Q3 results and Antamina stream purchase

Silver Wheaton 11 November 2015 Update

Silver Wheaton

Q3 results and Antamina stream purchase

Q3 results

Metals & mining

 

11 November 2015

Price

C$16.53

Market cap

C$6.7bn

C$1.3284/US$

Net debt (US$m) at end-Sept 2015

566.5

Shares in issue

403.4m

Free float

100%

Code

SLW

Primary exchange

TSX

Secondary exchange

NYSE

Share price performance

%

1m

3m

12m

Abs

(11.5)

(5.0)

(19.0)

Rel (local)

(7.9)

2.5

(11.2)

52-week high/low

C$29.8

C$14.8

Business description

Silver Wheaton (SLW) is the world’s pre-eminent pure precious metals streaming company with 24 precious metals streaming agreements relating to assets in Mexico, Peru, Canada, Brazil, Chile, Argentina, Sweden, Greece, Portugal, the US and Guyana.

Next events

Q4 results

March 2016

First quarterly dividend payment

March 2016

Analyst

Charles Gibson

+44 (0)20 3077 5724

Excluding a US$154.0m impairment charge relating to its 777-mine gold stream beyond 2020 (which was in any case omitted from our long-term forecasts), Silver Wheaton’s (SLW) Q315 results were closely in line with our expectations. PBT was 3.5% higher than our forecast; PAT was 2.6% lower due to a higher than expected tax charge. More significantly, SLW has acquired a new silver stream from the world-class Antamina copper mine in Peru that has caused us to increase both our earnings forecasts and valuation.

Year end

Revenue (US$m)

PBT* (US$m)

EPS* (c)

DPS (c)

P/E (x)

Yield (%)

12/13

706.5

381.6

106

45

11.7

3.6

12/14

620.2

268.8

75

26

16.6

2.1

12/15e

644.3

223.6

54

20

23.0

1.6

12/16e

886.6

314.1

78

30

16.0

2.4

Note: *PBT and EPS are normalised, excluding intangible amortisation and exceptional items.

Operations

Operationally, SLW posted both production and sales records in Q315, driven by production records at Salobo and Penasquito and a sales record at San Dimas. Sales at San Dimas in particular reversed the build-up of inventory in Q215, but were largely offset by under-sales at Yauliyacu and elsewhere. Gold production was lower at Sudbury (owing to planned maintenance), but higher than expected at both Constancia and Minto. The ramp-up of production at Salobo was weaker than expected in July and August, which resulted in an under-sale of gold during the quarter and consequently only a 1.6% decrease in payable ounces produced but not yet delivered overall, to 6.3Moz AgE.

Antamina stream acquisition

In addition to its Q315 results, Silver Wheaton also announced its acquisition of 100% of the silver attributable to Glencore from its 33.75% interest in the Antamina copper mine in Peru. SLW paid US$900m for the stream and will pay 20% of the spot price per silver ounce delivered. Production attributable to Silver Wheaton is forecast to be 1.0-1.5Moz Ag in Q415, followed by 5.1Moz per year for both FY16 and FY17 and 4.7Moz thereafter for a further 20 years (see page 3).

Valuation: 42.5% internal rate of return in US dollars

As a result of our long-term earnings upgrades on account of the Antamina stream acquisition (and contingent on SLW’s success against the CRA), we forecast a value per share of US$46.36, or C$61.59, in FY19 (vs US$41.43 or C$53.59 previously), representing a total internal rate of return to investors at the current share price of 42.5% in US dollar terms over five years (vs 38.2% previously). In the meantime, SLW trades on near-term financial ratios that are cheaper than its royalty/streaming ‘peers’ in 71% of instances considered (see Exhibit 3) and are cheaper than the miners themselves in c 46% of instances, despite being associated with materially less operational and cost risk, in particular.

Quarterly results and forecasts

Record attributable production was recorded at both Salobo and Penasquito and record sales at San Dimas (reversing the inventory build-up in Q215), although this was ostensibly offset by under-sales at Salobo, Yauliyacu and SLW’s ‘other’ silver assets, such that there was only a 1.6% decrease in payable silver equivalent ounces produced but not yet delivered, to 6.3Moz AgE, overall. Elsewhere, gold production was lower at Sudbury (owing to planned maintenance shutdowns), but higher than expected at both Constancia and Minto. A summary of Silver Wheaton’s underlying Q315 results and how they compared to both Q215 and our prior operating and financial forecasts is given in the table below. Note that Q415 forecasts now include the Antamina stream (see below).

Exhibit 1: Silver Wheaton FY15e forecasts, by quarter**

US$000s (unless otherwise stated)

FY14**

Q115

Q215

Q315e

Q315a

Q315 vs Q215 (%)

Q315a vs Q315e (%)

Q415e (previous)

Q415e (current)

FY15e (current)

Silver production (koz)

25,674

6,342

7,201

7,212

6,890

-4.3

-4.5

7,065

8,448

28,881

Gold production (oz)

142,815

55,106

50,509

54,070

54,513

7.9

0.8

63,381

63,381

223,509

AgE production (koz)

35,285

10,371

10,904

11,290

10,993

0.8

-2.6

11,737

13,188

45,341

 

 

 

 

Silver sales (koz)

23,484

5,665

5,575

7,212

6,575

17.9

-8.8

7,065

8,448

26,263

Gold sales (oz)

139,522

28,399

60,974

54,070

48,077

-21.2

-11.1

63,381

63,381

200,831

AgE sales (koz)

32,891

7,723

10,043

11,290

10,194

1.5

-9.7

11,737

13,188

41,087

 

 

 

 

Avg realised Ag price (US$/oz)

18.92

16.95

16.42

14.90

15.05

-8.3

1.0

15.82

14.87

15.69

Avg realised Au price (US$/oz)

1,261

1,214

1,195

1,124

1,130

-5.4

0.5

1,166

1,112

1,156

Avg realised AgE price (US$/oz)

18.86

16.90

16.38

14.90

15.03

-8.2

0.9

15.82

14.87

15.68

 

 

 

 

Avg Ag cash cost (US$/oz)

4.14

4.14

4.26

4.55

4.26

0.0

-6.4

4.57

4.70

4.38

Avg Au cash cost (US$/oz)

386

388

395

395

389

-1.5

-1.5

392

390

391

Avg AgE cash cost (US$/oz)

4.59

4.46

4.76

4.80

4.58

-3.8

-4.6

4.87

4.88

4.71

 

Sales

620,176

130,504

164,435

168,228

153,251

-6.8

-8.9

185,673

196,108

644,298

Cost of sales

 

 

 

Cost of sales, excluding depletion

151,097

34,464

47,795

54,157

46,708

-2.3

-13.8

57,110

64,415

193,382

Depletion

160,180

32,045

53,327

54,388

45,248

-15.1

-16.8

58,056

63,805

194,424

Total cost of sales

311,277

66,509

101,122

108,545

91,956

-9.1

-15.3

115,166

128,220

387,807

Earnings from operations

308,899

63,995

63,313

59,683

61,295

-3.2

2.7

70,507

67,888

256,492

Expenses and other income

 

 

 

- General and administrative*

37,860

8,170

7,886

6,486

7,170***

-9.1

10.5

6,486

6,486

29,712

- Foreign exchange (gain)/loss

(609)

(373)

0

 

 

(373)

- Net interest paid/(received)

2,277

1,500

798

888

428

-46.4

-51.8

888

428

3,154

- Other (income)/expense

2,439

2,297

992

1,190

763

-23.1

-35.9

1,190

1,148

5,200

Total expenses and other income

41,967

11,594

9,676

8,564

8,361

-13.6

-2.4

8,564

8,062

37,693

Earnings before income taxes

266,932

52,401

53,637

51,120

52,934

-1.3

3.5

61,943

59,826

218,799

Income tax expense/(recovery)

(1,045)

2,982

(89)

3,133****

-3,620.2

N/A 

6,026

Marginal tax rate (%)

-0.4

5.7

-0.2

0.0

5.9

-3,050.0

N/A 

0.0

0.0

2.8

Net earnings

267,977

49,419

53,726

51,120

49,801

-7.3

-2.6

61,943

59,826

212,773

 

 

 

Basic EPS (US$)

0.75

0.13

0.15

0.13

0.12

-20.0

-7.7

0.15

0.15

0.54

Diluted EPS (US$)

0.74

0.13

0.15

0.13

0.12

-20.0

-7.7

0.15

0.15

0.54

Source: Silver Wheaton, Edison Investment Research. Note: *Forecasts exclude stock-based compensation; **excluding impairments; ***includes 1,419 of equity settled stock-based compensation; ****after excluding taxation effect of impairments.

Despite a slower July and August, the ramp-up at Salobo recovered once again in September, with capacity utilisation exceeding 90%. It is expected to reach 100% in Q415. Production at Penasquito similarly reached a record as substantial mining took place in the heart of the deposit and despite the suspension of construction of the Northern Well Field project owing to an illegal blockade by a local community. Penasquito continues to seek an equitable resolution of the matter with the community, while taking steps to enforce its contractual rights. In addition, it is also advancing alternatives to complete the project, without crossing through the affected community lands. The operator, Goldcorp, believes that there will be a resolution of the matter in time to meet the future water needs of the mine. In the meantime, the Metallurgical Enhancement Project feasibility study remains on schedule to be completed in early 2016. Elsewhere, stripping at Minto North is also reportedly on schedule, with ore expected to be delivered to the mill in December 2015 and high grade ore in Q216.

Our estimate of 54c for FY15 compares to an average consensus basic EPS estimate of 52.6c, within the range 42-56c (source: Bloomberg, 10 November 2015). Note that our updated forecasts for Q415 and FY16 now both include the Antamina stream acquisition (see below).

By contrast, our basic EPS estimate of 78c for FY16 (vs 68c pre-Antamina, see Exhibit 4) compares to an average consensus estimate of 65.3c, within the range 29-83c. Note that our FY16 estimates are based on precious metals price forecasts of US$16.11/oz Ag and US$1,224/oz Au.

Antamina stream acquisition

In addition to its Q315 results, Silver Wheaton also announced its acquisition of 100% of the silver attributable to Glencore from its 33.75% interest in the Antamina copper mine in Peru (note that SLW already has a prior commercial relationship with Glencore via its Yauliyacu stream). SLW paid US$900m for the stream and will pay 20% of the spot price per silver ounce delivered. Once 140Moz of silver has been delivered (after approximately 30 years), the stream will reduce to two-thirds of Glencore’s interest (ie 22.5% of the silver produced by the mine).

Production attributable to Silver Wheaton is forecast to be 1.0-1.5Moz Ag in Q415, followed by 5.1Moz per year for both FY16 and FY17 and 4.7Moz thereafter for a further 20 years. Reserves are sufficient to support mining activities until 2028. Measured and indicated resources are capable of supporting mining for an additional 12 years thereafter (assuming conversion into reserves) and inferred resources for a further 27 years after that. Note that the main restriction to the immediate conversion of resources to reserves is the capacity of Antamina’s tailings ponds.

Based on our long-term silver price forecasts, we estimate that Antamina will therefore contribute an average of US$95.2m to SLW’s cash-flows per year and, as such, is approximately equivalent to SLW’s Salobo stream in terms of its scale and the quality of the underlying asset.

The Canada Revenue Agency

In response to a notice of reassessment from the Canada Revenue Agency on 24 September, Silver Wheaton duly confirmed that it has filed notices of objection for each of the reassessed tax years. As such, it is in a position to lodge an appeal with the CRA (a process that would typically last one to two years). However, it has indicated that it is more likely it will wait for a further 91 days after filing a notice of objection (ie until approximately January 2016), after which it will exercise its legal right to appeal directly to the Tax Court of Canada to reach a conclusion as quickly as possible via litigation. Initially, this would involve a case ‘discovery phase’, in which an assessment of each side's strengths and weaknesses would be considered. Typically, this phase takes six to nine months, during which a meaningful amount of cases are settled out of court. If no agreement can be reached, the case will proceed to court, likely to be approximately in early 2017.

Now that a notice of reassessment has been received, SLW is obliged to make a deposit of 50% of the disputed tax, interest and penalties (ie C$177m, US$133m, or US$0.33/share) on filing a notice of objection. Note that any cash outlay will be accounted for as a refundable deposit.

A brief consideration of some of the aspects of the case

As stated in our note of 9 July, the income the CRA is seeking to tax is earned by foreign subsidiaries from assets outside Canada. Key to the CRA’s case appears to be the assertion that services bought and contracted between SLW’s Vancouver and offshore offices were mispriced and that the profit split between the two jurisdictions was therefore distorted. Silver Wheaton is limited in what it can say publicly ahead of any legal action. However, investors should be aware of three matters relevant to this assertion:

1.

Silver Wheaton’s offshore Cayman subsidiary has an independent board and management.

2.

Silver Wheaton was aware of the issue of transfer pricing long before it received the CRA’s proposal letter of 6 July and employed a leading firm to advise on a reasonable range of prices to charge between the group’s different offices (of which it confirms that it always chose the most conservative, ie the highest price). As such, it is not the case that no transfer pricing was being employed and hence the validity of the CRA’s case (in our opinion) will rest on its being able to prove that the value placed on those services was incorrect (and that therefore the opinion of SLW’s consultant was also incorrect), rather than whether or not they were being charged and paid for.

3.

Since 2009, Silver Wheaton has employed the deposit method of accounting for its streams, which involves the accelerated depreciation of individual streams. Therefore, in any event (and notwithstanding point 1, above), taxable income for many of SLW’s newer streams will have been zero during the period under review.

Otherwise, it remains the case that: 1) the structure and relationship between SLW and its foreign subsidiaries is common and used by many companies both globally and within Canada; 2) any ruling against SLW could expose other multinational companies operating out of Canada to similar treatment; and 3) the CRA’s approach to the 2011-14 tax years remains unclear. In our opinion, this last point may be a risk in that the CRA may seek to similarly reassess tax during 2011-14. However, it could also be an opportunity in that its approach to these years therefore appears inconsistent compared to 2005-10.

Valuation

The effect of the Antamina stream acquisition increases our forecast of SLW’s EPS in FY19 from US$1.64 to US$1.84.

Excluding FY04 (part year) and FY08 (during which there was an exceptional write-down), Silver Wheaton's shares have historically traded on an average P/E multiple of 25.3x current-year basic EPS (cf 23.0x currently).

Exhibit 2: Silver Wheaton historic current year P/E multiples

Source: Edison Investment Research. Note: FY14 EPS excludes impairment charge.

Applying this multiple to our updated long-term EPS forecast of US$1.84 per share in FY19 (vs US$1.64 previously) implies a potential share value of US$46.36, or C$61.59 (cf US$41.43 or C$53.59 previously).

In the meantime, the table below shows Silver Wheaton’s current rating on a number of valuation measures relative to both a sample of its ‘peer’ royalty/streaming companies and a sample of gold miners. Using our forecasts in Exhibits 1 and 4, it is notable that Silver Wheaton trades on multiples that are cheaper than its royalty/streaming ‘peers’ in 71% of instances considered. It also trades on multiples that are cheaper than the gold miners themselves in c 46% of instances considered, despite being associated with materially less operational and cost risks, in particular.

Exhibit 3: Silver Wheaton comparative valuation vs a sample of operating and royalty/streaming companies

P/E (x)

Yield (%)

P/CF

Year 1

Year 2

Year 1

Year 2

Year 1

Year 2

Royalty companies

Franco-Nevada

81.3

74.7

1.8

1.8

23.9

21.5

Royal Gold

31.8

23.0

2.4

2.4

9.9

8.5

Sandstorm Gold

0.0

0.0

9.4

9.0

Osisko

40.0

38.9

0.9

1.0

35.7

24.4

Average

51.0

45.5

1.3

1.3

19.7

15.8

Silver Wheaton (our forecasts)

23.8

16.4

1.6

2.4

11.6

8.5

SLW (consensus)

24.0

19.3

1.6

1.9

12.9

9.4

Operators

Barrick

25.8

16.4

1.9

1.1

3.6

3.6

Newmont

15.3

21.4

0.6

0.5

4.1

4.8

Goldcorp

100.6

43.6

3.8

2.0

7.0

6.1

Newcrest

20.5

12.0

0.3

1.5

7.1

5.8

Kinross

0.0

0.0

2.7

2.5

Agnico-Eagle

64.7

64.8

1.2

1.2

8.2

8.4

Eldorado

62.6

34.2

0.6

0.5

10.9

8.6

Yamana

3.3

3.3

3.8

2.8

Average

48.2

32.1

1.5

1.3

5.9

5.3

Source: Bloomberg, Edison Investment Research. Note: Peers priced on 10 November 2015.

Financials

At 30 September, SLW has US$566.5m of net debt on its balance sheet (vs US$643.1m at end-June – consistent with its performance of generating c US$100m from operating activities per quarter). Since the quarter’s end, it has announced its US$900m investment into the Antamina stream acquisition; it has also repurchased 645,389 of its own shares under its share repurchase programme at an average price of US$11.86 and therefore an implied consideration of US$7.7m. SLW has TSX approval to repurchase up to 20,229,671 common shares (representing 5% of the total outstanding common shares at September 11, 2015) under a Normal Course Issuer Bid (NCIB) over 12 months starting after TSX approval (although potential future repurchases are excluded from our forecasts on the basis of the uncertainty surrounding the size, price and timing of any such repurchases).

In the aftermath of its Q415 investments, we forecast that SLW will have net debt on its balance sheet of US$1,345.0m at end-December 2015, equating to a gearing (net debt/equity) ratio of 29.7% and a leverage (net debt/[net debt+equity]) ratio of 22.9%. Nevertheless, such a level of debt is well within the tolerances required of its banking covenants that:

net debt should be no more than 0.75x tangible net worth (which we estimate to be US$4,529.8m at end-December 2015); and

interest should be no less than 3x covered by EBITDA.

Note that the interest rate associated with SLW’s revolving debt facility is Libor plus 120-220bp.

Exhibit 4: Financial summary

US$'000s

2012

2013

2014

2015e

2016e

Dec

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

849,560

706,472

620,176

644,298

886,611

Cost of Sales

(117,489)

(139,352)

(151,097)

(193,382)

(263,923)

Gross Profit

732,071

567,120

469,079

450,916

622,688

EBITDA

 

 

701,232

531,812

431,219

421,204

592,976

Operating Profit (before amort. and except.)

600,003

387,659

271,039

226,780

321,995

Intangible Amortisation

0

0

0

0

0

Exceptionals

0

0

(68,151)

(154,021)

0

Other

788

(11,202)

(1,830)

(4,827)

0

Operating Profit

600,791

376,457

201,058

67,932

321,995

Net Interest

0

(6,083)

(2,277)

(3,154)

(7,936)

Profit Before Tax (norm)

 

 

600,003

381,576

268,762

223,626

314,059

Profit Before Tax (FRS 3)

 

 

600,791

370,374

198,781

64,778

314,059

Tax

(14,755)

5,121

1,045

(6,026)

0

Profit After Tax (norm)

586,036

375,495

267,977

212,773

314,060

Profit After Tax (FRS 3)

586,036

375,495

199,826

58,752

314,059

Average Number of Shares Outstanding (m)

353.9

355.6

359.4

396.9

403.4

EPS - normalised (c)

 

 

166

106

75

54

78

EPS - normalised and fully diluted (c)

 

165

105

74

54

78

EPS - (IFRS) (c)

 

 

166

106

56

15

78

Dividend per share (c)

35

45

26

20

30

Gross Margin (%)

86.2

80.3

75.6

70.0

70.2

EBITDA Margin (%)

82.5

75.3

69.5

65.4

66.9

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

70.6

54.9

43.7

35.2

36.3

BALANCE SHEET

Fixed Assets

 

 

2,403,958

4,288,557

4,309,270

5,894,464

5,693,482

Intangible Assets

2,281,234

4,242,086

4,270,971

5,856,165

5,655,183

Tangible Assets

1,347

5,670

5,427

5,427

5,427

Investments

121,377

40,801

32,872

32,872

32,872

Current Assets

 

 

785,379

101,287

338,493

2,516

70,600

Stocks

966

845

26,263

751

1,033

Debtors

6,197

4,619

4,132

1,765

2,429

Cash

778,216

95,823

308,098

0

67,138

Other

0

0

0

0

0

Current Liabilities

 

 

(49,458)

(21,134)

(16,171)

(364,297)

(38,250)

Creditors

(20,898)

(21,134)

(16,171)

(17,797)

(38,250)

Short term borrowings

(28,560)

0

0

(346,500)

0

Long Term Liabilities

 

 

(32,805)

(1,002,164)

(1,002,856)

(1,002,856)

(1,002,856)

Long term borrowings

(21,500)

(998,136)

(998,518)

(998,518)

(998,518)

Other long term liabilities

(11,305)

(4,028)

(4,338)

(4,338)

(4,338)

Net Assets

 

 

3,107,074

3,366,546

3,628,736

4,529,827

4,722,976

CASH FLOW

Operating Cash Flow

 

 

720,209

540,597

434,582

445,882

612,483

Net Interest

0

(6,083)

(2,277)

(3,154)

(7,936)

Tax

(725)

(154)

(204)

(6,026)

0

Capex

(641,976)

(2,050,681)

(146,249)

(1,779,618)

(70,000)

Acquisitions/disposals

0

0

0

0

0

Financing

12,919

58,004

6,819

769,000

0

Dividends

(123,852)

(160,013)

(79,775)

(80,682)

(120,909)

Net Cash Flow

(33,425)

(1,618,330)

212,896

(654,598)

413,638

Opening net debt/(cash)

 

 

(761,581)

(728,156)

902,313

690,420

1,345,018

HP finance leases initiated

0

0

0

0

0

Other

0

(12,139)

(1,003)

0

0

Closing net debt/(cash)

 

 

(728,156)

902,313

690,420

1,345,018

931,380

Source: Company sources, Edison Investment Research

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New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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