Wheaton Precious Metals — Guidance changes already anticipated

Underlying net earnings in Q222 were 4.4% above our forecasts. In general terms, gold production was slightly (13.2%) weaker than prior expectations; however, gold sales were slightly (15.5%) better, while silver outperformed in terms of both production and sales (by 10.8% and 12.0%, respectively), led by notably strong performances at Zinkgruvan, Yauliyacu, Neves-Corvo and Minto as well as, albeit to a slightly lesser extent, Antamina and San Dimas.

In summary, WPM produced 162,569 GEOs during the quarter, compared with our expectation of 169,297 (a negative variance of 4.0%), but sold 170,371 GEOs, compared with our expectation of 152,618 (a positive variance of 11.6%) as a result of a 27,412 GEO draw down in the number of ounces produced but not yet delivered to the company. As a consequence, sales were US$29.5m (or 10.8%) better than our prior expectation, although this was partially offset by a US$23.1m increase in the cost of sales to result in earnings from operations that were US$6.4m (or 4.1%) above our prior forecast for the quarter – a variance which was then broadly maintained to the bottom line, such that adjusted net EPS were 4.4% better than our prior forecast at US$0.331/share (cf US$0.317/share) and the third quarterly dividend for the year was maintained at US$0.15/share.

A summary of WPM’s underlying financial and operating results in the context of both the preceding quarter and Edison’s prior expectations is provided in the exhibit below:

From an operational perspective, San Dimas, Antamina, Minto and Neves-Corvo all outperformed our prior expectations in terms of production and/or sales for at least the third quarter in succession, while Penasquito performed in line. Production at Sudbury increased for the third quarter in succession as it continued to recover from the closure – albeit temporary – of the Totten mine (which accounts for approximately 15–20% of Sudbury’s production). Readers should note that Sudbury’s operator, Vale, reports that Totten has now resumed production and is in in the process of normalising. At the same time, production of gold and palladium at Sibanye-Stillwater’s Stillwater mine was adversely affected by floods in the region, which damaged two bridges and the access road to the mine and resulted in its being suspended for seven weeks until 29 July. However, access to the East Boulder mine and the Columbus metallurgical facility remained intact and both facilities continued to operate throughout the flooding. Production of cobalt at Voisey’s Bay was, meanwhile, down 42%, quarter-on-quarter, owing to lower throughput resulting from a scheduled maintenance shutdown coupled with lower grades during the transition period between the depletion of the Ovoid open-pit mine and ramp-up to full production of the Voisey’s Bay underground project. As per Vale’s Q222 Performance Report, physical completion of the Voisey’s Bay underground mine extension was 74% at the end of the second quarter and civil works are planned to be completed by the end of 2022. However, production from the Eastern Deeps is expected to start in H222.

Production at WPM’s flagship asset, Salobo in Brazil (also operated by Vale), was hampered by a delayed ramp-up in operations after planned and corrective maintenance to the plant’s mill liners (which was the subject of our note, Incorporating Salobo Q222 operating results, published on 27 July). However, at the same time, Salobo also recorded its second largest over-sale of gold relative to production, of 14,386oz, since Q113. In the meantime, according to Vale’s most recent performance report, physical completion of the Salobo III mine expansion was 95% at end-Q222, with commissioning activities commencing at both the primary crushing and the stockpile areas. The degree of advancement of the project over successive quarters is as shown in the table below:

As such, Salobo III is expected to be commissioned in H222 (albeit probably Q422) to be followed by a 15-month ramp-up to full capacity.

At 10.5% the degree of under-sale of silver during the quarter, relative to production, was in line with the long-run average of 12.0% since Q112 and exactly in line with the previous quarter. By contrast, at 23.4%, the over-sale of gold relative to production (90% of which was attributable to Salobo) was its second highest on record since Q112 and noticeably higher than the long-run average of a 7.2% per quarter under-sale of metal relative to production.

Gold and silver ounces produced but not yet delivered as at 30 June amounted to 61,198oz and 3.7Moz, respectively (cf 81,365oz and 3.9Moz at end-Q122). At the period end, we estimate that ounces produced but not yet delivered equated to 2.34 months and 1.86 months of gold and silver production for FY22, respectively (cf 2.80 months and 1.97 months as at end-Q122) and compares with WPM’s target of two to three months of gold and palladium production and two months of silver production:

Note that, for these purposes, the use of the term ‘inventory’ reflects ounces of gold and silver 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, where it typically refers to metal in circuit and ore on stockpiles etc.

At the time of its Q122 results, WPM provided guidance for non-stock general and administrative (G&A) expenses of US$47–49m or US$11.75–12.25m per quarter (cf US$42–44m or US$10.5–11.0m per quarter for FY21 and US$40–43m in FY20), including all employee-related expenses, charitable contributions, etc, but excluding performance share units (PSU) and equity settled stock-based compensation. In the event, at US$10.8m, non-stock G&A expenses in Q222 were 7.7% below the bottom of the range implied by guidance for the sixth quarter in succession:

Given the performance of WPM’s shares, stock-based G&A expenses in Q222 were approximately US$2m above our prior estimate for the quarter (as shown in Exhibit 6, below), but were nevertheless within the ±US$2.9m error of estimation implied by the associated regression analysis.

The analysis of stock-based G&A expenses over the past 11 quarters relative to the change in WPM’s share price (also in US dollars) continues to exhibit a relatively close Pearson product-moment (correlation) coefficient between the two of 0.78, which remains statistically significant at the 5% level for a directional hypothesis (ie there is less than a 5% probability that this relationship occurred by random chance) and this therefore continues to form the basis of quarterly and full-year forecasts for G&A expenses in Exhibit 8.

In the light of lower short-term production from Salobo, as well as the sale of its Keno Hill stream in particular (which affects longer-term production expectations), WPM has provided updated guidance both for FY22 and the four- and nine-year periods thereafter. These changes, as well as Edison’s changes to its own shorter- and longer-term forecasts (including Marathon, Curipamba and Goose, but not yet Fenix) are summarised below:

WPM’s updated five-year and 10-year guidance is based on standardised pricing assumptions of US$1,800/oz Au, US$24.00/oz Ag, US$2,100/oz palladium and US$33.00/lb cobalt. Of note in this context is an implied gold/silver ratio of 75x, which compares with its current ratio of 87.6x and a long-term average of 61.5x (since gold was demonetised in August 1971). Self-evidently, at the standardised prices indicated, our gold equivalent production forecast of 669.3koz AuE for FY22e lies well within WPM’s updated guidance range of 640–680koz AuE.

Otherwise, readers will note that Edison’s medium-term production forecasts are within 1% of WPM’s (implied) guidance for the period FY23–26 and within 2% of its longer-term guidance for FY22–31 (albeit this estimate necessarily excludes potential future stream acquisitions).

In the short term, First Majestic is in the process of increasing production at San Dimas by restarting mining operations at the past-producing Tayoltita mine to add another 300tpd (12%) to throughput. In addition, it is investigating installing a 3,000tpd high-intensity grinding mill circuit and an autogenous grinding mill to improve recoveries and reduce operating costs. Production of palladium and gold at Stillwater (operated by Sibanye-Stillwater) will similarly increase under the influence of the Fill-the-Mill project at East Boulder (although the Blitz project has now been delayed by two years, to 2024, following the suspension of growth capital activities owing to COVID-19). At the same time, the Voisey’s Bay underground project is expected to ramp up to full production.

On 24 October 2018, Vale announced the approval of the Salobo III brownfields mine expansion, intended to increase processing capacity at Salobo from 24Mtpa to 36Mtpa, with start-up at that point scheduled for H222 and an estimated ramp-up time of 15 months. According to its agreement with Vale, depending on the grade of the material processed, WPM will be required to make a payment to Vale for this expansion, which WPM estimates will be in the range US$550–670m in FY23, in return for which it will be entitled to its full 75% attributable share of expanded gold production. Note however that the timing of this payment is dependent upon Salobo III successfully navigating a 90-day completion test, based largely on throughput, the start of which is at Vale’s discretion. The payment also compares to WPM’s purchase of a 25% stream from Salobo in August 2016 for a consideration of US$800m (see our note Going for gold, published on 30 August 2016), the US$900m it paid for a similar stream in March 2015 (when the gold price averaged US$1,179/oz) and the US$1.33bn it paid for its original 25% stream in February 2013.

According to Vale’s Q222 performance report, the Salobo III mine expansion is now 95% complete (see Exhibit 2) and remains on schedule for start-up in H222 (probably Q422). Once Salobo III has been completed, however, WPM believes reserves and resources could support a further 33% capacity increase at Salobo, from 90ktpd to 120ktpd (denoted Salobo IV). In addition to its long-term underground potential, WPM believes such an expansion could nevertheless still be supported by open-pit mining alone. Under the terms of its agreement with Vale, there would be no additional payment due from WPM in respect of the Salobo IV expansion, although Vale could exercise a right to alter the timing of the incremental payment due for Salobo III.

Another major project with which WPM has a streaming agreement for attributable gold and silver production is Rosemont in Arizona (now part of the wider Copper World complex).

Rosemont/Copper World is near a number of large porphyry-type producing copper mines and will be one of the largest copper mines in the United States, with initial output of c 86,000t copper per year from mined sources, accounting for c 8% of total US copper production, rising to c 101,000tpa after 16 years. Total by-product production of silver attributable to WPM is estimated to be c 1.7Moz Ag pa for Phase I, followed by c 2.4Moz Ag pa for Phase II.

Rosemont/Copper World’s operator, Hudbay, received both a Mine Plan of Operations from the US Forest Service and a Section 404 Water Permit from the US Army Corps of Engineers in March 2019, which was effectively the final material administrative step before the Rosemont mine could start development. Subsequently, Hudbay indicated it would seek board approval to start construction work by the end of CY19, which would have enabled first production ‘by the end of 2022’. In the meantime, it started early works to run concurrently with financing activities (including a potential joint venture partner).

On 31 July 2019, however, the US District Court for the District of Arizona issued a ruling relating to a number of lawsuits challenging the US Forest Service’s issuance of the Final Record of Decision effectively halting construction, saying that:

Hudbay responded by saying that it believed the ruling to be without precedent and that the court had misinterpreted federal mining laws and Forest Service regulations as they applied to Rosemont. It pointed out that the Forest Service issued its decision in 2017 after a ‘thorough process of 10 years involving 17 co-operating agencies at various levels of government, 16 hearings, over 1,000 studies, and 245 days of public comment resulting in more than 36,000 comments’ and with a long list of studies that have examined the potential effects of the proposed mine on the environment. Hudbay also pointed out that various agencies had accepted the company could operate the mine in compliance with environmental laws. As a result, Hudbay appealed the ruling to the Ninth Circuit Court of Appeals, which was delivered on 12 May 2022 to the effect that it affirmed the US District Court for the District of Arizona’s decision in July 2019. In the decision, the Court of Appeals agreed with the District Court’s ruling that the US Forest Service had relied on incorrect assumptions regarding its legal authority and the validity of Rosemont’s unpatented mining claims in the issuance of Rosemont’s Final Environmental Impact Statement. Hudbay is reviewing this decision. In the meantime, however, Hudbay has continued to explore in and around the area of the mine and, on 22 September 2021, announced the intersection of additional high-grade copper sulphide and oxide mineralisation predominantly located on its wholly owned patented mining claims (denoted Copper World). To date, seven deposits have been identified at Copper World with a combined strike length of over 7km and, on 15 December 2021, Hudbay announced a maiden mineral resource at Copper World of 272Mt in the indicated category and 142Mt in the inferred category, both at an average grade of 0.36% copper. The mineralisation consists of both skarn and porphyry copper sulphides with a significant oxidised component along a regional fault along the west side of the Rosemont, Bolsa and Broad Top Butte deposits known as the Backbone Fault. As a consequence of this exploration, it was determined that approximately 33Mt of inferred mineral resources at the Bolsa deposit, which were previously considered to be waste in the resource pit shell used for Rosemont’s NI 43-101 feasibility study, could now potentially be converted into reserves, which would result in less waste being mined at Rosemont, thereby reducing costs and energy consumption per tonne of ore mined. In addition, the Rosemont deposit also contains oxide mineralisation that was previously classified as waste, which could be processed with the oxide mineralisation at Copper World, and it is expected that further synergies will be identified as Hudbay continues to close the drilling gap between Bolsa and Rosemont. Note, the Copper World discovery is included in WPM’s area of interest under its precious metals purchase agreement (PMPA) with Hudbay.

As a result of these discoveries, Hudbay has adjusted its plan to develop the district. Among other things, it has now acquired a private land package totalling approximately 4,500 acres to support an operation on private lands. The initial technical studies for Copper World were incorporated into a preliminary economic assessment (PEA) investigating the development of the Copper World deposits in conjunction with an alternative plan for the Rosemont deposit, which was announced to the market on 8 June, and proposed a two-phase mine development plan. The first phase of the mine plan requires only state and local permits and reflects an approximate 16-year mine life. The second phase then extends the mine life to 44 years and incorporates an expansion onto federal lands to mine the entire Rosemont and Copper World deposits. The second phase of the mine plan would be subject to the federal permitting process and the company expects that it will be able to pursue the federal permits within the constraints imposed by the courts’ most recent legal decisions if any subsequent appeals are not successful.

Within this context, on 24 May, Hudbay received a favourable decision from the US District Court for the District of Arizona on all issues relating to the development of Copper World, including that Copper World and Rosemont are not connected under the National Environmental Policy Act (NEPA) and, therefore, that the Army Corps of Engineers (ACOE) does not have an obligation to include Copper World as part of its NEPA review of Rosemont. The District Court also granted Hudbay’s motion to dismiss the Copper World preliminary injunction request filed by the plaintiffs in the two lawsuits challenging the Section 404 Clean Water Act permit for Rosemont on the basis that the lawsuits were moot after the company surrendered its 404 permit back to the ACOE in April 2022. The ACOE has never determined that there are jurisdictional waters of the US on the Copper World site and Hudbay has independently concluded through its own scientific analysis that there are no such waters in the area. In this respect, Hudbay believes the District Court’s decision, together with the 12 May decision, clarifies the permitting path for Copper World, including the requirements to receive federal permits for the second phase only (ie years 16 to 44 of the project) under existing mining regulations.

Resources were reported to have expanded materially to 792Mt in the measured category, 381Mt in the indicated category and 262Mt in the inferred category at the time of Hudbay’s PEA at an average grade of 0.40% copper. In April 2022, the company commenced early works at Copper World with initial grading and clearing activities at site. It expects to advance a pre-feasibility study for Phase I of the Copper World project in H222, which will focus on converting the remaining inferred mineral resources to measured and indicated status and the evaluation of many of the project’s optimisation and upside opportunities. It will then complete a definitive feasibility study as well as receiving all required state and local permits during 2023, while simultaneously evaluating a variety of financing options, including a potential minority joint venture partner, prior to project sanction potentially as early as 2024. As a consequence, Edison is now forecasting production from Rosemont/Copper World attributable to WPM in FY27 (cf FY26 previously). However, readers should note that any acceleration in the process of being granted federal permits could allow Hudbay earlier access to higher grade areas of the orebody, especially at Rosemont. In the meantime, it is continuing exploration and technical work at site with seven drill rigs conducting infill drilling to support the feasibility studies.

In April, Antamina announced a US$1.6bn investment that will lengthen the mine’s useful life from 2028 to 2036. Currently, the mine is carrying out a third and final ‘public participation’ with residents of the northern Andean region of Ancash, where the mine is located, and is awaiting a response from the local authority, Senace, regarding the company’s request to modify its environmental impact assessment to allow the mine to extend its operating life by eight years. Production and the mine’s operational footprint would remain the same. The mine, which is co-owned by Glencore, BHP, Teck and Mitsubishi Corp and which is Peru’s largest, and the world’s second-largest, copper mine, anticipates being granted approval for the extension from the country’s environmental authority either later this, or early next, year.

WPM’s contract with Barrick provided for a completion test that, if unfulfilled by 30 June 2020, would result in WPM being entitled to the return of its upfront cash consideration of US$625m less a credit for any silver delivered up to that date from three other Barrick mines (at which point it would have no further streaming interest in the mine). Given the test was unfulfilled, WPM had the right to an estimated US$252.3m (the carrying value of Pascua-Lama in WPM’s accounts) repayment from Barrick in FY20. Given the long-term optionality provided by the Pascua-Lama project, however, WPM instead opted not to enforce the repayment of its entitlement and to instead maintain its streaming interest in the project (which was originally expected to deliver an attributable 1.7–12.0Moz silver pa, averaging 5.2Moz Ag pa, to WPM at a cost of US$3.90/oz inflating at 1% per year). A Chilean court ordered Pascua-Lama to close in 2020, but Barrick has raised the possibility that the orebody could be developed in a different manner, with an investment decision anticipated in 2024.

At the time of its Q222 results, WPM reported that its corporate development team was experiencing ‘healthy demand’ for streaming transactions, with development companies in the US$100–300m range. In general, it expects to be conducting due diligence processes on approximately 10–12 projects at any one time, which it expects to narrow to 3–4 target projects over the course of c 12 months. Most of the opportunities being evaluated by WPM are reported to be the precious metal by-product streams of base metal mines, although there are also reported to be some high-margin, purely precious metals mines involved in the process as well. In the first instance, WPM would fund any such transactions via the US$2bn available under its revolving credit facility, plus the US$448.6m in cash that it has on its balance sheet (at end-Q222) and, potentially, its US$300m at-the-market equity programme.

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

In the light of WPM’s Q222 results, updated guidance (see Exhibit 7), recent moves in metals prices, forex rates and WPM’s share price, Edison has updated its quarterly estimates for WPM for FY22 as follows:

Our basic EPS forecast of US$1.20/share for FY22 is a 3.4% upgrade relative to our prior estimate of US$1.16/share and is 7.7% below the consensus forecast of US$1.30/share (source: Refinitiv, 12 August 2022). Within this context, it is worth noting that our gold and silver price forecasts for the remainder of the year are now US$1,791/oz and US$20.44/oz, respectively, which are those prevailing at the time of writing (cf US$1,717/oz and US$18.64/oz previously).

WPM is a multi-asset company that has shown a willingness and desire to buy streams in the past to maintain production and maximise shareholder returns. As a result, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY22, in the case of WPM (as with Newmont and Endeavour), we have introduced a new valuation methodology whereby we discount forecast cash flows back over five years from the start of FY22 and then apply an ex-growth terminal multiple to forecast cash flows in that year (ie FY26) based on an appropriate discount rate.

In this case, in the wake of Q222 results, our estimate of WPM’s ‘terminal’ pre-financing cash flow in FY26 is US$2.76/share (cf US$2.81/share previously as a result of our revised assumption that first material production attributable to WPM from Rosemont/Copper World will occur in FY27 cf FY26 previously), as shown below:

Assuming 4% growth in nominal cash flows beyond FY26 (ie 0% growth in real cash flows) and applying a discount rate of 9.0% (being the expected long-term required nominal equity return), our terminal valuation of the company at end-FY26 is US$57.33/share, which, when discounted back to FY22 in combination with intervening cash flows, results in a valuation at the start of FY22 of US$41.47/share, or C$53.01/share (cf US$43.49/share previously). However, this valuation is inherently conservative in that it is based on the assumption of zero growth in (real) cash flows beyond FY26. This is inconsistent with the gold price, which has risen at a compound average annual growth rate of 7.6% per annum since 1968 and at a simple average annual growth rate of 9.7% per annum (as depicted below).

It is also inconsistent with WPM’s longer-term historical performance, wherein operational cash flows have increased at a compound average annual growth rate of 23.2% pa for the 16 years between FY05 and FY21, while its operational cash flows per share have increased at compound average annual growth rate of 15.8% pa.

Stated alternatively, we can say that WPM’s current share price of C$42.99 discounts a long-term compound annual average growth rate in cash flows per share of 2.7%, which is less than the compound average annual increase in US consumer prices from 1984 to the end of 2021.

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 30.1x current year basic underlying EPS, excluding impairments (cf 28.1x Edison or 25.9x Refinitiv consensus FY22e – see Exhibit 14).

Applying this 30.1x multiple to our EPS forecast of US$1.93 in FY26 (cf US$1.98 previously) implies a potential value per share for WPM of US$58.28 or C$74.50 in that year. However, the graph above suggests that the investing environment post-2017 has been able to support an enhanced WPM multiple relative to earlier years. We would ascribe this observation to macro-economic uncertainty and loose monetary policy combining to create a supportive environment for precious metals prices. As such, we believe that a multiple of 38.6x (the average of FY18–21) may still be supported in the event of a return to favour of precious metals and precious metals stocks. In this case, applying a 38.6x earnings multiple to our unchanged EPS forecast of US$1.52 in FY23 implies a potential value per share for WPM in that year of US$58.50 or C$74.79. Even at such share price levels however, a multiple of 38.6x would still put WPM’s shares on little more than par relative to those of Franco-Nevada (see Exhibit 14, below).

In the meantime, from a relative perspective, it is notable that WPM is cheaper than its peers on 75% (27 out of 36) of the valuation measures observed in Exhibit 14 if Edison estimates are used or 69% (25 out of 36) of the same valuation measures if consensus forecasts are used.

Within this context, it is worth noting that Edison forecasts imply that WPM’s EPS, DPS and cash flow will increase in FY23 and FY24 (relative to FY22), not least under the influence of the company’s increasing production profile (see Exhibit 7). By contrast, consensus forecasts appear to indicate that the market expects WPM’s EPS, in particular, to be broadly unchanged in FY23 and FY24 relative to FY22, implying that it is either not expecting any production/sales increase, or that it is anticipating the degree of any production/sales increase to be offset by an approximately equal and opposite move in precious metals prices.

At 30 June, WPM had US$448.6m in cash on its balance sheet and no debt outstanding under its US$2bn revolving credit facility. As such (including a modest US$2.4m in leases), it had US$446.2m in net cash overall after generating US$206.4m in operating cash flow during the quarter, consuming US$18.2m in investing activities and paying two quarterly dividends amounting to US$117.1m.

In FY22 we estimate that WPM will generate US$814.2m from operating activities, before consuming US$383.4m in investing activities in the form of instalments relating to the acquisitions of the Santo Domingo, Blackwater, Goose, Curipamba and Marathon streams and paying out a forecast dividend of US$270.8m to leave it with net cash of US$518.1m as at end-FY22.

In FY23, we forecast that it will generate US$1,008.9m from operating activities, before consuming US$1,100.0m in investing activities, including significant instalments relating to Salobo III (although readers should note that the timing of this payment is dependent on a successful completion test and could slip), Rosemont/Copper World and also Kutcho and, potentially, Fenix. On this basis, we estimate that WPM will end FY23 with net cash on its balance sheet of US$139.0m, before resuming its upward trend once again thereafter.