Silver Wheaton (NYSE:SLW) will announce its third quarter results on November 11 and conduct the earnings conference call on November 12. Although Silver Wheaton is not a mining company, its business model makes it very vulnerable to volatility in the prices of precious metals. Silver prices in the third quarter were lower on year-over-year and sequential bases. This is likely to have a significant negative impact on its year-over-year and sequential revenue figures because the company doesn’t hedge itself against market prices of silver. On the other hand, Silver Wheaton’s exposure to gold has been increasing. Gold generates higher revenues but lower profit margins for the company as compared to silver. 
Silver Wheaton links its dividend payment to cash generated by operating activities in the previous quarter. Low silver prices imply lower cash flows and hence lower dividends, which may put pressure on the company’s share price.
We have a price estimate for Silver Wheaton of $20 which represents a 7% downside from the current market price. Our price estimate will be revised once the third quarter earnings results are out.
Silver Wheaton is a silver streaming company. It signs long-term purchase agreements with mining companies that produce silver and gold as by-products. The company has the right to purchase all or a portion of the silver or gold production at a low fixed price for an upfront payment pursuant to any agreement. This gives it an edge over conventional mining companies as it does not incur any 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 production. However, Silver Wheaton doesn’t hedge itself against silver price movements which leaves it vulnerable to significant adverse price movements.
Weak Silver Prices Will Impact Margins
The prices of precious metals like gold and silver this year have been reacting largely to the Federal Reserve Bank’s various pronouncements and hints about continuing or tapering down monetary stimulus measures, better known as Quantitative Easing (QE). The first steep fall in price came in April when the minutes from the Federal Open Market Committee (FOMC) meetings suggested that the bank may stop its bond purchasing program well before the end of 2013. 
A second steep fall in gold and silver prices occurred in June when the Federal Reserve Bank chairman Ben Bernanke announced his intention to reduce the quantitative easing program or possibly withdraw it later in the year, if the U.S. economy and job market were to improve.
However, gold and silver prices again started inching upwards in July when a second announcement from Mr. Bernanke suggested that economic data continued to remain weak and the Federal Reserve may continue with monetary easing for the time being. In the wake of some positive economic data ahead of the monetary policy review meeting of the Federal Reserve in mid-September, the market largely expected the bank to begin a gradual QE tapering process. Accordingly, the prices of gold and silver began falling in September right till the end of the month. Since then, gold and silver prices have stayed largely flat as the Federal Reserve opted not to commence the QE tapering process for the time being. 
On the whole, the average prices of gold and silver for the third quarter this year have been much lower than in the third quarter last year. Therefore, we expect Silver Wheaton to report lower year-over-year profits for the third quarter. Low precious metal prices are a problem for Silver Wheaton because it does not hedge itself against price movements in the market. As a result, its cash flows and dividend payouts suffer, putting pressure on the stock price.
Impact Of Suspension Of Pascua Lama Mine
Barrick Gold has decided to halt all construction activities at its Pascua Lama project, except those required for environmental protection and regulatory compliance. This was done in view of a prolonged slump in gold prices as well as continued uncertainties and risks associated with the project which has been mired in legal, regulatory and operational troubles. Also, once the project resumes, the company intends to take a phased construction approach to ensure efficient deployment of capital and reduce costs. This would be best achieved by ramping down activities now and re-sequencing them later. ((Barrick Gold Q3 2013 Earnings Conference Call, Seeking Alpha))
Silver Wheaton entered into a silver purchase agreement with Barrick in September 2009 to acquire 25% of the life-of-mine silver production from Pascua-Lama. Under the agreement, Barrick provided a completion guarantee that required it to complete work at Pascua-Lama to at least 75% of design capacity by December 31, 2015. The original agreement stated that in case of a production shortfall at Pascua Lama in 2014 and 2015, Silver Wheaton would be entitled to compensatory silver production from Barrick’s Lagunas Norte, Pierina and Veladero mines until Barrick satisfied the completion guarantee. If Barrick did not satisfy the guarantee, Silver Wheaton retained the option of terminating the agreement. Silver Wheaton extended the deadline by one year to December 31, 2016 at the end of the second quarter this year when Barrick announced a delay of one and a half year for commencement of production.
With the Pascua Lama project indefinitely suspended for now, Barrick and Silver Wheaton have amended the agreement again. Silver Wheaton will now be entitled to compensatory production from Barrick’s Lagunas Norte, Pierina and Veladero mines for an additional year until the end of 2016. In exchange, Silver Wheaton has agreed to extend the completion guarantee deadline by one year to December 31, 2017. If this revised deadline is not met, Silver Wheaton has the option to terminate the agreement. If it does so, it will receive $625 million, the upfront cash consideration it has paid to Barrick, after adjusting for any silver delivered up to that point. 
Another Gold Stream Added
This week, Silver Wheaton signed a deal with Hudbay Minerals to acquire 50% of the life of the mine gold output from the latter’s Constancia mine. Silver Wheaton will pay $135 million as upfront consideration for the deal once Hudbay incurs capital expenditure of $1.35 billion at Constancia. The gold will be acquired at a price of the lesser of $400 per ounce (subject to an inflationary adjustment of 1% beginning in the fourth year after completion is achieved) and the prevailing market price.
In view of the events at Pascua Lama and the new Constancia deal, Silver Wheaton has reduced its 2017 production forecast by 13% to 42.5 million silver equivalent ounces. The production forecast for 2013 is intact at about 33.5 million silver equivalent ounces. Notes:
- Silver Price Chart, Kitco [↩]
- Falling Gold Prices Take Shine Off Mining Majors, Trefis [↩]
- Gold prices drop as markets brace for Fed tapering, Syria fears wane, Investing.com [↩]
- Silver Wheaton provides update on Pascua-Lama and extends Barrick silver stream agreements, Silver Wheaton Press Release [↩]
- Silver Wheaton expands precious metal stream on the Constancia Project to include gold, Silver Wheaton News Release [↩]