition to the short-term adjustments, we have also adjusted our medium- and longer-term production forecasts for Wheaton to account for:

On 20 February, WPM provided detailed production guidance for FY24 and beyond. This guidance is summarised below relative to our updated FY24 forecasts in light of the Q1 and Q2 results:

WPM’s guidance for FY24 and beyond is based on standardised pricing assumptions of US$2,000/oz gold, US$23.00/oz silver, US$1,000/oz palladium, US$1,000/oz platinum and US$13.00/lb cobalt. Of note is the implied gold/silver ratio of 87.0x, which compares with the current ratio of 84.8x, but a longer-term average of 60.1x since gold was demonetised in August 1971. At the updated standardised prices indicated, our production forecast of 596.5koz gold equivalent (AuE) for FY24 is towards the upper end of WPM’s guidance range of 550–620koz AuE, although our sales forecast of 540.2koz AuE is more conservative (see Exhibit 12).

Otherwise, readers will note that our longer-term production forecasts are within 5% of WPM’s guidance for the period FY29–33, albeit WPM’s guidance will have included neither a contribution from Koné nor any incremental contribution from Fenix as a result of the revision of the stream’s terms announced on 21 October.

In the light of our short-term earnings revisions, we have upgraded our forecasts for FY24 to those shown in Exhibit 12, below. Relative to our earlier numbers, the main changes in our estimates reflect higher metals prices leading to higher revenues – especially in Q4 – falling straight through to the bottom line after the appropriate pro rata effective tax charge:

Our updated adjusted basic EPS forecast of US$1.453 per share for the full year is nevertheless near to consensus, which has also been rising since the time of our last note in August, when it was US$1.354/share for FY24, within a range of US$1.22–1.52/share.

Readers should note that our low EPS forecast for FY25 arises largely from the use of relatively low precious metals forecasts of US$2,004/oz Au and US$23.72/oz Ag (see also Exhibit 20). These will be revisited early in the next financial year. In the event that metals prices remain at current levels, however, our FY25 EPS estimate instead rises to US$1.72/share.

Wheaton hosted a site visit to Salobo earlier this month, which was attended by Edison’s analyst. A brief summary of some of the pertinent observations and conclusions arising from the trip is as follows:

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 FY24, in the case of WPM, we discount forecast cash flows back over four years to the start of FY24 and then apply an ex-growth terminal multiple to forecast cash flows in that year (FY27) based on the appropriate discount rate.

In this case, our estimate of WPM’s ‘terminal’ cash flow in FY27 remains ostensibly unchanged at US$2.73/share (cf US$2.77/share previously).

Assuming 4% growth in nominal cash flows beyond FY27 (ie 0% growth in real cash flows) and applying a discount rate of 9% (being the expected long-term required nominal equity return), our ‘terminal’ valuation of the company at end-FY27 is US$57.01 per share, or C$79.24 per share. However, it should be noted that this valuation is inherently conservative in that it assumes a gold price of US$2,239/oz and zero growth in (real) cash flows beyond FY27. This is inconsistent with the gold price, which has risen at a compound average annual growth rate of 7.4% per year from 1967 to 2023, a simple average annual growth rate of 9.3% per year (cf a compound average inflation rate over the same period of 4.0%) and a compound average real annual growth rate of 3.0% per year.

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 19.6% pa for the 18 years between FY05 and FY23, while its operational cash flows per share have increased at a compound average annual growth rate of 13.2% pa.

If we instead assume that cash flows per share increase at a compound average annual growth rate of 7.4% (ie the average compound average annual growth rate in the gold price from 1967 to 2023, cf 4.0% above), then our ‘terminal’ valuation of WPM increases many times to US$187.57/share, or C$260.71/share, and our current valuation to US$136.28/share, or C$189.42/share.

Stated alternatively, WPM’s current share price of C$91.91 appears to be discounting future compound annual average increases in cash flow per share of just 5.7% pa from FY27, which is only slightly higher than the long-term average rate of US inflation of 4.0% pa from 1967 to 2023 (inclusive).

A summary of these valuations with respect to their cash flow growth rate assumptions is as follows:

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 30.8x current year basic underlying EPS, excluding impairments (cf 45.5x Edison and 46.1x LSEG Data & Analytics consensus FY24e currently – see Exhibit 20).

Applying this 30.8x multiple to our EPS forecast of US$1.83 in FY27 (cf US$1.77 previously) implies a potential value per share for WPM of US$56.57 or C$78.62 in that year.

In the meantime, WPM is maintaining its premium rating relative to its peers, albeit it also appears good value within the context of future dividend expectations, especially in years two and three:

Readers will note our relatively high year 2 P/E ratio, which arises from our relatively low precious metals forecasts of US$2,004/oz Au and US$23.72/oz Ag for FY25. These will be revisited early in the next financial year (see also Exhibit 13).

As at 30 June, WPM had US$534.5m in cash on its balance sheet and no debt outstanding under its US$2bn revolving credit facility. Including a modest US$5.7m in lease liabilities, it therefore had US$534.5m in net cash after generating US$234.4m in operating cash flow and receiving a further US$131.7m from investing activities (cf a US$463.5m outflow in Q124, a US$464.2m outflow in Q423 but only a US$98.9m outflow in Q323), largely from the disposal of its Hecla shareholding and after relatively few PMPA investments during the quarter.

In addition, WPM had long-term investments, in the form of equity share holdings and warrant holdings, in listed companies in the sum of US$88.1m as at end-June (cf US$246.7m as at end March), equivalent to US$0.19/share, after it disposed of its investment in Hecla for gross proceeds of US$177.1m.

For FY23, WPM generated US$750.8m from operating activities, before consuming US$646.6m in investing activities and paying out US$265.1m in dividends. In FY24, we estimate that it will generate US$1,024.3m from operating activities (cf US$973.3m previously), before consuming US$648.1m in net investing activities (cf US$824.2m previously) and paying out an increased US$281.1m in forecast dividends under the influence of its new, progressive dividend policy. However, readers should note that the timing of PMPA payments is uncertain and, inasmuch as investments are advanced or delayed, it is possible that WPM could register either a larger or smaller net cash position on its balance sheet by the year end than that forecast. All other things being equal however – and notwithstanding its recently announced PMPAs with Koné and Fenix – in the absence of any major new asset acquisitions, we do not expect WPM to need recourse to its debt facilities in the future.