Silver Wheaton — Update 11 November 2015

Record attributable production was recorded at both Salobo and Penasquito and record sales at San Dimas (reversing the inventory build-up in Q215), although this was ostensibly offset by under-sales at Salobo, Yauliyacu and SLW’s ‘other’ silver assets, such that there was only a 1.6% decrease in payable silver equivalent ounces produced but not yet delivered, to 6.3Moz AgE, overall. Elsewhere, gold production was lower at Sudbury (owing to planned maintenance shutdowns), but higher than expected at both Constancia and Minto. A summary of Silver Wheaton’s underlying Q315 results and how they compared to both Q215 and our prior operating and financial forecasts is given in the table below. Note that Q415 forecasts now include the Antamina stream (see below).

Despite a slower July and August, the ramp-up at Salobo recovered once again in September, with capacity utilisation exceeding 90%. It is expected to reach 100% in Q415. Production at Penasquito similarly reached a record as substantial mining took place in the heart of the deposit and despite the suspension of construction of the Northern Well Field project owing to an illegal blockade by a local community. Penasquito continues to seek an equitable resolution of the matter with the community, while taking steps to enforce its contractual rights. In addition, it is also advancing alternatives to complete the project, without crossing through the affected community lands. The operator, Goldcorp, believes that there will be a resolution of the matter in time to meet the future water needs of the mine. In the meantime, the Metallurgical Enhancement Project feasibility study remains on schedule to be completed in early 2016. Elsewhere, stripping at Minto North is also reportedly on schedule, with ore expected to be delivered to the mill in December 2015 and high grade ore in Q216.

Our estimate of 54c for FY15 compares to an average consensus basic EPS estimate of 52.6c, within the range 42-56c (source: Bloomberg, 10 November 2015). Note that our updated forecasts for Q415 and FY16 now both include the Antamina stream acquisition (see below).

By contrast, our basic EPS estimate of 78c for FY16 (vs 68c pre-Antamina, see Exhibit 4) compares to an average consensus estimate of 65.3c, within the range 29-83c. Note that our FY16 estimates are based on precious metals price forecasts of US$16.11/oz Ag and US$1,224/oz Au.

In addition to its Q315 results, Silver Wheaton also announced its acquisition of 100% of the silver attributable to Glencore from its 33.75% interest in the Antamina copper mine in Peru (note that SLW already has a prior commercial relationship with Glencore via its Yauliyacu stream). SLW paid US$900m for the stream and will pay 20% of the spot price per silver ounce delivered. Once 140Moz of silver has been delivered (after approximately 30 years), the stream will reduce to two-thirds of Glencore’s interest (ie 22.5% of the silver produced by the mine).

Production attributable to Silver Wheaton is forecast to be 1.0-1.5Moz Ag in Q415, followed by 5.1Moz per year for both FY16 and FY17 and 4.7Moz thereafter for a further 20 years. Reserves are sufficient to support mining activities until 2028. Measured and indicated resources are capable of supporting mining for an additional 12 years thereafter (assuming conversion into reserves) and inferred resources for a further 27 years after that. Note that the main restriction to the immediate conversion of resources to reserves is the capacity of Antamina’s tailings ponds.

Based on our long-term silver price forecasts, we estimate that Antamina will therefore contribute an average of US$95.2m to SLW’s cash-flows per year and, as such, is approximately equivalent to SLW’s Salobo stream in terms of its scale and the quality of the underlying asset.

In response to a notice of reassessment from the Canada Revenue Agency on 24 September, Silver Wheaton duly confirmed that it has filed notices of objection for each of the reassessed tax years. As such, it is in a position to lodge an appeal with the CRA (a process that would typically last one to two years). However, it has indicated that it is more likely it will wait for a further 91 days after filing a notice of objection (ie until approximately January 2016), after which it will exercise its legal right to appeal directly to the Tax Court of Canada to reach a conclusion as quickly as possible via litigation. Initially, this would involve a case ‘discovery phase’, in which an assessment of each side's strengths and weaknesses would be considered. Typically, this phase takes six to nine months, during which a meaningful amount of cases are settled out of court. If no agreement can be reached, the case will proceed to court, likely to be approximately in early 2017.

Now that a notice of reassessment has been received, SLW is obliged to make a deposit of 50% of the disputed tax, interest and penalties (ie C$177m, US$133m, or US$0.33/share) on filing a notice of objection. Note that any cash outlay will be accounted for as a refundable deposit.

As stated in our note of 9 July, the income the CRA is seeking to tax is earned by foreign subsidiaries from assets outside Canada. Key to the CRA’s case appears to be the assertion that services bought and contracted between SLW’s Vancouver and offshore offices were mispriced and that the profit split between the two jurisdictions was therefore distorted. Silver Wheaton is limited in what it can say publicly ahead of any legal action. However, investors should be aware of three matters relevant to this assertion:

Otherwise, it remains the case that: 1) the structure and relationship between SLW and its foreign subsidiaries is common and used by many companies both globally and within Canada; 2) any ruling against SLW could expose other multinational companies operating out of Canada to similar treatment; and 3) the CRA’s approach to the 2011-14 tax years remains unclear. In our opinion, this last point may be a risk in that the CRA may seek to similarly reassess tax during 2011-14. However, it could also be an opportunity in that its approach to these years therefore appears inconsistent compared to 2005-10.

The effect of the Antamina stream acquisition increases our forecast of SLW’s EPS in FY19 from US$1.64 to US$1.84.

Excluding FY04 (part year) and FY08 (during which there was an exceptional write-down), Silver Wheaton's shares have historically traded on an average P/E multiple of 25.3x current-year basic EPS (cf 23.0x currently).

Applying this multiple to our updated long-term EPS forecast of US$1.84 per share in FY19 (vs US$1.64 previously) implies a potential share value of US$46.36, or C$61.59 (cf US$41.43 or C$53.59 previously).

In the meantime, the table below shows Silver Wheaton’s current rating on a number of valuation measures relative to both a sample of its ‘peer’ royalty/streaming companies and a sample of gold miners. Using our forecasts in Exhibits 1 and 4, it is notable that Silver Wheaton trades on multiples that are cheaper than its royalty/streaming ‘peers’ in 71% of instances considered. It also trades on multiples that are cheaper than the gold miners themselves in c 46% of instances considered, despite being associated with materially less operational and cost risks, in particular.

At 30 September, SLW has US$566.5m of net debt on its balance sheet (vs US$643.1m at end-June – consistent with its performance of generating c US$100m from operating activities per quarter). Since the quarter’s end, it has announced its US$900m investment into the Antamina stream acquisition; it has also repurchased 645,389 of its own shares under its share repurchase programme at an average price of US$11.86 and therefore an implied consideration of US$7.7m. SLW has TSX approval to repurchase up to 20,229,671 common shares (representing 5% of the total outstanding common shares at September 11, 2015) under a Normal Course Issuer Bid (NCIB) over 12 months starting after TSX approval (although potential future repurchases are excluded from our forecasts on the basis of the uncertainty surrounding the size, price and timing of any such repurchases).

In the aftermath of its Q415 investments, we forecast that SLW will have net debt on its balance sheet of US$1,345.0m at end-December 2015, equating to a gearing (net debt/equity) ratio of 29.7% and a leverage (net debt/[net debt+equity]) ratio of 22.9%. Nevertheless, such a level of debt is well within the tolerances required of its banking covenants that:

Note that the interest rate associated with SLW’s revolving debt facility is Libor plus 120-220bp.