A Closer Look At Silver Wheaton’s Constancia And San Dimas Mines

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 silver or gold obtained at a fixed price is sold at market rates, which exposes it to the daily volatility of these metals’ prices. Its gains increase when the market prices of silver and gold rise. The prices of gold and silver plunged in 2013, mainly due to the Federal Reserve Bank’s announcements regarding tapering of the Quantitative Easing (QE) program.

In this article, we focus specifically on the company’s silver streaming business from the Constancia and San Dimas mines. Constancia is owned by Hudbay Minerals Inc. San Dimas is one of the most significant precious metal deposits in Mexico and is owned and operated by Primero Mining Corporation.Below, we talk about the reserve base at these mines, expected output, upfront payments made by Silver Wheaton and the per ounce cash cost to be paid.

See our full analysis for Silver Wheaton

The Constancia Mine

The Constancia mine is located in Peru. In August 2012, Silver Wheaton entered into an agreement with Hudbay to acquire 100% of the silver production from its Constancia Project. The total upfront consideration to be paid for this mine is $294.9 million. Of this, $44.9 million was paid on September 28, 2012, when the deal was closed. A further payment of $125 million is to be made once $500 million in capital expenditures have been incurred at Constancia. A final payment of $125 million will be made once $1 billion in capital expenditures have been incurred. ^[1]

The key environmental permits for Constancia have been procured, and engineering and design work is complete. First production is anticipated in 2015, and full production is expected to be achieved in 2016. As of now, an annual production of 85,000 tonnes of copper is expected, with molybdenum, silver and gold as by-products. The life of the mine is expected to be 15 years.

The Constancia mine has proven and probable reserves of 450 metric tonnes and it is estimated that 3.4 gm of silver is present in each metric tonne. In all, it is estimated that 48.8 million ounces of silver are present in these reserves. The process recovery rate for this mine is estimated at 72%.

The San Dimas Mine

The San Dimas mine is located in the San Dimas district of Mexico on the border of Durango and Sinaloa states and is one of the most significant precious metal deposits in Mexico. ((The San Dimas Mine, Silver Wheaton Website))

In October 2004, Silver Wheaton entered into a silver purchase agreement with Goldcorp to purchase 100% of the silver at San Dimas and Los Filos mines for a period of 25 years for an upfront payment of almost $190 million. It also agreed to pay the lesser of $3.90 per ounce of silver (subject to an annual inflationary price adjustment) and the prevailing market price of silver.

In August 2010, Goldcorp sold the San Dimas mine to Primero. Following this, Silver Wheaton entered into an amended agreement under which the deal for San Dimas was extended to the life of the mine. For the first four years after the transaction, Silver Wheaton is entitled to 3.5 million ounces of silver from San Dimas and 50% of anything produced in excess of that figure. In addition, Goldcorp agreed to supply Silver Wheaton an additional 1.5 million ounces of silver per annum. Beginning in the fifth year, Primero will deliver a per annum amount to Silver Wheaton equal to the first 6 million ounces of silver produced at San Dimas and 50% of anything produced in excess. Goldcorp will continue to guarantee the delivery by Primero of all silver produced and owed to Silver Wheaton until 2029 and pay a penalty of $0.5 per ounce for any shortfall below 215 million cumulative silver ounces by 2031. The silver stream from Los Filos will continue to be delivered in full to Silver Wheaton as per the original agreement.

Silver Wheaton is not required to fund any further capital or exploration expenditures at San Dimas, nor is it required to fund any expansion scenarios.

The Story So Far At San Dimas And Future Potential

As of December 31, 2013, Silver Wheaton has received approximately 57.5 million ounces of silver from the San Dimas mine under the agreement and has generated cumulative operating cash flows of approximately $808 million. On December 31, 2013, the San Dimas mine had proven and probable silver reserves stood at 49.5 million ounces and inferred silver resources at 73 million ounces. ^[2]

San Dimas will deliver at least 215 million silver ounces to Silver Wheaton by 2031. In 2013, it received 6.5 million ounces of silver from San Dimas and sold 6.7 million ounces. The total 2013 production for the company was 26.72 million ounces so San Dimas alone accounted for 25% of the total. At average realized prices of $23.58 per ounce of silver, this translates to revenues of nearly $157.4 million. Total revenues in 2013 for the company stood at $706.5 million.

Assuming a conservative 25-year mine life (as mentioned in the original agreement) the upfront cost per year can be assumed to be $7.6 million (190/25 ~ 7.6). If Silver Wheaton receives 6 million ounces each year (3.5 million as guaranteed by Primero, 1.5 million that Goldcorp is obligated to supply and approximately 1 million ounces in excess production from Primero), the cost per ounce would be nearly $1.26. Added to the procurement cost of $4.15 per ounce (the inflation-adjusted figure for 2012), the total cost of purchase would stand at around $5.41 per ounce. Given that silver is currently trading at around $20 per ounce despite the steep decline in prices witnessed recently, we think that it is a good deal by any standard. ^[3]

Benefits To Silver Wheaton

In our opinion, the deals fix 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. Also, with industrial demand expected to pick up sooner or later, the market price of silver is likely to rise. This will allow streaming companies like Silver Wheaton to earn good returns. Hence, we think that Silver Wheaton has good deals in these mines.

We have a price estimate for Silver Wheaton of $19 which represents 16% downside to the current market price.

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1. Silver Wheaton Constancia Mine, Silver Wheaton Website [↩]
2. Silver Wheaton 2013 40-F, SEC [↩]
3. Silver Price Charts, Kitco [↩]