Wheaton Precious Metals — Peerless

In general, in the second quarter, Wheaton’s production and sales of gold, palladium and cobalt were all higher than our prior expectations and, although sales of silver were also higher, production of silver was slightly lower. Overall, production of GEOs was 4.6% higher than our prior forecasts for the quarter, while sales of GEOs were 6.9% higher, driving a positive variance in revenue of 6.6%, or US$16.4m. This was partially offset by costs of sales that were 8.2%, or US$8.6m higher, which drove a 5.4%, or US$7.8m, positive variance in earnings from operations that, to all intents and purposes, dropped through to the bottom line. An exceptional charge of US$15m (Edison estimate) that we thought might arise as a consequence of the suspension of activities at the Minto mine during the quarter ultimately did not do so. A complete analysis of WPM’s underlying financial and operating results relative to both Q123 and Edison’s prior expectations is provided in the exhibit below:

At the level of the individual mines, Penasquito, Cozamin, Salobo, San Dimas, Voisey’s Bay and Stillwater all unequivocally outperformed our prior (sometimes quite conservative) expectations, while Zinkgruvan and Aljustrel slightly underperformed.

Compared with the prior year period, Antamina, Constancia and Voisey’s Bay all experienced lower grades. At the same time, output and sales at Salobo were notable for having been driven by higher throughput and grades. According to Vale, production in the second quarter was driven by a better-than-expected ramp up of Salobo III partially offset by planned maintenance activities and additional work on the crushers at Salobo I and II. Vale reports that planned maintenance activities will continue in the second half of 2023, and that the ramp up of Salobo III is expected to be fully completed in 2024. Contrary to our prior expectations, most of the gold production associated with Salobo III (we estimate 75% cf our prior expectation of 25%) was recovered to Wheaton’s account during the quarter. Had all of the gold anticipated to be produced, given Salobo’s level of copper production, been produced, we estimate that it would have added a further 4,790oz to WPM’s production in Q223, as shown in the graph below:

Entering Q323:

At 11.5%, the degree of under-sale of gold in Q223, relative to production, was slightly greater than the prior historical average of 6.7% (from Q112 until Q123). By contrast, the 0.5% over-sale of silver relative to production was materially better than its prior historical average of a 12.1% under-sale and contributed to a notable run down in silver ounces produced but not sold (see below).

As a result, while gold ounces produced but not delivered increased by 5,812oz (or 8.4%) over the quarter, to 75,291oz, silver ounces produced but not delivered decreased by more than a third to just 1.3Moz.

Consequently, we calculate that gold and silver ounces produced but not yet delivered as at end-June now amount to 2.67 and 0.79 months of full-year production (cf 2.43 and 2.03 months as at end-Q123 previously), respectively, and compare with WPM’s target levels of two to three months for gold and palladium and two months for silver (see below).

At the time of its Q422 results, WPM provided guidance for non-stock general and administrative (G&A) expenses of US$47–50m or US$11.75–12.50m per quarter for FY23 (cf US$47–49m in FY22, US$42–44m in 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$12.2m, non-stock G&A expenses in Q123 were towards the middle of the range implied by WPM’s official guidance:

Given the performance of WPM’s shares during the quarter, stock-based G&A expenses in Q223 were well within the error of estimation implied by the regression analysis between the two (as shown in Exhibit 6, below):

The analysis of stock-based G&A expenses over the past 15 quarters relative to the change in WPM’s share price (also in US dollars) continues to exhibit a 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 remain the basis of our quarterly and full-year forecasts for G&A expenses in Exhibit 8.

At the time of its 21 February production and sales announcement, Wheaton also provided detailed production guidance for FY23 (for the first time), as well as for the five years from FY23–27 (inclusive) and the 10 years from FY23–32 (inclusive). These remain unchanged and compare with Edison’s forecasts over the equivalent periods, as follows:

WPM’s updated five-year and 10-year guidance is based on standardised pricing assumptions of US$1,850/oz gold, US$24.00/oz silver, US$1,800/oz palladium and US$18.75/lb cobalt. Of note in this context is an implied gold/silver ratio of 77.1x, which compares with its current ratio of 84.2x, but a long-term average of 61.5x (since gold was demonetised in August 1971). At the standardised prices indicated, our gold equivalent production forecast of 610.6koz gold equivalent (AuE) for FY23 self-evidently lies well within WPM’s guidance range of 600–660koz AuE.

Otherwise, readers will note that Edison’s medium-term production forecasts are within 1% of WPM’s guidance for the period FY23–27 and within 4% of its longer-term guidance for FY23–32, which we regard as an acceptable range of variance, given the time horizons involved. Note that both Edison’s and Wheaton’s estimates necessarily exclude potential future stream acquisitions (of which there are likely to be a number over the timeframe indicated).

Although Constancia experienced both lower throughput and grades relative to the prior year period in Q223, as per Hudbay’s recent earnings releases, full mining activities have resumed in the Pampacancha pit since February. Output was adversely affected by a period of higher stripping in Q223. However, we are now anticipating that gold production attributable to Wheaton from Constancia will increase by in excess of 75% in Q3 and Q4 compared with Q2 to c 13,000–15,000oz per quarter.

Since First Majestic’s acquisition of Primero in January 2018, it has been developing a long-term mine and mill optimisation plan for San Dimas, including:

Production of palladium and gold at Stillwater (operated by Sibanye-Stillwater) will increase under the influence of the Fill-the-Mill project at East Boulder as well as the Blitz project scheduled for FY24. Similarly, the Voisey’s Bay underground project is in the process of ramping up to full production.

In the medium term, Wheaton has six projects that are progressing on their route to 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 at the time, depending on the grade of the material processed, WPM was to have made a payment to Vale for this expansion, subject to a 90-day completion test, which WPM estimated was to have been in the range US$550–670m in FY23–25, in return for which it was to be entitled to its full 75% attributable share of expanded gold production.

After the end of Q422 however, Wheaton and Vale agreed to amend the Salobo PMPA to adjust the expansion payment terms to provide increased flexibility for the ramp-up of the expansion, while also maintaining an incentive for Vale to maximise grade on an annual basis. The expansion payment will now be phased, with Wheaton making an initial payment once actual throughput is expanded above 32Mtpa and a second payment if actual throughput is expanded above 35Mtpa by 1 January 2031. The total cumulative payments will range from US$283m to US$552m, dependent on Vale’s timing for each of the production increases. Where before Edison had been forecasting that Wheaton would make the whole payment (of US$530m) in FY24, owing to the successful nature of the ramp-up of the Salobo III project to date in FY23 (it contributed 30.9% of total Salobo copper production in Q223 cf an expected 33.3% pro-rata to throughput at full capacity), we are now forecasting that it will make the whole payment (of US$552m) in FY23. In addition, Wheaton will be required to make annual payments of between US$5.1m and US$8.5m for a 10-year period following payment of the expansion payments if the Salobo mine maintains a high-grade mine plan.

These payments compare 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, the project successfully commenced at the end of 2022 and is expected to achieve full capacity in FY24. Once full capacity at Salobo III has been completed, however, WPM believes that reserves and resources at the mine could support a further 33% capacity increase, from 90ktpd to 120ktpd (denoted Salobo IV). Notwithstanding its long-term underground potential, WPM believes such an expansion could 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.

Rosemont/Copper World is in the vicinity of 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 (c 8% of total US copper production), rising to c 101,000tpa after 16 years. Total byproduct 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.

The evolution of the project from Rosemont to Copper World

In March 2019, 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 (ACOE), 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).

A legal challenge, lunched in July 2019, has since delayed the project. 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, 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 explores the gap between Bolsa and Rosemont. Note that the Copper World discovery is included in WPM’s area of interest under its PMPA with Hudbay.

A new development plan

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 2022, and proposed a two-phase mine development plan. The first phase of the mine plan requires only state and local permits and demonstrates 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 will 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.

On 24 May 2022, 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 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. Within this context, the ACOE has never determined that there are jurisdictional waters of the United States 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 2022 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 and no requirement for a 404 (water) Permit. In May, Hudbay also received a favourable ruling from the US Court of Appeals for the Ninth Circuit that reversed the US Fish and Wildlife Service’s designation of the area near Copper World and the former Rosemont project as jaguar critical habitat. While this ruling does not affect the state permitting process for Phase I of Copper World, it is expected to simplify the federal permitting process for Phase II of the project. In the meantime, Hudbay continues to expect to receive the two remaining state permits required (an Aquifer Protection Permit and an Air Quality Permit) in H223.

PEA completed and PFS underway ahead of potential project sanctioning in 2024

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 and, in January, it received an approved right-of-way from the Arizona State Land Department that will allow for infrastructure such as roads, pipelines and powerlines to connect the properties in the company’s private land package. Shortly afterwards, it also announced the receipt of confirmation from the Army Corps of Engineers that its previous surrender of the Section 404 Clean Water Act permit for the former Rosemont project had been formally accepted and revoked, as requested.

Clearing and grading work to prepare for the Copper World site, including the construction of roads and other facilities, is underway. In the meantime, pre-feasibility activities for the private land Phase I of the Copper World project are reported to be well-advanced and a pre-feasibility study is expected to be released in Q323. Among other things, this 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 over the next 12 months, 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 such, Edison is continuing to forecast production from Rosemont/Copper World attributable to WPM from FY27. 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 to support its feasibility studies.

In April 2022, 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 and it hopes to achieve mine extension approval this year. The mine, which is co-owned by Glencore, BHP, Teck and Mitsubishi Corp, is Peru’s largest, and the world’s second-largest, copper mine.

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 (WPM’s carrying value of Pascua-Lama) 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 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. However, Barrick is advancing a high-level study into the project, which is thought to be nearing completion. The study is understood to be focusing on the fact that a substantial portion of the resource could be processed by leaching or agitated leaching, which would require only modest modifications to the circuit already built. This raises the possibility that the orebody could be developed in a different manner and Barrick’s goal is to demonstrate a viable project to both the Chilean and Argentinian governments. If successful, it would then pursue permitting options (and, in particular, water permits) and build out a new model for the project’s development, in which case an investment decision on Pascua-Lama could be made as early as 2024.

Wheaton reports that its development team remains ‘exceptionally busy’ evaluating new opportunities. In general, WPM expects to be conducting due diligence processes on approximately 10–12 projects at any one time, which it expects to narrow to three to four target projects over approximately 12 months. Most of the opportunities currently 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 included in the evaluation process. In the first instance, WPM would fund any such transactions via the US$2bn available under its revolving credit facility, plus the US$828.8m in cash that it has on its balance sheet (at end-Q223) 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, being:

In formulating our quarterly forecasts for WPM for Q323 and for the remainder of the year, we have reduced our gold price for the remainder of the year by 2.1%, from US$1,955/oz to US$1,914/oz and our silver price by 8.3%, from US$24.79/oz to US$22.74/oz, while increasing our palladium price by 2.8% – all to reflect currently prevailing prices. We have also honed our production and sales forecasts for Zinkgruvan, Neves-Corvo and Sudbury (albeit immaterially). As a consequence, our Q323, Q423 and FY23 full financial forecasts are now as follows:

Our updated adjusted basic EPS forecast of US$1.18 per share for FY23 compares with the market, as follows:

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 (most recently over Lumina’s Cangrejos mine in south-west Ecuador). As a result, rather than our customary method of discounting maximum potential dividends over the life of operations back to FY23, in the case of WPM (as with Newmont and Endeavour), we discount forecast cash flows back over four years from the start of FY23 and then apply an ex-growth terminal multiple to forecast cash flows in that year (ie FY26) based on an appropriate discount rate.

Compared with our previous estimates, our forecast for pre-financing cash flow has reduced in FY23 as a result of our assumption that Wheaton will now pay its full commitment for Salobo III of US$552m in FY23 (cf US$530m in FY24 previously). However, our pre-financing cash flow estimate for FY24 has increased commensurately and our estimate of WPM’s ‘terminal’ pre-financing cash flow in FY26 is, to all intents and purposes, unchanged, at US$2.65 per share, 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% (being the expected long-term required nominal equity return), our ‘terminal’ valuation of the company at end-FY26 is US$54.88 per share (cf US$54.92/share previously), or C$73.76 per share. However, it should be noted that this valuation is inherently conservative in that it assumes 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 7.4% per year from 1967 to 2022 and at a simple average annual growth rate of 9.6% per year (cf a compound average inflation rate over the same period of 4%).

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 21% pa for the 17 years between FY05 and FY22, while its operational cash flows per share have increased at compound average annual growth rate of 14.1% pa.

Excluding FY04 (part-year), WPM’s shares have historically traded on an average P/E multiple of 30.4x current year basic underlying EPS, excluding impairments (cf 37.4x Edison or 38.2x Refinitiv consensus FY23e currently – see Exhibit 12).

Applying this 30.4x multiple to our (ostensibly unchanged) EPS forecast of US$1.87 in FY26 implies a potential value per share for WPM of US$56.71 (cf US$56.77 previously) or C$76.23 in that year.

From a relative perspective, it is notable that WPM is cheaper than its peers on at least 63% (23 out of 36) of the valuation measures observed in Exhibit 13 if Edison estimates are used or 50% (18 out of 36) of the same valuation measures if consensus forecasts are used.

Stated alternatively, were WPM to trade at the average multiples of its peers, we calculate that its share price should be US$50.40, or C$67.75 currently, on the basis of Edison’s financial forecasts.

In this context, we note that, whereas Edison’s financial forecasts for Wheaton in years one to three imply improving profitability (based on improving volumes of production and sales superimposed on broadly flat metals prices), consensus forecasts appear to imply a much flatter profitability profile, suggesting that either the market is assuming smaller increases in volumes or a simultaneous decrease in metals prices.

As at 30 June, WPM had US$828.8m in cash on its balance sheet and no debt outstanding under its US$2bn revolving credit facility. As such (including a modest US$6.5m in lease liabilities), it had US$822.3m in net cash overall after generating US$202.4m in operating cash flow and paying out US$131.1m in (two) dividends during the quarter.

In addition, WPM has long-term investments, in the form of equity share- and warrant-holdings, in listed companies in the sum of US$255.5m as at 30 June, or the equivalent of US$0.56/share.

In FY23 we estimate that WPM will generate US$763.8m from (net) operating activities, before consuming US$847.7m (cf US$425.9m previously – lower on account of the deferral of the Salobo III payment) in investing activities and paying out up to US$271.7m in forecast dividends to leave the company with net cash of US$338.6m (cf US$834.1m previously) on its balance sheet as at end-FY23. However, investors should note that the timing of payments relating to the Salobo III, Santo Domingo, Blackwater, Goose, Curipamba, Marathon and Rosemont/Copper World streams is uncertain and inasmuch as investments are delayed, we calculate that it is possible that Wheaton could register a larger cash balance on its balance sheet by the year end. Either way, all other things being equal, in the absence of any major new asset acquisitions, we do not expect that Wheaton will require recourse to its debt facilities in the foreseeable future.