After witnessing spectacular growth on the back of skyrocketing silver prices prices in past two years, Silver Wheaton (NYSE:SLW) has seen its stock struggling in the low $30’s, perfectly in line with silver prices, which also have dwindled to about $32 per ounce from a high of about $49 per ounce in last April. However, the silver prices may continue Silver Wheaton, the world’s largest silver streaming company, purchases silver from mining companies that produce silver as a by-product. Silver Wheaton competes with silver manufacturers like Silver Standard Resources (NASDAQ:SSRI), Pan American Silver (NASDAQ:PAAS), Bear Creek Mining Corporation (CVE:BCM) and Endeavor Silver (NYSE:EXK).
While we are structurally bullish on Silver Wheaton, we have slightly downward revised our price estimate for Silver Wheaton to $40, which is about 18% above the current market price. We have updated our forecasts for silver prices, shipments and capital expenditures over the next 2-3 years to reflect the company’s near-term outlook.
Business model gives an advantage over traditional mining companies
Silver Wheaton signs long term purchase agreement with mining companies that produce silver as a by-product, typically gold and copper mining companies. It has positioned itself as the world’s largest silver streaming company in a very short time. The company currently has fourteen silver purchase agreements and two purchase agreements for precious metals like gold and has the right to purchase all or a portion of the silver production attributable at a low fixed price for an upfront payment.
This gives it an edge over the conventional mining companies as it does not incur any kind of operational losses in volatile market conditions. Since the company does not own any of the mines, it does not incur any operational and capital costs associated with the production. Moreover, it is not as much as exposed to political risks as conventional miners.
Rising industrial utility of silver, Demand from India and China intact
Silver, being a very good conductor of electricity, is used in many electronic devices. The continuing increase in the production of electronic devices will lead to an increased demand for silver. Further, increasing demand for the photo-voltaic cells (solar-cells) will also boost the demand for silver as it is one of the main constituents of the photo-voltaic cell.
Further, we believe India and China’s rising middle class complemented with increasing disposable income will keep the strong demand for precious metals intact.
Inflation concerns a boost to silver prices
Encouraged by the recent economic reports in the U.S., the Federal Reserve has recently said that it won’t go for further quantitative easing unless the growth subsides. But, the easy monetary policy already adopted in response to the economic crisis has led many to believe that this could result in high inflation. Further, many are not convinced if the global economy is actually on the right course. As growth, inflation and policy concerns are still loom over the global economy, investors look to investing in physical assets and commodities including gold and silver to hedge against these risks.
But, of late gold prices have appreciated significantly, sending gold silver ratio to about 50. This makes silver an attractive investment alternative to gold. While we estimate Silver Wheaton’s average price for silver will rise closer to $42 per ounce by the end of our forecast period, many people predict it to even top $50.
EBITDA margins to improve, Taxes could go up
The company procures silver at very low fixed price adjusted for inflation and does not incur any operational and capital costs associated with the production. Therefore upside to silver prices leads to significant upside in the company’s margins. Margins will improve on back of economies of scale even if silver prices don’t outpace the inflation.
Silver Wheaton currently pays no income taxes as all its operations are carried out in tax heaven Cayman islands, where the company is exempt from income tax laws. But, the governments around the globe have begun coordinated efforts to close these loopholes to increase their revenue kitty in wake of recent recession. We expect tax rates to gradually increase as the governments tightens their noose on tax heavens.
Winner’s curse: How to get new agreements?
Currently, almost all the contracts enable the company to purchase silver at amazingly low fixed price of $4-$5 per ounce as compared to current market price of $32. However, this recent rise in silver could make mining companies asking for bigger share of the pie in form of upfront payment, that Silver Wheaton pays for investment in their mines. This could hinder the company from procuring new silver agreements in what could be called winner’s curse.