Wheaton Precious Metals — Teeing up to hit long-term targets

Wheaton’s Q323 production of 154,800oz GEOs and sales of 119,030oz GEOs were 2.3% higher and 1.3% lower than our prior expectations, as a result of which WPM recorded revenue for the quarter that was 1.0% lower than our forecast. However, this was more than balanced by lower than expected costs of sales and centralised expenses to result in a positive variance of US$4.0m (or 3.4%) at the pre-tax level and one of US$4.2m (or 3.6%) at the post-tax level.

A complete analysis of WPM’s underlying financial and operating results relative to both Q223 and Edison’s prior expectations is provided in the exhibit below:

As a result, Wheaton’s adjusted EPS exceeded both Edison’s forecast for the quarter and the prior market consensus:

At the level of the individual mines, Constancia, Zinkgruvan, Neves-Corvo, Marmato, Sudbury and Stillwater all outperformed our prior expectations in terms of production, while Los Filos and Aljustrel underperformed.

Compared with the prior year period, Constancia and Sudbury benefited from a rising grade profile, while San Dimas, Antamina and Voisey’s experienced a falling one (albeit this was counteracted in the case of San Dimas by higher mill throughput). Most striking was production at Salobo, where production of gold attributable to WPM was a) at its highest since Q419, b) close to record levels and c) almost exactly where it was predicted to be, given the level of copper production reported by Vale in the quarter as Salobo III continues to ramp up, as shown in the graphs below:

Entering Q423:

At 29.4%, the degree of under-sale of gold in Q323, relative to production, was materially higher than the prior historical average of 6.8% (from Q112 until Q223) and a record in terms of ounces, albeit 79% of the sales shortfall (or 24,601oz out of 31,010oz) could be accounted for by the shortfall at Salobo as sales lagged the ramp-up of Salobo III. By contrast, the 11.8% under-sale of silver relative to production was exactly in line with its prior historical average 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 more than a third (or 26,520oz) to 99,923oz, silver ounces produced but not delivered decreased by 15.5% to just 1.1Moz.

Consequently, we calculate that gold and silver ounces produced but not yet delivered as at end-September now amount to 3.33 and 0.76 months of full-year production (cf 2.67 and 0.79 months as at end-Q223 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$10.3m, non-stock G&A expenses in Q323 were 12.0% below the bottom 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 9, below):

The analysis of stock-based G&A expenses over the past 16 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 14.

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:

The decline in Edison’s gold equivalent forecasts in FY23–27 and FY23–32 arise almost solely as a result of the cessation of zinc and lead concentrates at Aljustrel from September 2023 until Q225. Otherwise, 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 87.2x, 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 600.9koz gold equivalent (AuE) for FY23 self-evidently lies within WPM’s guidance range of 600–660koz AuE.

Otherwise, readers will note that Edison’s medium-term production forecasts are within 2% of WPM’s guidance for the period FY23–27 and within 5% 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 in the time frame indicated).

As per Hudbay’s recent earnings releases, full mining activities have resumed in the Pampacancha pit since February, as a result of which we are forecasting that gold production attributable to Wheaton from Constancia will remain at elevated levels into FY25 (see ‘Constancia site visit overview’, below).

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:

Physical completion of the Voisey’s Bay mine extension is reported, by its operator, Vale, to be 88% complete, while the underground project is in the process of ramping up to full production. Within that:

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.

In the medium term, Wheaton has six brownfields 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, depending on the timing of the production increases. Where before Edison had been forecasting that Wheaton would make one payment of US$370m in FY24, when the 32Mtpa test is completed, followed by a further one of US$140m in FY25, when the 35Mtpa test is completed, we now believe (in line with Wheaton’s disclosures on ‘other contractual obligation and contingencies’ in its management discussion & analysis) that it will make its first US$370m payment 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.

Once full capacity at Salobo III has been completed, however (NB expected in FY24), 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 US, with initial output of c 92,000t copper per year (c 98 of total US copper production), potentially rising to c 101,000tpa. Total by-product production of silver attributable to WPM is estimated to be c 1.6Moz 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, launched 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 consisted 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 continues to explore the gap between the Bolsa and Rosemont deposits. 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 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 required only state and local permits and demonstrated a 16-year mine life. The second phase then extended the mine life to 44 years and incorporated an expansion onto federal lands to mine the entire Rosemont and Copper World deposits. Under any circumstances, 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 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 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 and PFS completed 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 0.40% copper grade. 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.

On 8 September 2023, Hudbay announced the results of its enhanced PFS for Phase I of Copper World (requiring state and local permits only). The main findings of the study were as follows:

Hudbay will now 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 a consequence, Edison is continuing to forecast the start of mining at Copper World in FY27 in the form of pre-stripping activities. However, we have put back our estimate of the first production of gold and silver doré from Rosemont/Copper World to FY32 to coincide with the installation of the SX/EW plant in year five of the project’s life. Readers should nevertheless 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.

In April 2022, Antamina announced a US$1.6bn investment (now estimated at US$2.0bn) 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 (EIA) 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 streams and that it has experienced an ‘influx’ of new opportunities over the course of the past few months. 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 in the US$100–300m size range, although there are also reported to be some more advanced, high-margin, purely precious metals mines included in the evaluation process and some opportunities in excess of US$400m. In the first instance, WPM would fund any such transactions via the US$2bn available under its revolving credit facility, plus the US$833.9m in cash that it has on its balance sheet (at end-Q323) 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:

From 27–30 September the operator of the Constancia mine in Peru, Hudbay Minerals, hosted a site visit for analysts attended by the author of this report, among others. Constancia is a significant stream for Wheaton and we estimate that it will account for c 14.1% of its sales in FY23.

A summary of our observations from the visit is as follows:

In formulating our quarterly forecasts for WPM for Q423 and for FY23, we have reduced our gold price for the remainder of the year by 1.4%, from US$1,968/oz to US$1,940/oz, our silver price by 4.3%, from US$23.25/oz to US$22.26/oz, and our palladium price by 13.0%, from US$1,104/oz to US$1,033/oz, to reflect current prevailing prices. We have also removed our future production and sales forecasts for Aljustrel. As a consequence, our Q423 and FY23 full financial forecasts are now as follows:

Our updated adjusted basic EPS forecast of US$1.10 per share for FY23 compares with the market, as follows:

In addition to our short-term gold price and production forecasts, on 27 September 2023, Edison updated its long-term gold price forecasts in its report, Shades of the 1970s.

Readers are invited to read the report at their leisure. In the meantime, a summary of our conclusions – while recognising the scope for significant upside – is provided in Exhibit 16, below.

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.

Relative to our previous note published on 23 October 2023, a summary of the principal changes to our financial model is as follows:

As a consequence of these changes, our estimate of WPM’s ‘terminal’ cash flow in FY26 has increased by 6.3%, from US$2.71 per share to US$2.88 per share, as shown below:

Readers should note that 88% of the increase in our estimate of FY26 cash flows is attributable to the changes in our long-term metals prices. Otherwise, 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$59.74 per share (cf US$54.02/share previously), or C$82.44 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, a simple average annual growth rate of 9.6% per year (cf a compound average inflation rate over the same period of 4%) and a compound average real annual growth rate of 3.3% per year.

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 a compound average annual growth rate of 14% 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 39.0x Edison or 39.6x Refinitiv consensus FY23e currently – see Exhibit 20).

Applying this 30.4x multiple to our increased EPS forecast of US$2.07 in FY26 (cf US$1.90/share previously) implies a potential value per share for WPM of US$62.78 (cf US$57.71 previously) or C$86.64 in that year.

From a relative perspective, it is notable that WPM is cheaper than its peers on at least 55% (20 out of 36) of the valuation measures observed in Exhibit 20 if Edison estimates are used or 30% (11 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$45.15, or C$62.31, 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 onto rising metals prices), consensus P/E and yield forecasts, in particular, 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 September, WPM had US$833.9m in cash on its balance sheet and no debt outstanding under its US$2bn revolving credit facility. As such (including a modest US$6.2m in lease liabilities), it had US$827.7m in net cash overall after generating US$171.1m in operating cash flow, investing US$98.9m and paying out US$67.0m in 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$200.9m as at 30 September, or the equivalent of US$0.56/share.

In FY23 we estimate that WPM will generate US$713.9m from (net) operating activities, before consuming US$584.5m (cf US$295.7m previously – on account of the rephasing of the initial Salobo III expansion payment into Q423 and the Mineral Park PMPA acquisition) in investing activities and paying out up to US$271.7m in forecast dividends to leave the company with net cash of US$551.8m (cf US$844.7m 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.