Q415e results, Cotabambas analysis and CRA

Silver Wheaton 15 February 2016 Update

Silver Wheaton

Q415e results, Cotabambas analysis and CRA

Q415e/Cotabambas/CRA

Metals & mining

 

15 February 2016

Price

C$21.15

Market cap

C$9bn

C$1.3912/US$

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

566.5

Shares in issue

404.0m

Free float

100%

Code

SLW

Primary exchange

TSX

Secondary exchange

NYSE

Share price performance

%

1m

3m

12m

Abs

32.6

29.0

(24.5)

Rel (local)

32.5

36.7

(7.2)

52-week high/low

C$28.4

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

16 March 2016

First quarterly dividend payment

16 March 2016

Analyst

Charles Gibson

+44 (0)20 3077 5724

Silver Wheaton is a research client of Edison Investment Research Limited

Silver Wheaton’s (SLW) Q4/FY15 results are scheduled for release on 16 March and will include the Antamina gold stream for the first time. Average gold and silver prices in the three-month period were slightly below our previous forecasts, at US$1,104/oz (vs US$1,112/oz) and US$14.75/oz (vs US$14.87/oz), respectively. Notwithstanding the inclusion of Antamina, SLW’s continued production guidance of 230,000oz Au for FY15 is indicative of a very strong Q4 for the gold division, in particular. Q4 is also the quarter in which production can tend to be ‘flushed through’ into sales.

Year end

Revenue (US$m)

PBT* (US$m)

EPS* (c)

DPS (c)

P/E (x)

Yield (%)

12/13

706.5

381.6

106

45

14.3

3.0

12/14

620.2

268.8

75

26

20.3

1.7

12/15e

637.5

220.4

53

20

28.8

1.3

12/16e

902.2

320.9

80

31

19.1

2.0

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

Operations – Constancia and San Dimas updates

An operational update from Hudbay Minerals indicates that silver production attributable to SLW from Constancia in Q4 was ahead of our expectations and gold production was in line. Notwithstanding the planned replacement of the trunnions on both the SAG and ball mills in one of the two grinding circuits in Q116, precious metals output is expected to be 50-65koz AuE in FY16 – cf our forecast of 54.2koz (at an Au:Ag ratio of 70:1) and indicative of the fact that Constancia is continuing to ramp up in line with expectations. At the same time, silver production of 2.32Moz from San Dimas (Primero) is consistent with production attributable to SLW of 1.9725Moz (Edison calculation), with the mine exceeding expectations as a result of higher throughput related to the ongoing expansion of the mill to 3,000tpd and increased availability of the high-grade Jessica vein.

Cotabambas stream acquisition

SLW has entered in to an early deposit scheme with Panoro, whereby it will pay US$140m for 100% of the silver and 25% of the gold from Panoro’s Cotabambas project in Peru (up to 90Moz AgE sold). We calculate that this stream will provide SLW with a 34.4% IRR over the forecast life of the mine at long-term metals prices or 22.8% at current spot prices (see page 6).

Valuation: 51.8% internal rate of return in US dollars

We forecast a value per share for SLW of US$47.51, or C$66.09, in FY19, representing a total internal rate of return to investors at the current share price of 51.8% in US dollar terms over four years. In the meantime, it is trading on near-term financial ratios that are cheaper than its royalty/streaming ‘peers’ in 71% of instances considered (see Exhibit 6) and cheaper than the miners themselves in 57% of instances, despite being associated with materially less operational and cost risk.

Quarterly results and forecasts

A summary of our forecasts for SLW at the time of its Q315 results is shown in the table below. Since then, SLW has provided broad production forecasts of 28Moz for silver and 230koz for gold for FY15, which are 3.1% below and 2.9% above our previous forecasts (respectively). In addition, various of SLW’s counterparties have announced production results for Q415 (see page 3), while the silver price averaged US$14.75/oz during the quarter and the gold price US$1,104/oz, compared with our previous forecasts of US$14.87/oz and US$1,112/oz, respectively. Notwithstanding the inclusion of Antamina in the gold stream for the first time in Q4 (see our update note published on 11 November 2015), investors should note the particularly strong implied performance of SLW’s gold assets during the quarter. In addition, while parity is broadly assumed between sales and production, the fourth quarter is traditionally the one in which sales may be ‘flushed through’ by operators and inventories reduced.

Exhibit 1: Silver Wheaton FY15 forecasts, by quarter*

US$000s (unless otherwise stated)

FY14**

Q115

Q215

Q315

Q415e (previous)

Q415e (current)

Change (%)

FY15e (previous)

FY15e

(current)

Change (%)

Silver production (koz)

25,674

6,342

7,201

6,890

8,448

7,567

-10.4

28,881

28,000

-3.1

Gold production (oz)

142,815

55,106

50,509

54,513

63,381

69,872

10.2

223,509

230,000

2.9

AgE production (koz)

35,285

10,371

10,904

10,993

13,188

12,687

-3.8

45,341

44,840

-1.1

 

 

 

 

Silver sales (koz)

23,484

5,665

5,575

6,575

8,448

7,509

-11.1

26,263

25,324

-3.6

Gold sales (oz)

139,522

28,399

60,974

48,077

63,381

72,661

14.6

200,831

210,111

4.6

AgE sales (koz)

32,891

7,723

10,043

10,194

13,188

12,833

-2.7

41,087

40,732

-0.9

 

 

 

 

Avg realised Ag price (US$/oz)

18.92

16.95

16.42

15.05

14.87

14.75

-0.8

15.69

15.69

0.0

Avg realised Au price (US$/oz)

1,261

1,214

1,195

1,130

1,112

1,081

-2.8

1,156

1,143

-1.1

Avg realised AgE price (US$/oz)

18.86

16.90

16.38

15.03

14.87

14.75

-0.8

15.68

15.65

-0.2

 

 

 

 

Avg Ag cash cost (US$/oz)

4.14

4.14

4.26

4.26

4.70

4.56

-3.0

4.38

4.32

-1.4

Avg Au cash cost (US$/oz)

386

388

395

389

390

385

-1.3

391

389

-0.5

Avg AgE cash cost (US$/oz)

4.59

4.46

4.76

4.58

4.88

4.85

-0.6

4.71

4.69

-0.4

 

 

 

Sales

620,176

130,504

164,435

153,251

196,108

189,290

-3.5

644,298

637,480

-1.1

Cost of sales

 

 

 

Cost of sales, excluding depletion

151,097

34,464

47,795

46,708

64,415

62,214

-3.4

193,382

191,182

-1.1

Depletion

160,180

32,045

53,327

45,248

63,805

62,455

-2.1

194,424

193,075

-0.7

Total cost of sales

311,277

66,509

101,122

91,956

128,220

124,670

-2.8

387,807

384,256

-0.9

Earnings from operations

308,899

63,995

63,313

61,295

67,888

64,621

-4.8

256,492

253,224

-1.3

Expenses and other income

 

 

 

- General and administrative**

37,860

8,170

7,886

7,170***

6,486

6,486

0.0

29,712

29,712

0.0

- Foreign exchange (gain)/loss

(609)

(373)

0

 

(373)

-373

0.0

- Net interest paid/(received)

2,277

1,500

798

428

428

428

0.0

3,154

3,154

0.0

- Other (income)/expense

2,439

2,297

992

763

1,148

1,148

0.0

5,200

5,200

0.0

Total expenses and other income

41,967

11,594

9,676

8,361

8,062

8,062

0.0

37,693

37,693

0.0

Earnings before income taxes

266,932

52,401

53,637

52,934

59,826

56,559

-5.5

218,799

215,531

-1.5

Income tax expense/(recovery)

(1,045)

2,982

(89)

3,133****

N/A 

6,026

6,026

0.0

Marginal tax rate (%)

-0.4

5.7

-0.2

5.9

0.0

0.0

N/A 

2.8

2.8

0.0

Net earnings

267,977

49,419

53,726

49,801

59,826

56,559

-5.5

212,773

209,505

-1.5

 

 

 

Basic EPS (US$)

0.75

0.13

0.15

0.12

0.15

0.14

-6.7

0.54

0.53

-1.9

Diluted EPS (US$)

0.74

0.13

0.15

0.12

0.15

0.14

-6.7

0.54

0.53

-1.9

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

Record attributable production was recorded at both Salobo and Penasquito in Q315 and record sales at San Dimas, although this was ostensibly offset by under-sales at Salobo, Yauliyacu and SLW’s ‘other’ silver assets. In the meantime, gold production was lower at Sudbury (owing to planned maintenance shutdowns), but higher than expected at both Constancia and Minto.

Production at Penasquito 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, is confident 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 on schedule and high-grade ore is expected to be delivered to the mill in Q216. Finally, Salobo’s operator, Vale, has been aiming to achieve capacity utilisation at the mine of 100% in Q415.

Our estimate of 53c for FY15 compares to an average consensus basic EPS estimate of 51.6c, within the range 39-56c (source: Bloomberg, 12 February 2016). By contrast, our basic EPS estimate of 80c for FY16 compares to an average consensus estimate of 55.3c (vs 65.3c on 11 November 2015), within the range 24-78c (excluding Edison). Note that our FY16 estimates are based on precious metals price forecasts of US$16.11/oz Ag and US$1,224/oz Au (vs spot prices of US$15.79/oz and US$1,239/oz at the time of writing).

Counterparties’ post-year developments

A number of SLW’s counterparties have made statements so far in 2016 regarding the performance of their operations during Q415, which are summarised below.

Hudbay (Constancia and 777 mines)

During the fourth quarter of 2015, Hudbay reported that Constancia produced 6,560oz Au (SLW interest 50%) and 636,514oz Ag (SLW interest 100%) and sold 7,888oz Au and 511,148oz Ag. Shipments of copper concentrate from the mine to the port in Matarani increased with improved trucking capacity, resulting in a significant drawdown of inventory to normal working levels, with all excess copper concentrate having been sold by the year end. As a result, approximate concentrate inventory levels in Peru (including the mine site and port inventories) decreased from 74,000 dry metric tonnes (dmt) at the end of Q3 (including 65,000dmt at the mine) to a normal working level of approximately 28,000dmt at the end of Q4, including 11,000dmt at the mine.

Constancia’s production in Q116 is expected to be affected by the planned replacement of the trunnions on both the SAG and ball mills in one of the two grinding circuits. The trunnions were damaged due to a lubrication failure during the commissioning period and are expected to be replaced over a six- to eight-week period in the first quarter of 2016, during which time the second grinding circuit should continue to operate normally. Nevertheless, output of precious metals is expected to increase to 50-65koz in FY16 (at an Au:Ag ratio of 70:1), compared with our forecast of 54.2koz on the same basis, ie Constancia is ramping up very much in line with expectations.

Production of gold from Hudbay’s operations in Manitoba (comprising the 777, Lalor and Reed mines, in which SLW has an interest only in the 777 stream) was 20,184oz and consistent with output levels for the previous three quarters, although there was also evidence of additional inventory drawdown in the form of sales of 23,996oz. Precious metals output from Manitoba is forecast to increase from 92,973oz AuE in FY15 to within the range 95-115koz AuE, although no detail between the three mines was provided in terms of a production breakdown. Nevertheless, according to Hudbay Minerals, the 777 mine “is expected to benefit from improved equipment reliability resulting from its fleet renewal program”.

Primero (San Dimas)

Primero produced 2.32Moz Ag from San Dimas in Q415, resulting in annual production of 8.30Moz Ag and consistent with production attributable to SLW of 1.9725Moz (Edison calculation), with the mine exceeding expectations as a result of higher throughput related to the ongoing expansion of the mill to 3,000tpd and increased availability of the high-grade Jessica vein. Average throughput in FY15 increased by 10% to a record 2,721tpd (vs a nameplate capacity of 2,500tpd). The focus of operations in FY16 will be the completion of the mill expansion to 3,000tpd, while “continuing to identify productivity opportunities while also ensuring… a transformational shift in attitude at the mine towards a safety culture committed to a workplace free of accidents”.

Eldorado (Stratoni)

During Q4, Stratoni produced 11,734t of lead/zinc concentrate out of a total for the year of 40,232t (ie Q4 outperformed the average of the previous three quarters). There was additional evidence of inventory drawdown in the form of 14,007t of sales during the same period (ex-46,502t for the full year). During 2016, Stratoni is expected to process 220,000t of ore at grades of 6.2% lead, 10.0% zinc and 163g/t silver (ie 1.2Moz of contained silver, implying 968koz production at an 84% metallurgical recovery rate). Sustaining capital costs for the year are expected to total US$10.0m, including underground equipment rebuilds and replacement, and environmental infrastructure.

Eldorado is conducting its annual impairment review and “preliminary analysis” is reported to indicate an impairment expense of approximately US$1.2-1.6bn (after-tax) primarily related to its Greek assets (of which a portion could, obviously, pertain to Stratoni and, thereby, SLW, albeit in non-cash terms).

Capstone (Cozamin and Minto)

A pocket of high-grade underground ore in excess of 3% copper in close proximity to existing development was opportunistically mined and processed at Minto, which resulted in above average production of silver of 52,849oz. In the meantime, stripping of the Minto North pit was reported to be proceeding well and the lower-grade ore was reached (as expected) in December. Gold output during Q4 was steady at 4,320oz.

Production in the fourth quarter at Cozamin amounted to 399,834oz Ag, which was 6.6% higher than our previous forecast of 375,000oz.

Other

Investors should be aware that both Goldcorp and Vale – major SLW counterparties – are scheduled to provide their own investors with operational and financial results updates on 25 February.

 

Cotabambas stream

On 27 January, SLW announced the terms of a proposed Early Deposit Precious Metals Stream with Panoro Minerals. Under the terms of the agreement, SLW will purchase 100% of the silver and 25% of the gold from Panoro’s Cotabambas project in Peru (up to a cumulative total of 90Moz AgE sold) for an initial payment of US$140m and ongoing payments of US$5.90/oz Ag and US$450/oz Au (inflating at 1% pa from the fourth year of production). Once 90Moz of silver equivalent has been delivered, the stream will reduce to 66.67% of silver produced and 16.67% gold.

Once certain conditions have been met, SLW will advance US$14m to Panoro, spread over up to nine years, to fund corporate expenses relating to the project. Provisions also exist to accelerate these payments via SLW matching, up to certain limits, any additional third-party financing of Cotabambas, such that up to US$7m could be made available by SLW in the first two years of the agreement. Following the delivery of a bankable/definitive feasibility study, environmental study and impact assessment and other related documents and the receipt of permits and commencement of construction, SLW may then advance the remaining deposit or elect to terminate the agreement. If it elects to terminate, SLW will be entitled to the return of a portion of the US$14m paid less US$2m payable on certain triggering events occurring. If it does not terminate, the balance of the US$140m becomes payable in instalments during construction. Until 1 January 2020, Panoro also has a one-time option to repurchase 50% of the precious metals stream in the event of a change in control for an amount based on a calculated rate of return to SLW.

Thus far, Panoro’s board of directors and SLW have both approved the term sheet. However, the final conclusion of the deal is subject to the negotiation and completion of definitive documentation.

Cotabambas is at a relatively early stage of development, with Panoro (PML.CN, share price C$0.13, market capitalisation C$29m) having produced an updated preliminary economic assessment (PEA) for the project in September 2015. A brief summary of the project (at US$3.00/lb Cu, US$1,250/oz gold and US$18.50/oz Ag) is as follows:

Resources in the indicated and (mostly) inferred categories totalling 722.4Mt of mineralised material at average grades of 0.33% Cu, 0.18g/t Au and 2.4g/t Ag, containing 5.2bnlb Cu, 4.2Moz Au and 55.7Moz Ag.

US$1.5bn initial capital expenditure.

80,000tpd throughput of oxide, mixed and sulphide mineralisation in a conventional copper porphyry flotation concentrator to produce c 270ktpa of copper, gold and silver concentrate over a 19-year mine life.

Average annual payable production of 155Mlb Cu, 95koz Au and 1.0Moz Ag.

C1 cash costs of US$1.22/lb Cu, net of by-product credits.

Pre-tax IRR of 20.4%.

Post-tax NPV7.5 of US$683.9m.

Post-tax payback of 3.6 years.

 

The following table is based on production data provided in Panoro’s NI 43-101 Technical Report on the updated preliminary economic assessment for Cotabambas for the first 10 years of the mine’s life (the remaining years being omitted only on account of space). Given that the project is currently at the PEA stage of development, we (tentatively) estimate that it will be the best part of 10 years before it enters production, being approximately four years before the required bankable/definitive feasibility study, environmental study, environmental impact assessment and other related documents are produced (plus the receipt of permits) plus a further one to two years for financing and then approximately three years of construction before production begins. Note that this time frame would seem to be borne out by the estimate that SLW will advance US$14m to Panoro, spread over up to nine years. As such, we assume the first year of production of the project to be 2025, although clearly this timing could vary as the project develops.

Exhibit 2: Cotabambas stream analysis

Production year

1

2

3

4

5

6

7

8

9

10

Estimated calendar year

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

Production

Cu (t)

88,128

105,555

97,505

98,088

55,676

81,850

88,066

85,832

78,893

70,811

Au (oz)

140,845

131,416

122,390

134,292

125,049

88,505

125,863

122,166

104,645

86,188

Ag (oz)

582,703

896,324

1,058,432

1,304,432

647,946

1,183,135

1,436,703

1,385,243

1,181,027

886,973

SLW terms

Au (%)

25

25

25

25

25

25

25

25

25

25

Au (oz)

35,211

32,854

30,597

33,573

31,262

22,126

31,466

30,542

26,161

21,547

Ag (%)

100

100

100

100

100

100

100

100

100

100

Ag (oz)

582,703

896,324

1,058,432

1,304,432

647,946

1,183,135

1,436,703

1,385,243

1,181,027

886,973

Cumulative AgE (Moz)

2.5

5.3

8.0

11.2

13.6

16.0

19.2

22.3

24.9

27.0

Financial

Silver price payable (US$/oz)

5.90

5.90

5.90

5.96

6.02

6.08

6.14

6.20

6.26

6.33

Gold price payable (US$/oz)

450

450

450

454.50

459.05

463.64

468.27

472.95

477.68

482.46

Forecast silver price (US$/oz)

25.08

25.52

25.64

25.79

25.26

25.01

25.01

25.19

25.36

25.99

Forecast gold price (US$/oz)

1,398

1,423

1,431

1,439

1,409

1,395

1,394

1,405

1,414

1,450

Silver stream revenue (US$000s)

14,613

22,874

27,143

33,641

16,368

29,595

35,933

34,896

29,948

23,052

Gold stream revenue (US$000s)

49,235

46,766

43,771

48,305

44,039

30,859

43,878

42,904

36,998

31,247

Total stream revenue (US$000s)

63,848

69,639

70,915

81,946

60,407

60,453

79,811

77,800

66,945

54,299

Silver stream cost (US$000s)

3,438

5,288

6,245

7,773

3,900

7,192

8,821

8,590

7,397

5,611

Gold stream cost (US$000s)

15,845

14,784

13,769

15,259

14,351

10,258

14,735

14,445

12,497

10,396

Total stream cost (US$000s)

19,283

20,073

20,014

23,032

18,250

17,451

23,555

23,035

19,894

16,006

Stream cash flow (US$000s)

44,565

49,567

50,901

58,914

42,156

43,003

56,256

54,765

47,052

38,292

Source: Edison Investment Research, Silver Wheaton, Panoro Minerals

Note that at no point does the cumulative production from the stream approach the 90Moz AgE limit that would trigger a lower SLW interest in the stream.

The analysis in the above table is conducted at our real price forecasts for gold and silver in 2015 money terms. Assuming a US$140m investment to generate the cash flow shown above (ie just 10 years), the internal rate of return of the stream is 32.7%. Over the full life of the project it is 34.4%. However, whereas the cash flows above are depicted in 2015 money terms, the associated US$140m will be in money-of-the-day terms. That is to say, the real value of US$14m in the next nine years plus US$126m thereafter is actually less than US$140m in 2015 money terms and, as such, the above analysis can be regarded as conservative.

Analysing the stream in terms of multiples, it can be seen that SLW is potentially paying approximately 3.1x average annual cash flows for the Cotabambas stream (vs 9.5x for Antamina, with the proviso that Antamina is already in production, etc).

Finally, if the current spot prices for copper, gold (US$1,239/oz at the time of writing) and silver (US$15.79/oz) are substituted for our forecasts, the life-of-mine annual average cash flow of the streams falls from US$45.6m to US$28.1m and the IRR of the stream to 22.8% (with the same proviso that this is conservative on the basis of the 2015 money terms’ value of US$140m in 10 years’ time).

The Canada Revenue Agency (CRA)

On 19 January, SLW confirmed that it had filed a Notice of Appeal with the Tax Court of Canada against the Canada Revenue Agency (CRA) on 8 January (as expected), in relation to the latter’s notice of reassessment for the 2005-10 tax years of 24 September. In doing so, SLW has exercised its right to pursue a resolution of the dispute through a judicial court process rather than via the CRA’s internal appeals process. Once a court date has been set (which is likely to be in Q217 and gazetted to that effect in Q216), the case will enter a ‘discovery phase’, during which an assessment of the strengths and weaknesses of each side’s case will 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.

Subsequent to filing the Notice of Appeal, SLW received further correspondence from the CRA advising that it will now be commencing an audit of the company’s international transactions for the 2011-13 taxation years (which is only to be expected under the circumstances). Thus far, it is important to note that the correspondence received is not a formal proposal or notice of reassessment. However, SLW estimates that were the CRA to take a position in respect of the 2011-13 taxation years similar to the one it took for the 2005-10 tax years, it would assert that an additional US$310m in taxes is payable in Canada. Taxation years subsequent to 2013 also remain open to audit by the CRA.

An updated summary of SLW’s situation with respect to the CRA is therefore as shown in Exhibit 3 below.

Exhibit 3: Summary of tax, interest and penalties either estimated by SLW or sought by CRA

Tax years

Status

SLW estimate of potential tax liability (US$m)

Transfer penalty sought by CRA (US$m)

Interest and other penalties sought by CRA (US$m)

Total (US$m)

2005-10

In dispute

151

54

60

265

2011-13

Under audit

310

Not defined

Not defined

Unknown

Post-2013

Open

Unknown

Unknown

Unknown

Unknown

Source: Silver Wheaton, Edison Investment Research

In per share terms, the equivalent table is as follows:

Exhibit 4: Summary of tax, interest and penalties either estimated by SLW or sought by CRA (US$/share)

Tax years

Status

SLW estimate of potential tax liability (US$/sh)

Transfer penalty sought by CRA (US$/sh)

Interest and other penalties sought by CRA (US$/sh)

Total (US$/sh)

2005-10

In dispute

0.37

0.13

0.15

0.66

2011-13

Under audit

0.77

Not defined

Not defined

Unknown

Post-2013

Open

Unknown

Unknown

Unknown

Unknown

Source: Silver Wheaton, Edison Investment Research

These numbers compare to the US$5.83 decline in the price of SLW’s shares since the announcement of the CRA’s reassessment notice on 6 July 2015. However, as stated consistently, SLW believes that it has always complied with Canadian tax law and intends to “vigorously defend” its position.

A brief consideration of some of the aspects of the case

As stated in previous notes, 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. SLW is limited in what it can say publicly ahead of its legal action. However, investors should be aware of three matters relevant to this assertion:

1.

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

2.

SLW 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 has always chosen 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 ability to prove that the value placed on those services was incorrect (and that therefore the opinion of SLW’s professional consultant was also incorrect), rather than whether or not they were being charged and paid for.

3.

Since 2007, SLW 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 the structure and relationship between SLW and its foreign subsidiaries is common and used by many companies both globally and in Canada, and any ruling against SLW could expose other multinational companies operating out of Canada to similar treatment.

Valuation

Excluding FY04 (part year) and FY08 (during which there was an exceptional write-down), SLW’s shares have historically traded on an average P/E multiple of 25.9x current year basic EPS (cf 19.1x Edison FY16 currently or 27.5x consensus FY16).

Exhibit 5: Silver Wheaton historic current year P/E multiples

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

Applying this multiple to our (unchanged) long-term EPS forecast of US$1.84 per share in FY19 implies a potential share value of US$47.51, or C$66.09 (cf US$46.36 or C$61.59 previously).

In the meantime, the table below shows SLW’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 7, it is notable that SLW trades on multiples that are cheaper than its royalty/streaming ‘peers’ in 71% of instances considered (63% using consensus forecasts). It also trades on multiples that are cheaper than the gold miners themselves in c 57% of instances considered (52% using consensus forecasts), despite being associated with materially less operational and cost risk, in particular.

Exhibit 6: Silver Wheaton comparative valuation vs a sample of operating and royalty/streaming companies

Share price

P/E (x)

Yield (%)

P/CF

Year 1

Year 2

Year 1

Year 2

Year 1

Year 2

Royalty companies

Franco-Nevada

C$54.13

101.5

103.5

1.5

1.5

28.6

26.9

Royal Gold

US$41.09

41.5

31.5

2.2

2.3

14.5

10.4

Sandstorm Gold

C$3.94

N/A

N/A

0.0

0.0

10.7

10.7

Osisko

C$14.55

45.8

42.2

0.9

1.1

39.5

25.8

Average

62.9

59.1

1.1

1.2

23.3

18.4

Silver Wheaton (Edison forecasts)

C$21.15

28.8

19.1

1.3

2.0

20.2

10.0

SLW (consensus)

C$21.15

29.4

27.5

1.4

1.5

15.6

12.3

Operators

Barrick

C$16.93

42.0

35.1

1.1

0.7

6.0

7.1

Newmont

US$25.39

23.2

47.0

0.4

0.4

5.9

7.6

Goldcorp

C$21.04

189.1

105.1

2.9

1.6

9.1

8.3

Newcrest

A$16.30

33.2

21.7

0.1

0.9

10.4

8.9

Kinross

C$4.15

N/A

N/A

0.0

0.0

3.9

3.8

Agnico-Eagle

C$49.27

295.0

73.9

0.9

0.9

12.4

11.2

Eldorado

C$4.34

58.8

N/A

0.6

0.5

10.4

11.7

Yamana

C$3.69

N/A

N/A

2.3

1.0

5.7

4.7

Randgold Resources

£61.15

40.3

30.1

0.9

1.0

17.5

15.1

Average

97.4

56.6

1.0

0.8

9.0

8.7

Source: Bloomberg, Edison Investment Research. Note: Peers priced on 12 February 2016.

Note the inclusion of Randgold Resources for the first time in the above table, to provide a European benchmark valuation with which to compare SLW.

Financials

At 30 September, SLW had 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). During Q4, it announced its US$900m 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. Note: SLW has TSX approval to repurchase up to 20,229,671 common shares (representing 5% of the total outstanding common shares at 11 September 2015) under an enhanced normal course issuer bid, according to which its broker may also purchase shares for the same purpose over 12 months until 22 September 2016 (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 addition, in the aftermath of receiving a notice of reassessment from the CRA, SLW became obliged to make a deposit of 50% of the disputed tax, interest and penalties relating to 2005-10 (ie C$177m, US$133m, or US$0.33/share) on filing a notice of objection. Consistent with SLW’s intention to treat this deposit as refundable, we have therefore assumed this to be a ‘receivable’ for accounting purposes.

In the aftermath of its Q415 investments, we forecast that SLW will have net debt on its balance sheet of US$1,483m at end-December 2015 (vs US$1,345.0m previously – the difference being almost exclusively attributable to the effect on cash of the deposit relating to the CRA dispute), equating to a gearing (net debt/equity) ratio of 32.8% and a leverage (net debt/[net debt+equity]) ratio of 24.7%. 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$4,527m as 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 7: Financial summary

US$000s

2012

2013

2014

2015e

2016e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

849,560

706,472

620,176

637,480

902,206

Cost of Sales

(117,489)

(139,352)

(151,097)

(191,182)

(267,932)

Gross Profit

732,071

567,120

469,079

446,298

634,274

EBITDA

 

 

701,232

531,812

431,219

416,586

604,562

Operating Profit (before amort. and except.)

600,003

387,659

271,039

223,512

329,640

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

64,664

329,640

Net Interest

0

(6,083)

(2,277)

(3,154)

(8,748)

Profit Before Tax (norm)

 

 

600,003

381,576

268,762

220,358

320,892

Profit Before Tax (FRS 3)

 

 

600,791

370,374

198,781

61,510

320,892

Tax

(14,755)

5,121

1,045

(6,026)

0

Profit After Tax (norm)

586,036

375,495

267,977

209,505

320,893

Profit After Tax (FRS 3)

586,036

375,495

199,826

55,484

320,892

Average Number of Shares Outstanding (m)

353.9

355.6

359.4

396.9

403.4

EPS - normalised (c)

 

 

166

106

75

53

80

EPS - normalised and fully diluted (c)

 

165

105

74

53

80

EPS - (IFRS) (c)

 

 

166

106

56

14

80

Dividend per share (c)

35

45

26

20

31

Gross Margin (%)

86.2

80.3

75.6

70.0

70.3

EBITDA Margin (%)

82.5

75.3

69.5

65.3

67.0

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

70.6

54.9

43.7

35.1

36.5

BALANCE SHEET

Fixed Assets

 

 

2,403,958

4,288,557

4,309,270

5,895,814

5,690,892

Intangible Assets

2,281,234

4,242,086

4,270,971

5,857,515

5,652,593

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

135,490

136,523

Stocks

966

845

26,263

133,743

134,052

Debtors

6,197

4,619

4,132

1,747

2,472

Cash

778,216

95,823

308,098

0

0

Other

0

0

0

0

0

Current Liabilities

 

 

(49,458)

(21,134)

(16,171)

(501,888)

(100,304)

Creditors

(20,898)

(21,134)

(16,171)

(17,610)

(38,810)

Short term borrowings

(28,560)

0

0

(484,277)

(61,494)

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

4,526,559

4,724,255

CASH FLOW

Operating Cash Flow

 

 

720,209

540,597

434,582

308,104

624,728

Net Interest

0

(6,083)

(2,277)

(3,154)

(8,748)

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)

(123,196)

Net Cash Flow

(33,425)

(1,618,330)

212,896

(792,375)

422,783

Opening net debt/(cash)

 

 

(761,581)

(728,156)

902,313

690,420

1,482,795

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

1,482,795

1,060,012

Source: Company sources, Edison Investment Research

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority (www.fsa.gov.uk/register/firmBasicDetails.do?sid=181584). Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Silver Wheaton and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers’ exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

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

Share this with friends and colleagues