A fine finish

Wheaton Precious Metals 27 March 2018 Update
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Wheaton Precious Metals

A fine finish

Q4 and FY17 results

Metals & mining

27 March 2018

Price

C$25.79

Market cap

C$11,418m

C$1.3071/US$

Net debt* (US$m) at 31 December 2017
*Ex-dividend

671.5

Shares in issue

442.7m

Free float

100%

Code

WPM

Primary exchange

TSX

Secondary exchange

NYSE

Share price performance

%

1m

3m

12m

Abs

5.9

(6.4)

(4.6)

Rel (local)

8.8

(0.6)

(3.3)

52-week high/low

C$29.3

C$23.4

Business description

Wheaton Precious Metals is the world’s pre-eminent pure precious metals streaming company, with c 30 high-quality, precious metals streaming and early deposit agreements relating to assets in Mexico, Peru, Canada, Brazil, Chile, Argentina, Sweden, Greece, Portugal, the US and Guyana.

Next events

First quarterly dividend payment

c 20 April 2018

Q118 results

May 2018

Second quarterly dividend announced

May 2018

Analyst

Charles Gibson

+44 (0)20 3077 5724

Wheaton Precious Metals is a research client of Edison Investment Research Limited

FY17 results were characterised by a record level of gold sales and of dividend payouts to shareholders. Overall, production attributable to Wheaton Precious Metals (WPM) in FY17 was 28.6Moz Ag and 355koz Au cf guidance of 28Moz Ag and 340koz Au and our prior forecast of 28.5Moz Ag and 343koz Au. Results for Q4 were notable for the close correlation of production and sales, demonstrating the traditional ‘flush through’ effect in the final quarter of the year. Financial results were similarly better than our forecasts (see Exhibit 1, overleaf), partly on account of an increase in gold production compared to Q317, but also on account of a material increase in other income. Nevertheless, excluding this item, Q4 net earnings still exceeded our forecasts by 3.6%.

Year end

Revenue (US$m)

PBT*
(US$m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

12/16

891.6

269.8

62

21

31.8

1.1

12/17

843.2

277.4

63

33

31.3

1.7

12/18e

841.3

279.4

63

37

31.2

1.9

12/19e

952.3

402.1

91

42

21.7

2.1

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles and exceptional items.

Corporate development entering next phase

As at 31 December 2017, WPM had net debt of US$671.5m, which equated to financial gearing (net debt/equity) of 13.7% and leverage (net debt/[net debt+equity]) of 12.1%. All other things being equal, we estimate that WPM’s net debt position will have declined organically, to US$351.8m by the end of FY18 and that it will be net debt free in H219/H120. As a result, WPM reports that it is busy from a corporate development perspective, with at least six potential deals that could close within the next 12 months and US$2-3bn of deals that could close within 12-24 months, approximately evenly split between ‘development and expansion’ projects and corporate ‘balance sheet repair’.

Valuation: Investors in line for 40.1% IRR over 2.75yrs

Guidance for FY18 is for production of 22.5Moz Ag and 355koz Au – the variance cf FY17 primarily arising from the expiry of the Primero stream over San Dimas to be replaced by the First Majestic stream. Assuming no material purchases of additional streams (which is unlikely), we forecast a per share value for WPM of US$35.13, or C$45.93 in FY20 (at average precious metals prices of US$25.95/oz Ag and US$1,482/oz Au), implying a 40.1% pa total internal rate of return (IRR) for investors in US dollar terms over the next 2.75 years. These valuations rise by 10.5% to US$38.82, C$50.74 and 44.8% in the event that Vale decides to increase Salobo’s processing capacity by 50% to 36Mpa. In the meantime, WPM’s shares are trading on near-term financial ratios that are lower than those of its royalty/streaming ‘peers’ on at least 95% of financial measures considered in Exhibit 9, and the miners themselves in at least 36% of the same measures, despite being associated with materially less operating and cost risk. Additional potential upside still then exists in the form of the optionality provided by the development of major assets such as Pascua-Lama etc.

Q4 and FY17 in perspective

Overall, production attributable to WPM during FY17 was 28.6Moz Ag and 355koz Au, compared with guidance of 28Moz Ag and 340koz Au and our most recent forecast of 28.5Moz Ag and 343koz Au. Results for Q4 were notable for the close correlation of production and sales, demonstrating the traditional ‘flush through’ effect in the final quarter of the year. From a financial perspective, results were better than our prior expectations for both Q417 and FY17, partly on account of an increase in gold production compared to the prior quarter, but also on account of a material increase in other income, which largely reflected fees from contract amendments and reconciliations. Excluding this item, Q4 net earnings would otherwise have been US$80.9m (assuming no taxation effect) cf our prior forecast of US$78.1m – a 3.6% positive variance. A summary of WPM’s Q4 results, as calculated by Edison, relative to both Q3 and our prior expectations is as follows:

Exhibit 1: Wheaton Precious Metals FY17 forecast, by quarter*

US$000s
(unless otherwise stated)

Q117

Q217

Q317

Q417e

Q417

Chg**
(%)

Diff***
(%)

FY17e

FY17

Diff****
(%)

Silver production (koz)

6,513

7,192

7,595

7,156

7,211

-5.1

0.8

28,456

28,646

0.7

Gold production (oz)

84,863

78,127

95,897

83,765

96,474

0.6

15.2

342,652

355,104

3.6

AgE production (koz)

12,454

12,898

14,874

13,549

14,572

-2.0

7.6

53,793

54,841

1.9

Silver sales (koz)

5,225

6,369

5,758

7,156

7,292

26.6

1.9

24,508

24,644

0.6

Gold sales (oz)

88,397

71,965

82,548

83,765

94,295

14.2

12.6

326,675

337,205

3.2

AgE sales (koz)

11,412

11,625

12,024

13,549

14,488

20.5

6.9

48,619

49,519

1.9

Avg realised Ag price (US$/oz)

17.45

17.09

16.87

16.72

16.75

-0.7

0.2

17.00

17.01

0.1

Avg realised Au price (US$/oz)

1,208

1,263

1,283

1,276

1,277

-0.5

0.1

1,256

1,257

0.1

Avg realised AgE price (US$/oz)

17.35

17.18

16.89

16.72

16.74

-0.9

0.1

17.01

17.03

0.1

Avg Ag cash cost (US$/oz)

4.54

4.51

4.43

4.51

4.48

1.1

-0.7

4.50

4.49

-0.2

Avg Au cash cost (US$/oz)

391

393

396

395

399

0.8

1.0

394

395

0.3

Avg AgE cash cost (US$/oz)

5.11

4.90

4.84

4.82

4.85

0.2

0.6

4.91

4.92

0.2

 

 

 

Sales

197,951

199,684

203,034

226,540

242,547

19.5

7.1

827,209

843,215

1.9

Cost of sales

 

 

 

Cost of sales, excluding depletion

58,291

56,981

58,234

65,365

70,295

20.7

7.5

238,871

243,801

2.1

Depletion

63,943

59,772

61,852

68,924

76,813

24.2

11.4

254,491

262,380

3.1

Total cost of sales

122,234

116,753

120,086

134,289

147,108

22.5

9.5

493,362

506,181

2.6

Earnings from operations

75,717

82,931

82,948

92,251

95,439

15.1

3.5

333,846

337,034

1.0

Expenses and other income

 

 

 

- General and administrative*****

7,898

9,069

8,793

8,500

8,913

1.4

4.9

34,260

34,673

1.2

- Foreign exchange (gain)/loss

41

163

0

66

-59.5

N/A

204

270

32.4

- Net interest paid/(received)

6,373

6,482

6,360

5,686

5,778

-9.2

1.6

24,901

24,993

0.4

- Other (income)/expense

94

283

1,317

0

(10,093)

-866.4

N/A

1,694

(8,399)

-595.8

Total expenses and other income

14,365

15,875

16,633

14,186

4,664

-72.0

-67.1

61,059

51,537

-15.6

Earnings before income taxes

61,352

67,056

66,315

78,065

90,775

36.9

16.3

272,788

285,497

4.7

Income tax expense/(recovery)

128

(556)

(263)

0

(195)

-25.9

N/A

(691)

-886

28.2

Marginal tax rate (%)

0.2

(0.8)

(0.4)

0.0

(0.2)

-50.0

N/A

(0.3)

-0.3

0.0

Net earnings

61,224

67,612

66,578

78,065

90,970

36.6

16.5

273,479

286,383

4.7

Avg no. shares in issue (000s)

441,484

441,784

442,094

442,094

442,469

0.1

0.1

441,864

441,961

0.0

Basic EPS (US$)

0.14

0.15

0.15

0.18

0.21

40.0

16.7

0.62

0.65

4.8

Diluted EPS (US$)

0.14

0.15

0.15

0.18

0.21

40.0

16.7

0.62

0.65

4.8

Source: Wheaton Precious Metals, Edison Investment Research. Note: *As reported, excluding impairments; **Q417 vs Q317; ***Q417 actual vs Q417 estimate; ****FY17 actual vs FY17 estimate; *****Quarterly forecasts exclude stock-based compensation costs.

From an operational perspective, key features of the quarter were strong production performances at Salobo and Penasquito, which both performed above our expectations, and positive sales performances from Penasquito and Sudbury. Combined, these more than offset a slightly less dynamic performance at WPM’s ‘other’ gold assets, reflecting, in particular, reduced production at Minto owing to lower grades on account of mine sequencing as part of an extended mine plan.

The Salobo plant continued to operate above nameplate capacity for a second consecutive quarter (largely on account of management initiatives, rather than ore characteristics), which resulted in the record quarterly production of copper concentrate and acted to mitigate otherwise lower grades and recovery.

At Penasquito, by contrast, higher grades and recoveries were complemented by increased throughput as a result of the implementation of a new management operating system and the better delivery of ore to the primary crusher.

Constancia was similarly affected by lower grade ore (as expected), albeit partially offset by higher throughput and recovery.

Finally, extended unscheduled maintenance at the Coleman mine resulted in lower throughput at Sudbury, partially offset by higher grades and recovery.

In the longer term, the Pyrite Leach Project at Penasquito (which will add c 1Moz gold and 44Moz silver over the current life of the mine, by recovering 40% Au and 48% Ag currently reporting to the tailings) is reported to be 62% complete (vs 40% at the end of Q317) and is expected to commence commissioning three months ahead of schedule, in Q418.

Pascua-Lama impairment

On 18 January, Barrick (the operator of Pascua-Lama) reported that it had received a revised resolution from Chile’s environmental regulator, SMA, requiring it to close its existing infrastructure on the Chilean side of the border. Barrick went on to say that the revised resolution does not affect its ongoing evaluation of an underground, block-caving operation at the mine, which would anyway require additional permitting and regulatory approvals in both Chile and Argentina and are unconnected to SMA’s decision. Nevertheless, in the light of the order to close surface facilities, Barrick has reclassified Pascua-Lama’s proven and probable mineral reserves of c 14Moz Au (based on an open-pit plan) as measured and indicated resources instead. As a result, WPM has similarly reclassified 151.7Moz of proven and probable silver reserves as measured and indicated resources, which it has interpreted as an ‘indicator of impairment’ in the sum of US$229m (from US$485m to US$256m).

Note that if the requirements of the Pascua-Lama completion test have not been satisfied by the deadline of 30 June 2020, WPM has the right to terminate its Pascua-Lama silver purchase agreement with Barrick, in which case it would be entitled to the return of its upfront cash payment of US$625m less cashflows received relative to the Lagunas Norte, Veladero and Pierina mines in the meantime – a figure that would have been US$261m as at 31 December 2017 (WPM figure) and we estimate is likely to be in the order of US$255m in 2020.

FY18 outlook

WPM has provided the market with production guidance of 22.5Moz of silver and 355,000oz of gold for FY18. Our updated FY18 production forecasts vary slightly compared to WPM’s, as follows:

Exhibit 2: WPM FY18 production guidance

Asset

WPM estimated output

(koz)

Edison estimated output

(koz)

Prior Edison forecast

(koz)

Comment

Silver

Penasquito

6,500

6,279

vs 6,024koz in FY17.

San Dimas

1,000

1,000

Assumes First Majestic (FR) deal closes end-Q118.

Antamina

5,300

5,120

vs 6,554koz in FY17.

Constancia

2,800

2,705

vs 2,374koz in FY17; mining Pampacancha from H218.

Other

6,900

7,415

Cessation of Cozamin agreement in April 2017; Barrick stream expiry end-Q118.

Total

22,500

22,519

22,528

Gold

Salobo

240

234

Slight moderation from record Q417 with grade profile.

Sudbury

33

33

After impairment announced in Q417.

San Dimas

30

32

Three quarters of gold production after FR deal closes.

Constancia

17

17

vs 10koz in FY17; gold production on upward profile.

Other

35

39

vs 47koz in FY17. Lower Minto grades; reduced 777 interest.

Total

355

355

313

Source: Wheaton Precious Metals, Edison Investment Research. Note: Totals may not add up owing to rounding.

San Dimas

On 12 January, First Majestic (FR, C$8.65) announced that it is to buy Primero Mining (the operator of the San Dimas mine in Mexico, over which WPM holds a silver purchase agreement). As a part of the terms of the (friendly) takeover, WPM has agreed to terminate the existing silver purchase agreement (SPA) and to then enter into a precious metals purchase agreement (PMPA) with the new operator on the following terms, including:

25% of gold production plus an additional amount of gold equal to 25% of silver production converted into to gold at a fixed gold:silver ratio of 70:1 (subject to certain adjustments which could render it 50:1 or 90:1 depending on market conditions) from San Dimas cf 6.0Moz plus 50% of any excess previously (to all intents and purposes 100% of silver production in recent quarters).

For each ounce of gold delivered, WPM will pay a production payment equal to the lesser of US$600/oz, subject to a 1% annual inflationary adjustment and the prevailing market price cf US$4.32/oz Ag in Q317 similarly subject to a 1% annual inflationary adjustment.

First Majestic will provide a corporate guarantee over the PMPA; security for such will be limited to the San Dimas assets (similar to the guarantee over its SPA with Primero).

To the extent that ore from certain areas outside the current area of interest is processed through the San Dimas mill, such ore will be subject to the stream.

WPM has the right of first refusal on certain areas outside the current area of interest.

Under the First Majestic PMPA, San Dimas is expected to contribute, on average, approximately 40-50koz of gold production (equivalent to 2.80-3.15Moz Ag at an Au:Ag ratio of 70:1) annually to WPM over the next five years (company estimate). In addition to the new stream, First Majestic will also issue to WPM 20.9m FR common shares with an aggregate value at the time of the announcement of US$151m (US$168m at the time of writing).

The termination of the existing SPA and the effectiveness of the First Majestic PMPA remain subject to a number of conditions, including completion of the arrangement. In addition, at the time of closing, WPM has agreed to release the guarantee previously provided by Goldcorp under the existing SPA in consideration of a payment of US$10m from the latter. It will also extinguish the US$0.50/oz penalty for each ounce less than 215Moz delivered by 2031.

Primero has indicated that closing of the transaction is anticipated before the end of April. Note that, for the purposes of the analysis below, we have assumed that it will complete on 31 March and that Q118 of WPM’s financial year will therefore be governed by the existing SPA and that the new PMPA will then become effective thereafter.

General and administrative expenses

WPM is forecasting non-stock general and administrative expenses in the range of US$34-36m for the full year, ie c US$8.5-9.0m per quarter, including all employee-related expenses, charitable contributions and additional legal costs relating to WPM’s dispute with the Canadian Revenue Agency. Investors should note that our financial forecasts in Exhibits 6 and 10 exclude stock-based compensation costs.

Ounces produced but not yet delivered – aka inventory

Compared to an erstwhile 11.0% average historical under-sale of silver relative to production and a 9.5% historical under-sale of gold, production and sales of both silver and gold were closely aligned in Q417, demonstrating, among other things, the traditional ‘flush through’ effect in the final quarter. Note that this compares to under-sales of silver and gold of 24.2% and 13.9%, respectively, in Q317.

Exhibit 3: Over/(under) sale of silver and gold as a % of production, Q112-Q417

Source: Edison Investment Research, WPM

As at 31 December, payable ounces attributable to WPM produced but not yet delivered amounted to 4.5Moz silver and 79,500oz gold (cf 5.3Moz silver and 57,200oz gold reported in September). This ‘inventory’ equates to 1.89 months and 2.68 months of FY17 silver and gold production, respectively (cf 2.23 months and 2.00 months in Q317), or 2.31 months on a silver equivalent basis (cf 2.15 months as at end-September) and compares with WPM’s target level of two months of annualised production for silver and two to three months for gold.

Exhibit 4: WPM oz produced but not yet delivered, Q316-Q417 (months of production)

Source: Edison Investment Research, Wheaton Precious Metals

Note that, for these purposes, the use of the term ‘inventory’ reflects ounces produced by WPM’s operating counterparties at the mines over which it has streaming agreements, but which have not yet been delivered to WPM. It in no way reflects the other use of the term in the mining industry itself, where it is typically refers to metal in circuit (among other things), and may therefore (under certain circumstances) be considered to be a consequence of metallurgical recoveries in the plant.

Solid medium-term outlook

Over the next five years, including FY18, management estimates average annual production of approximately 25Moz of silver and 370,000oz of gold (cf 29Moz of silver and 340,000oz of gold in March 2017 – the difference being substantially accounted for by the First Majestic takeover of Primero and the termination of the existing San Dimas silver purchase agreement in favour of a new precious metals purchase agreement). This compares with our current expectations, which are, on average, 7.2% more conservative than guidance (simple average):

Exhibit 5: Edison forecast WPM precious metals production

FY18e

FY19e

FY20e

FY21e

FY22e

Silver production (Moz)

22.5

22.3

23.0

23.9

23.7

Gold production (koz)

355

362

337

333

339

Source: Edison Investment Research.

In the immediate future, silver output from Penasquito attributable to Wheaton Precious is expected to recover back to its steady-state level of 7Moz as the Chile Colorado pit contributes to mill feed ahead of schedule in CY18 and grades improve once again with mine sequencing. From Q418 onwards, it will also benefit from the development of the Pyrite Leach Project, which will add an additional 1.0-1.5Moz of silver attributable to WPM per year. At the same time, mining at Constancia will start at the Pampacancha pit, which hosts significantly higher gold grades than those mined hitherto. Moreover, should the mining of Pampacancha be delayed, WPM will still be entitled to an increased portion of gold from Hudbay.

Apart from exploration success, however, the other major source of organic production growth for WPM is Salobo (which already accounts for 74-79% of WPM’s gold division’s output). The operator, Vale, is studying expansion scenarios and is deploying four drill rigs to test the deposit at depth. Given the open-ended nature of the deposit and depending on the work that Vale does and the decision that it makes, any expansion could add as much as 100% to gold output attributable to Wheaton Precious from Salobo per year – albeit at the cost of an additional payment from WPM. Mill throughput at the Salobo mine is currently reported to be running in excess of its 24Mtpa nameplate capacity. If throughput capacity is expanded within a predetermined period and depending on the grade of material processed, WPM will be required to make an additional payment to Vale regarding its 75% gold stream. The additional payments range in size from US$113m if throughput is expanded beyond 28Mtpa by 1 January 2036, to US$953m if throughput is expanded beyond 40Mtpa by 1 January 2021.

Potential future stream acquisitions

WPM estimates the size of the potential market open to it to be the 70% of global silver production of c 870Moz in FY17 that is produced as a by-product of either gold or base metals mines (ie approximately 609Moz silver per year). This compares with WPM’s production of 28.6Moz Ag in FY17 – ie WPM estimates that it has penetrated a mere c 5.0% of its potential market.

As a consequence, WPM reports that it is busy on the corporate development front, with at least six potential deals that could close within the next 12 months and US$2-3bn of deals that could close within 12-24 months, approximately equally split between ‘development and expansion’ projects and corporate ‘balance sheet repair’.

While it is difficult, or impossible, to predict potential future stream acquisition targets with any degree of certainty, it is perhaps possible to highlight four that may be of interest to WPM in due course and regarding which it already has strong, existing counterparty relationships:

The 75% of the silver output at Penasquito that is currently not subject to any streaming arrangement.

The platinum group metal (PGM) by-product stream at Sudbury.

The 75% of the silver output at Pascua-Lama that is currently not subject to any streaming arrangement (subject to permitting and development).

The 50% of the gold output at Constancia that is currently not subject to any streaming arrangement.

FY18 by quarter

We have honed our silver price for FY18 to US$16.75/oz in Q1, followed by US$16.50/oz thereafter to reflect recent movements in the spot market. Our gold price forecast remains unchanged at US$1,320/oz over all four quarters.

In the aftermath of these changes, our updated basic EPS forecast for FY18 remains ostensibly unchanged, at US$0.63/sh cf an average consensus estimate (source: Bloomberg) of 61.8c within a range 49-77c (cf a consensus of 64.5c, within a range 49-80c, in February). Broken down by quarter, our estimates are as follows:

Exhibit 6: Wheaton Precious Metals FY18 forecast, by quarter*

US$000s (unless otherwise stated)

Q118e

Q218e

Q318e

Q418e

FY18e

(current)

FY18e

(previous)

Silver production (koz)

6,736

5,261

5,261

5,261

22,519

22,528

Gold production (oz)

80,670

91,295

91,295

91,295

354,555

312,517

AgE production (koz)

13,093

12,565

12,565

12,565

50,787

46,794

Silver sales (koz)

6,736

5,261

5,261

5,261

22,519

22,528

Gold sales (oz)

80,670

91,295

91,295

91,295

354,555

312,517

AgE sales (koz)

13,093

12,565

12,565

12,565

50,787

46,794

Avg realised Ag price (US$/oz)

16.75

16.50

16.50

16.50

16.57

17.00

Avg realised Au price (US$/oz)

1,320

1,320

1,320

1,320

1,320

1,320

Avg realised AgE price (US$/oz)

16.75

16.50

16.50

16.50

16.56

17.00

Avg Ag cash cost (US$/oz)

4.62

4.58

4.58

4.58

4.59

4.54

Avg Au cash cost (US$/oz)

396

420

420

420

414

416

Avg AgE cash cost (US$/oz)

4.82

4.97

4.97

4.97

4.93

4.96

Sales

219,314

207,317

207,317

207,317

841,266

795,500

Cost of sales

Cost of sales, excluding depletion

63,077

62,407

62,407

62,407

250,299

232,283

Depletion

66,575

64,778

64,778

64,778

260,910

235,556

Total cost of sales

129,651

127,186

127,186

127,186

511,209

467,840

Earnings from operations

89,662

80,131

80,131

80,131

330,056

327,660

Expenses and other income

- General and administrative**

8,750

8,750

8,750

8,750

35,000

34,000

- Foreign exchange (gain)/loss

0

0

- Net interest paid/(received)

3,911

3,911

3,911

3,911

15,645

16,079

- Other (income)/expense

0

0

Total expenses and other income

12,661

12,661

12,661

12,661

50,645

50,079

Earnings before income taxes

77,001

67,470

67,470

67,470

279,411

277,581

Income tax expense/(recovery)

0

0

Marginal tax rate (%)

0.0

0.0

0.0

0.0

0.0

0.0

Net earnings

77,001

67,470

67,470

67,470

279,411

277,581

Ave. no. shares in issue (000s)

442,469

442,469

442,469

442,469

442,469

442,094

Basic EPS (US$)

0.17

0.15

0.15

0.15

0.63

0.63

Diluted EPS (US$)

0.17

0.15

0.15

0.15

0.63

0.63

DPS (US$)

0.09

0.10

0.09

0.09

0.37

0.37

Source: WPM, Edison Investment Research. Note: *Excluding impairments. **Forecasts exclude stock-based compensation costs. Totals may not add up owing to rounding.

Note that, as a result of the conversion of the San Dimas stream from a silver one to (effectively) a gold one, we expect WPM to become a majority gold streaming company from 31 March onwards on an annual basis (albeit there will inevitably be some quarterly fluctuations depending upon the balance of production, sales etc).

In the meantime, our FY19 EPS forecast was made on the basis of assumed precious metals prices of US$22.21/oz Ag and US$1,263/oz Au (see our report, Mining overview, Unlocking the price to NPV discount, published in November 2017) – as much to demonstrate WPM’s operational gearing to a normalisation of the gold:silver ratio from its current, unprecedented, level of over 80x:

Exhibit 7: Gold price as a multiple of silver price, 1792-2017

Source: Edison Investment Research (underlying data South African Chamber of Mines, Bloomberg and www.kitco.com)

Miscellaneous

Kutcho

WPM has an early deposit agreement with the Kutcho Copper Corporation (formerly Desert Star, market cap C$23.9m) whereby it will advance to it US$65m in instalments (upon achieving a predetermined set of milestones) in return for the right to purchase 100% of the silver and gold production from the Kutcho project in British Columbia at 20% of the spot price of the metals over the life of the mine. In the meantime, on 14 December, WPM acquired 6,153,846 shares and half warrants in Kutcho for a total consideration of C$4m (US$3m) to give it a 12.88% equity stake in the company. Additionally, it advanced Kutcho US$16m (C$20m) in exchange for a subordinated secured convertible term debt loan agreement receivable, bearing interest at a rate of 10% per annum.

Minto

As of 2 February 2018, Minto’s operator, Capstone, has agreed to sell the mine to Pembridge Resources (a UK-listed company run by David Linsley, formerly of Behre Dolbear). According to Capstone’s Q417 management discussion and analysis, at the start of 2017, it was its intention to place Minto on ‘care and maintenance’ at the end of the year. On account of the rising copper price however, it reconsidered its position and instead decided to continue operations until at least mid-2021 (cf our expectation of 2022).

Valuation and sensitivities

Excluding FY04 (part year), WPM’s shares have historically traded on a contemporary average P/E multiple of 27.6x current year basic underlying EPS, ie excluding impairments (cf 31.2x Edison or 31.8x consensus FY18e, currently – see Exhibit 9).

Exhibit 8: WPM’s historic current year P/E multiples

Source: Edison Investment Research.

Applying this multiple to our EPS forecast of US$1.28 in FY20 (cf US$1.40 previously as a result of the presumed deferment of production from Rosemont until after FY20) implies a potential share value for WPM shares of US$35.13, or C$45.93 (cf US$37.90, or C$47.18 previously) in that year (excluding the US$0.38/share value of its equity interest in First Majestic).

In the meantime, from a relative perspective, it is notable that WPM is cheaper than its royalty/streaming ‘peers’ in at least 95% (23 out of 24) of the valuation measures used in Exhibit 9 and on multiples that are cheaper than the miners themselves in at least 36% (33 out of 90) of the same valuation measures, despite being associated with materially less operational and cost risk (as WPM’s costs over time are contracturally predetermined)

Exhibit 9: WPM comparative valuation vs a sample of operating and royalty/streaming companies

P/E (x)

Yield (%)

P/CF (x)

Year 1

Year 2

Year 1

Year 2

Year 1

Year 2

Royalty companies

Franco-Nevada

60.6

52.7

1.4

1.4

25.6

22.8

Royal Gold

49.1

39.2

1.2

1.2

19.4

17.1

Sandstorm Gold

72.0

46.5

0.0

0.0

17.2

13.7

Osisko

68.0

37.4

1.4

1.6

23.3

16.9

Average

62.4

43.9

1.0

1.1

21.4

17.6

Wheaton Precious (Edison forecasts)

31.2

21.7

1.9

2.1

15.8

13.5

WPM (consensus)

31.8

27.2

1.7

2.1

15.5

14.3

Gold producers

Barrick

15.4

16.2

0.9

0.9

5.3

5.6

Newmont

26.2

23.2

1.5

1.4

9.0

8.8

Goldcorp

29.4

19.9

0.6

0.6

8.2

6.6

Newcrest

37.5

16.5

1.1

1.7

11.3

8.0

Kinross

23.9

24.7

0.0

3.4

4.5

4.4

Agnico-Eagle

61.4

41.5

1.1

1.1

12.6

11.2

Eldorado

38.0

14.8

0.6

0.8

9.4

5.8

Yamana

26.8

14.7

0.8

0.8

4.4

3.7

Randgold Resources

22.7

21.4

4.1

4.4

12.7

12.2

Average

31.3

21.4

1.2

1.7

8.6

7.4

Silver producers

Hecla

151.4

26.0

0.2

0.2

9.4

6.3

Pan American

19.8

19.2

0.8

1.0

9.2

8.6

Coeur Mining

N/A

21.3

0.0

0.0

11.3

6.1

First Majestic

112.5

36.1

0.0

0.0

10.8

7.3

Hocschild

32.5

18.4

1.2

1.7

5.7

5.0

Fresnillo

23.9

21.3

2.1

2.3

14.1

12.9

Average

68.0

23.7

0.7

0.9

10.1

7.7

Source: Bloomberg, Edison Investment Research. Note: Peers priced on 20 March 2018.

Sensitivities

Currently, we make no provision for either future expansion at Salobo or related expansion payments in our long-term forecasts. However, in the event that Salobo were to be expanded from 24Mtpa to 36Mtpa by the addition of a further 12Mtpa processing line by 1 January 2023 – thereby attracting an estimated c US$603m incremental payment from WPM to Vale – we estimate that it would increase our estimate of WPM’s earnings by a material c US$0.11 (or 15.0%) per share from the date of successful expansion. This, in turn, would increase our forecast value per share for the company to US$38.82, or C$50.74 at prevailing FX rates (excluding the US$0.38/share value of its equity interest in First Majestic), implying an internal rate of return to investors buying WPM shares currently at C$25.79, equivalent to 44.8% pa in US dollar terms.

Financials – solid equity base

As at 31 December 2017, WPM had US$98.5m in cash (ex-dividend) and US$770.0m of debt outstanding under its US$2bn revolving credit facility (which attracts an interest rate of Libor plus 120-220bp and matures in February 2022), such that it had net debt of US$671.5m overall, after US$165.1m (US$0.37/share) of cash inflows from operating activities during the quarter. Relative to the company’s equity, this level of net debt equated to a financial gearing (net debt/equity) ratio of 13.7% and a leverage (net debt/[net debt+equity]) ratio of 12.1%. It also compares with a net debt position of US$784.1m as at 30 September and US$1,068.7m as at the end of December 2016, and is consistent with WPM continuing to sustainably generate c US$100-150m per quarter from operating activities before financing and investing activities. Otherwise, assuming the operational performance set out in Exhibit 6, we estimate that WPM’s net debt position will have declined organically, to US$351.8m by the end of FY18 (equating to gearing of 7.0% and leverage of 6.6%), and that WPM will be net debt free early in FY20 (or in H219 if WPM’s First Majestic shares are treated as cash), all other things being equal and contingent on its making no further major acquisitions (which is unlikely). Self-evidently, such a level of debt is well within the tolerances required by its banking covenants that:

net debt should be no more than 0.75x tangible net worth (which was US$4,8997m as at end-December 2017); and

interest should be no less than 3x covered by EBITDA (we estimate that net interest was covered 22.7x in FY17).

Note that the C$191.7m letter of guarantee that WPM has posted re 50% of the disputed taxes relating to its dispute with the CRA (see below) has been determined under a separate agreement and is therefore specifically excluded from calculations regarding WPM’s banking covenants.

Canadian Revenue Agency

There have been no further substantive developments regarding WPM’s dispute with the Canadian Revenue Agency (CRA) since our update note of 15 February 2016.

WPM notes that the CRA’s position is that the transfer pricing provisions of the Income Tax Act (Canada) in relation to income earned by WPM’s foreign subsidiaries should apply “such that the income of Silver Wheaton [sic] subject to tax in Canada should be increased by an amount equal to substantially all of the income earned outside of Canada by the company’s foreign subsidiaries for the 2005-2010 taxation years”. Should this interpretation be upheld, we would expect it to have potentially profound consequences for Canada’s status as a supplier of finance and capital to overseas destinations in general (ie not just for the mining industry).

In 2017, WPM’s CEO, Randy Smallwood, was quoted as saying that the company is willing to settle its tax dispute with the CRA via a payment of C$5-10m “with gritted teeth”, but still believes no payment should be required. As such, the C$5-10m quoted should not be interpreted as an admission of guilt, but rather an appreciation of the costs involved in going to a full trial and also of the effect that the issue is having on WPM’s share price rating relative to its peers (see Exhibit 9).

In the meantime, WPM is now nearing the end of the case ‘discovery process’ with the CRA, designed to provide both sides with the opportunity to arrive at an out-of-court settlement before formal proceedings commence. If a ‘principled’ settlement cannot be reached, however, the company has stated that it is willing to go to trial, which would be likely to be towards the middle of this year.


Exhibit 10: Financial summary

US$'000s

2012

2013

2014

2015

2016

2017

2018e

2019e

Dec

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

849,560

706,472

620,176

648,687

891,557

843,215

841,266

952,338

Cost of Sales

(117,489)

(139,352)

(151,097)

(190,214)

(254,434)

(243,801)

(250,299)

(264,230)

Gross Profit

732,071

567,120

469,079

458,473

637,123

599,414

590,967

688,108

EBITDA

 

 

701,232

531,812

431,219

426,236

602,684

564,741

555,967

653,108

Operating Profit (before amort. and except.)

600,003

387,659

271,039

227,655

293,982

302,361

295,056

410,320

Intangible Amortisation

0

0

0

0

0

0

0

0

Exceptionals

0

0

(68,151)

(384,922)

(71,000)

(228,680)

0

0

Other

788

(11,202)

(1,830)

(4,076)

(4,982)

8,129

0

0

Operating Profit

600,791

376,457

201,058

(161,343)

218,000

81,810

295,056

410,320

Net Interest

0

(6,083)

(2,277)

(4,090)

(24,193)

(24,993)

(15,645)

(8,196)

Profit Before Tax (norm)

 

 

600,003

381,576

268,762

223,565

269,789

277,368

279,411

402,124

Profit Before Tax (FRS 3)

 

 

600,791

370,374

198,781

(165,433)

193,807

56,817

279,411

402,124

Tax

(14,755)

5,121

1,045

3,391

1,330

886

0

0

Profit After Tax (norm)

586,036

375,495

267,977

222,880

266,137

286,383

279,411

402,124

Profit After Tax (FRS 3)

586,036

375,495

199,826

(162,042)

195,137

57,703

279,411

402,124

Average Number of Shares Outstanding (m)

353.9

355.6

359.4

395.8

430.5

442.0

442.5

442.5

EPS - normalised (c)

 

 

166

106

75

53

62

63

63

91

EPS - normalised and fully diluted (c)

 

165

105

74

53

62

63

63

91

EPS - (IFRS) (c)

 

 

166

106

56

(-41)

45

13

63

91

Dividend per share (c)

35

45

26

20

21

33

37

42

Gross Margin (%)

86.2

80.3

75.6

70.7

71.5

71.1

70.2

72.3

EBITDA Margin (%)

82.5

75.3

69.5

65.7

67.6

67.0

66.1

68.6

Operating Margin (before GW and except.) (%)

70.6

54.9

43.7

35.1

33.0

35.9

35.1

43.1

BALANCE SHEET

Fixed Assets

 

 

2,403,958

4,288,557

4,309,270

5,526,335

6,025,227

5,579,898

5,390,988

5,220,200

Intangible Assets

2,281,234

4,242,086

4,270,971

5,494,244

5,948,443

5,454,106

5,265,196

5,094,408

Tangible Assets

1,347

5,670

5,427

12,315

12,163

30,060

30,060

30,060

Investments

121,377

40,801

32,872

19,776

64,621

95,732

95,732

95,732

Current Assets

 

 

785,379

101,287

338,493

105,876

128,092

103,415

422,061

809,498

Stocks

966

845

26,263

1,455

1,481

1,700

1,510

1,710

Debtors

6,197

4,619

4,132

1,124

2,316

3,194

2,305

2,609

Cash

778,216

95,823

308,098

103,297

124,295

98,521

418,246

805,180

Other

0

0

0

0

0

0

0

0

Current Liabilities

 

 

(49,458)

(21,134)

(16,171)

(12,568)

(19,057)

(12,143)

(24,712)

(26,086)

Creditors

(20,898)

(21,134)

(16,171)

(12,568)

(19,057)

(12,143)

(24,712)

(26,086)

Short term borrowings

(28,560)

0

0

0

0

0

0

0

Long Term Liabilities

 

 

(32,805)

(1,002,164)

(1,002,856)

(1,468,908)

(1,194,274)

(771,506)

(771,506)

(771,506)

Long term borrowings

(21,500)

(998,136)

(998,518)

(1,466,000)

(1,193,000)

(770,000)

(770,000)

(770,000)

Other long term liabilities

(11,305)

(4,028)

(4,338)

(2,908)

(1,274)

(1,506)

(1,506)

(1,506)

Net Assets

 

 

3,107,074

3,366,546

3,628,736

4,150,735

4,939,988

4,899,664

5,016,831

5,232,106

CASH FLOW

Operating Cash Flow

 

 

720,209

540,597

434,582

435,783

608,503

564,187

569,614

653,978

Net Interest

0

(6,083)

(2,277)

(4,090)

(24,193)

(24,993)

(15,645)

(8,196)

Tax

(725)

(154)

(204)

(208)

28

(326)

0

0

Capex

(641,976)

(2,050,681)

(146,249)

(1,791,275)

(805,472)

(19,633)

(72,000)

(72,000)

Acquisitions/disposals

0

0

0

0

0

0

0

0

Financing

12,919

58,004

6,819

761,824

595,140

1,236

0

0

Dividends

(123,852)

(160,013)

(79,775)

(68,593)

(78,708)

(121,934)

(162,244)

(186,849)

Net Cash Flow

(33,425)

(1,618,330)

212,896

(666,559)

295,298

398,537

319,725

386,934

Opening net debt/(cash)

 

 

(761,581)

(728,156)

902,313

690,420

1,362,703

1,068,705

671,479

351,754

HP finance leases initiated

0

0

0

0

0

0

0

0

Other

0

(12,139)

(1,003)

(5,724)

(1,300)

(1,311)

0

0

Closing net debt/(cash)

 

 

(728,156)

902,313

690,420

1,362,703

1,068,705

671,479

351,754

(35,180)

Source: Company sources, Edison Investment Research


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