Silver Wheaton Preview: Higher Silver Prices Will Help Earnings Sparkle

Silver Wheaton (NYSE:SLW) will report its earnings for the third quarter on Monday next week. Last quarter, 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. ((Silver Wheaton Reports Record Quarterly Financial Results Including Operating Cash Flows Of Over US$172 Million, Silver Wheaton Press Release, August 9 2012)) Silver prices increased in the earlier part of this quarter in the run-up to the expected QE3 monetary stimulus by the Federal Reserve Bank. It has moderated to some extent since then.

Any upside in the price of silver benefits Silver Wheaton which buys silver from mining companies at fixed prices under long-term contracts but sells it at market prices. Since average silver prices have been higher compared to the previous quarter, we expect higher revenues and profit margins this quarter. Production will also increase due to the additional production stream resulting from the Hudbay deal. ^[1]

Silver Wheaton, the world’s largest silver streaming company, purchases silver from mining companies that produce silver as a by-product. Silver Wheaton provides funds for capital expenditures upfront when a project is being developed and obtains the right to buy precious metals produced at low, fixed prices. It does not pay for any ongoing capital or exploration costs at the mines. Thus, the company’s costs are one-time and fixed. This greatly reduces its business risk. 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

Silver Prices

Silver derives its demand from industrial use as well as its use as an investment vehicle. According to The Silver Institute, almost half of the total demand for silver is derived from industrial use. The remaining half is divided into jewelry and physical demand which takes up as much as 31%. Photography and silverware constitute rest of the silver demand. Weak global economic conditions could impact industrial demand for silver and put downward pressure on prices in the short and medium term. Interestingly, the use of silver as a hedging instrument in a volatile economic environment could provide upside to prices. We will have to wait to see which of the two factors dominates.

The Hudbay Deal

Silver Wheaton closed a deal with Hudbay Minerals Inc. this quarter, under which it will buy Hudbay’s silver production from two of its mines along with some gold production from one of them for about $750 million, plus additional ongoing payments. ^[2] The increased availability of silver will allow it to leverage its unique business model to take further advantage of high silver prices in the market. In our opinion, the deal fixes the price of silver at a relatively lower figure, considering the huge jump in the cost of production over the last few years. Going forward, we think it will rise further owing to higher costs associated with labor, energy, and regulatory compliance. Silver Wheaton, however, will be insulated from these owing to its fixed-price contracts.

Of the $750 million that Silver Wheaton has to pay Hudbay, $500 million has been paid with the closing of the deal. Two further payments of $125 million each are to be made subject to fulfillment of minimum capital expenditure criteria at Constancia. ((The Hudbay Stream Continuing the Growth, Silver Wheaton, August 8 2012)) Prior to the acquisition of Hudbay, Silver Wheaton had a cash war-chest of $1 billion. With $500 million already paid, we are interested to know if the company is open to more deals in the short term.

With 16 separate streaming agreements in place, silver equivalent production is expected to grow substantially over the next few years as silver production from Goldcorp’s Penasquito and Barrick’s Pascua Lama mines increases. ^[3]

We have a price estimate for the company of $37 which will be revised once the earnings results are out.

Understand how a company’s products impact its stock price at Trefis

1. Silver Price Charts, Kitco [↩]
2. Silver Wheaton Closes Acquisition of Precious Metals Streams From HudBay’s 777 Mine & Constancia Project, MineWeb [↩]
3. Silver Wheaton: A Less Risky Way To Profit From Silver’s Upsurge, Seeking Alpha [↩]