Silver Wheaton Upbeat On Future Despite Modest Earnings

Silver Wheaton (NYSE:SLW) announced its Q2 2012 results last week. The company reported a 3% year-over-year increase in revenues to $201.4 million, whereas net income declined by 4.5%  year-over-year to $141.4 million from $148.1 million. The company reported attributable silver equivalent production of 6.7 million ounces (6.5 million ounces of silver and 3,200 ounces of gold), an increase of 10% compared to Q2 2011. ((Silver Wheaton Reports Record Quarterly Financial Results Including Operating Cash Flows Of Over US$172 Million, Silver Wheaton Press Release, August 9 2012))

Silver Wheaton, the world’s largest silver streaming company, purchases silver from mining companies that produce silver as a by-product. Its main competitors are Silver Standard Resources (NASDAQ:SSRI), Pan American Silver (NASDAQ:PAAS), Bear Creek Mining Corporation (CVE:BCM) and Endeavor Silver (NYSE:EXK).

See our full analysis for Silver Wheaton

Earnings at a Glance

Revenue growth was due to a 36% increase in the number of silver equivalent ounces sold, which was partially offset by a 24% decrease in the realized price per silver equivalent ounce. The average realized price fell to $29.1 per ounce from $32.6 per ounce year-over-year. The increase in sales was primarily due to the timing of shipments of stockpiled concentrate as well as due to increased production at some of the mines underlying the company’s silver purchase agreements. These factors, along with higher cost of sales, were responsible for the decline in net income.

Business Model: Strength is the Weakness

Silver Wheaton signs long-term purchase agreements with mining companies (typically gold and copper mining companies) that produce silver as a by-product. The company has the right to purchase all or a portion of the silver production attributable at a low fixed price for an upfront payment pursuant to any agreement. This gives it an edge over the conventional mining companies as it does not incur any kind of operational losses in volatile market conditions. Moreover, since the company does not own any of the mines, it does not incur any operational and capital costs associated with the production.

However, the same business model makes is hugely dependent on silver prices for earnings growth. Even a slight change in silver price translates into a major variance in EBITDA.

Company Continues to Build Asset Base in Anticipation of Long-Term Demand

Silver Wheaton has been actively scouting for productive assets to deploy its cash chest of $1 billion. It recently announced a deal to buy all of HudBay Minerals Inc.’s silver production from two of its mines, along with some of the gold production from one of them, for about $750 million, plus additional ongoing payments. Under the deal, Silver Wheaton is entitled to 100% of the life-of-mine silver production from Hudbay’s currently producing 777 Mine in Manitoba, and 100% of the life-of-mine silver production from its Constancia Copper-Molybdenum-Silver Project in south Peru. The combined production from these two mines is expected to add 4.9 million ounces annually to the production figures by 2016.

Euro Zone Weakness Continues to Worry

Global economic conditions have led to increased volatility in commodity prices, making it difficult to forecast commodity prices in the short term. Europe’s problems continue unabated, and any proposed remedy that finds broad acceptance is unlikely to solve problems in the short or medium term. This, combined with muted demand from China, could depress prices if the contagion were to spread. Industrial use is a key demand driver for silver, so weak economic conditions equate to muted demand and lower prices. The price movement in the previous quarter has been confined to a relatively narrow zone, albeit lower than the last quarter on average, reflective of the watchful mode in the market. We believe that the prices will see an upward push if QE3 materializes and investors start chasing commodities across the board. Without QE3, we see no reason for a price rally in the near term as industrial demand, even if it were to pick up, won’t be sufficient to cause a meaningful price impact so soon.

We are currently in the process of updating our estimates in light of the recent earnings and the deal with HudBay Minerals Inc.

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