Silver Wheaton (NYSE:SLW) is a silver streaming company that signs long-term purchase agreements with mining companies producing silver or gold as a by-product. The company provides funds for capital expenditure upfront to the mining company 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, which greatly lowers its business risk.
The silver or gold obtained at a fixed price is sold at market rates, exposing the company to the daily volatility of these metals’ prices. Its gains increase when market prices of silver and gold rise. The prices of precious metals continuously declined this year until late June and have been making modest gains since then. Apart from use in jewelry, silver is an industrial metal as well. This ensures a relatively steady demand for silver as compared to gold, which is primarily used in jewelry.
In this article, we focus specifically on the company’s silver streaming business from the San Dimas mine. It is one of Mexico’s most significant precious metals deposits and is owned and operated by Primero, which purchased it from Goldcorp in 2010.
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We have a price estimate for Silver Wheaton of $20, which represents a 7% downside to the current market price.
The San Dimas Mine
The San Dimas mine is a low cost producer of gold and silver. It is located in the San Dimas district on the border of Durango and Sinaloa states and consists of more than 100 mineralized gold-silver veins. In October 2004, Silver Wheaton entered into an agreement with Golcorp to purchase 100% of the silver produced at San Dimas for a period of 25 years. 
As of June 30, 2013, Silver Wheaton had received approximately 53.8 million ounces of silver from the San Dimas mine, having generated cumulative operating cash flows of approximately $747 million. On December 31, 2012, San Dimas’ proven and probable silver reserves stood at 39.4 million ounces and inferred silver resources at 64.6 million ounces. 
San Dimas continues to provide excellent exploration upside and and the current mine life is estimated at over 20 years. In 2012, the company received 5.9 million ounces of silver from San Dimas and sold 5.8 million ounces. The total 2012 production for the company was 29.6 million ounces so San Dimas alone accounted for 20% of the total. At average realized prices of $31.03 per ounce of silver, this translates to revenues of nearly $180 million. Total revenues in 2012 for the company stood at $849.6 million. 
As per the original agreement between Silver Wheaton and Goldcorp, Silver Wheaton will buy silver for $3.90 per ounce (subject to annual inflationary adjustments) and sell it at the prevailing market price when the delivery is made. In 2006, Silver Wheaton and Goldcorp amended their initial agreement and Silver Wheaton was freed from the requirement to make further capital expenditure contributions. After Goldcorp sold San Dimas to Primero in 2010, the agreement was amended again. It was extended to the life of the mine from the previously agreed period of 25 years and Primero guaranteed the delivery of 215 million cumulative silver ounces to Silver Wheaton by 2031. Therefore, after June 30, 2013, Silver Wheaton will continue to receive silver for the next 17.5 years.
Considering that almost 54 million ounces of silver have been delivered to Silver Wheaton thus far, the company can expect to receive another 161 million ounces over the next 17.5 years at a fixed cost of $3.90 per ounce and sell the silver at market spot prices. Further costs of $0.21 per ounce (upfront cash payment of $46 million divided by 215 million ounces) should be allocated to the cost figure of $3.90 per ounce. Given that silver is currently trading at around $22 per ounce, we think that it is a good deal by any standard. 
Benefits To Silver Wheaton
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 that production costs will rise further owing to higher costs associated with labor, energy, and regulatory compliance. Silver Wheaton, however, will be insulated from these increased costs owing to its fixed-price contracts. In addition, with industrial demand expected to pick up eventually, the market price of silver is likely to rise going forward. This will allow streaming companies such as Silver Wheaton to earn good returns.Notes: