A Look At Silver Wheaton’s Business Model: Risks And Opportunities

SLW: Wheaton Precious Metals logo
SLW
Wheaton Precious Metals

Silver Wheaton (NYSE:SLW) is the world’s largest precious metals streaming company. It is one of the largest producers of silver, despite not owning a single mine. [1] This is due to the company’s business model, which basically involves making an upfront payment to mining companies in return for acquiring long-term rights to buy precious metals from different mines.

The company’s business model allows it to avoid many of the risks that typical mining companies face. In addition, cash payments from precious metal streaming companies form an attractive source of funding for conventional mining companies. In this article, we will take a closer look at Silver Wheaton’s business model, including the risks and prospects.

See our complete analysis for Silver Wheaton

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The Business Model

Silver Wheaton is the pioneer of the silver streaming business model. It provides funds for capital expenditure upfront when a mining project is being developed, and obtains the right to buy a portion or all of the silver and gold produced as by-products of mining operations. The prices at which Silver Wheaton purchases precious metals under these agreements are generally significantly below market prices. It does not pay for any operating expenses or sustaining capital expenditure at the mines. Thus, the company’s costs are one-time and fixed, which greatly reduces its business risk. The mining company that sells the precious metals stream gets funds for capital expenditure without taking additional debt. In exchange it only has to supply silver or gold which are marginal by-products of their core operations, such as production of copper or zinc. Thus, the business model is a win-win for both parties. The company does not hedge itself against precious metals prices. Thus, its business model is exposed to volatility in gold and silver prices. [2]

Risks

Silver Wheaton’s unique business model allows it to bypass many of the risks that a conventional mining company faces. However, there are some risks inherent to its business model.

Silver Wheaton is not engaged in mining operations itself. It is dependent on the mining operations of its partners. Any disruptions to the operations of its partners would negatively impact its prospects. Thus, it is indirectly exposed to its partners’ business risks. A glaring example of such a risk is Silver Wheaton’s streaming agreement with Barrick Gold, to purchase silver produced from its Pascua Lama project in Chile, upon commencement of operations. Barrick Gold decided to suspended construction activities at Pascua Lama in Q4 2013, except those required for environmental and regulatory compliance, due to legal challenges for the project over alleged environmental infractions. [3] Silver Wheaton subsequently amended its silver purchase agreement with Barrick which entitled it to a share of silver from Barrick’s other mines for a longer period of time. However, this example demonstrates how Silver Wheaton’s business model is indirectly exposed to its partners’ business risks.

Another risk to Silver Wheaton’s business model is volatility in precious metals prices. It does not hedge its exposure to volatility in silver and gold prices. Thus, a fall in precious metals prices directly impacts Silver Wheaton’s prospects. Gold and silver prices have corrected significantly over the last year. These have been reacting to cues regarding Quantitative Easing (QE) tapering by the Federal Reserve.  Silver London Fix prices have fallen from average levels $30 per ounce in Q1 2013 to levels of around $21 per ounce in Q1 2014. ((Silver Price Chart, Kitco))  London PM Fix gold prices have fallen from average levels of $1,650 per ounce in Q1 2013 to $1,300 per ounce in Q1 2014. [4] With the U.S. economy strengthening and QE tapering expected to continue, precious metals prices will remain subdued. Gross margins fell from approximately 73.4% in Q1 2013 to 55.4% in Q1 2014, primarily driven by a fall in precious metals prices. [5] This shows the vulnerability of Silver Wheaton’s business model to volatility in precious metals prices.

The attractiveness of Silver Wheaton’s business model is also impacted by the attractiveness of streaming deals as a source of financing for mining companies. One attractive feature of financing through streaming deals is that it is considered a source of non-debt financing by ratings agencies. However, in October 2013, Standard & Poor’s (S&P) decided to classify streaming deals as debt rather than non-debt financing. [6] Such a practice may decrease the attractiveness of streaming deals as an avenue of financing, as under such a system streaming deals would impact a company’s credit rating in the same way as taking on additional debt. However, this practice has not been replicated by other major ratings agencies. As long as this remains the case, streaming deals will continue to remain attractive to mining companies.

Opportunities

Precious metals streaming deals are attractive sources of funding for mining companies, especially in subdued pricing environments, such as those persisting at the moment. Copper prices are low due to a persisting oversupply situation and weak demand. ((Copper Miners Forecast Years Of Surplus, The Financial Times)) Gold prices are weak due to QE tapering and strengthening of the U.S. and world economies. Due to the subdued pricing environments, sentiment is negative regarding the mining sector in general. Equity valuations are subdued, which make issuing stock less desirable. Debt is hard to come by for mining companies, most of which have highly leveraged balance sheets, and are looking to deleverage.

Under such conditions, streaming deals are an attractive source of funding for mining companies. This is especially the case for gold and copper producers, or diversified mining companies that produce these metals, as these are the major counterparties for Silver Wheaton’s precious metal streaming deals. Over 70% of mined silver is produced as a by-product from base metal or gold mines. [7] Thus, there is significant growth potential in the silver streaming space.

Conclusion

Silver Wheaton’s business model has significant advantages as compared to a traditional mining company. Its capital expenditures are one-time, and the prices at which it buys silver or gold are predictable. It is not directly exposed to business risks that conventional mining companies are exposed to. Though it is negatively impacted by a weak precious metals pricing environment, the same provides opportunities for acquisition of precious metal streams. Thus, Silver Wheaton’s precious metal streaming business has potential under both good and bad business conditions.

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Notes:
  1. Silver Wheaton Pioneers Payment Streams for Miners, Financial Times []
  2. Silver Wheaton 2013 40-F, SEC []
  3. Barrick Gold’s 2013 40-F, SEC []
  4. Gold Price Chart, Kitco []
  5. Silver Wheaton’s Q1 2014 6-K, SEC []
  6. Big Miners May Balk On Streaming As S&P Changes Tack, Reuters []
  7. Silver Wheaton’s Q1 2014 Earnings Presentation, SEC []