Wheaton Precious Metals Stock: A Cost Inflation-Resistant Play

Rows of golden and silver bars

Ravitaliy

Precious metals stocks are having a tough 2022. While the Au and Ag prices have fallen YTD, the AISCs have been rising, squeezing margins. In such an environment, the royalty and streaming business model offers cost inflation protection, while it maintains the potential upside in increasing PM’s prices scenario. Additionally, in raising interest rates environment, when market participants are in a risk-off mode, the access to capital for the development of mining assets becomes more difficult and expensive, opening opportunities for royalty and streaming as an alternative or supplementary financing source. With its strong balance sheet and available liquidity, Wheaton Precious Metals (NYSE:WPM) is in a great position to benefit from such environment. Q2’22 turned out to be challenging as production declined significantly, due to operational problems in some assets, which are expected to be resolved going forward. Looking at the valuation of the company, the current multiples are trading below its 5-year historical averages, which could offer some upside.

Company overview

WPM is a Canadian streaming company with a primary focus on precious metals (over 95% of revenue). The company has a diverse asset base, which includes 21 operating mines and 13 projects in advanced development stage. Geographically, the primary focus has been North and South America.

assets

WPM’s assets (WPM)

The business model of WPM is to generally purchase not the main metal that a mine will produce, but the by-products. Such is the case with the company’s flagship asset – Salobo, historically accounting for 55-60% of total gold production, which is a primary copper mine owned by Vale (VALE). However, WPM has a streaming agreement for 75% of gold production with a LOM term. In order to manage risk, WPM generally makes the upfront payment in a few instalments throughout the construction of the mine, reducing construction risk. The recurring payment part of the streaming agreements are at a nominal fixed price with a minor annual upward adjustment, typically fixed at around 1% or are fixed as a percentage of current spot prices at the time. This is a significant advantage of the royalty and streaming business model, especially in times like today, when miners are facing sharp increases in production costs.

quality

WPS’s asset quality (WPM)

WPM has been selective when entering into partnerships, which led to high quality of the asset base. For reference, 37% of production comes from mines within the lowest quartile in terms of operating costs, while only 5% is from the 4th quartile. Also, the life of mine of the operating portion of the portfolio is very high.

Capital structure

The company has slightly below 451.7M shares as of 11 August 2022 with the majority of it owned by institutional investors. The ownership structure is quite dispersed with the largest shareholder being the mutual fund management company Capital World Investors with 4.56% stake, followed by Van Eck Associates Corporation (4.17%) and First Eagle Investment Management (3.78%). There are 10M of outstanding warrants as part of the streaming agreement for Vale’s Salobo mine. The exercise price of these instruments is US$43.75, which is considerably higher than the current market price and the expiry date is 28 February 2023. There are also slightly below 1.7M options outstanding with a weighted average exercise price of CAD$38.59 (around US$28.42) per share.

Challenging Q2’22

The company had a tough Q2’22 as attributable production from assets dipped to 162.6k of gold equivalent ounces (GEOs), which is 14.6% lower YoY. The main reason for the decline were lower ore grades, lower throughput and some operational challenges in the flagship asset – Salobo. To make matters worse, the area around the Stillwater mine, operated by Sibanye Stillwater (SBSW), suffered a flooding, which led to the mine being shut down for a period of time.

production

WPMs attributable production (WPM)

However, the decline in revenue was lower, as the company dipped deeper into its PBND (payable but not delivered) and inventory, which declined by 24.3k GEOs, during the quarter, compared to a depletion of just 2k GEOs in Q2’21. Consequently, revenue for the quarter amounted to US$302.9M (-8.3% YoY) with gold and silver contributing 52% and 43%, respectively. Net income for the quarter fell 10.3% YoY to US$149.1M and the respective margin amounted to 49.2%. For H1’22, US$610.2M of revenue was generated (-6.8% YoY), while the bottom line amounted to US$306.5M (-6.6% YoY), bringing the net income margin to 50.2%. G&A expenses for the first half of the year increased slightly to US$19.1M (+2.4% YoY). However, dividends were also increased as a total of US$135.4M (+11.4% YoY) were distributed in two equal instalments of US$0.15/share each.

guidance

WPM’s 2022 updated guidance (WPM)

Due to the operational challenges in H1’22, especially in the second quarter, the company had to reduce its 2022 production guidance. In terms of revenue and earnings, I expect Q3’22 to be lower in both, as Au and Ag prices have fallen, but at least the company won’t face cost pressures unlike the actual miners.

Expansion plans and liquidity

The company is enjoying a strong balance sheet as it has no debt and cash and equivalents of US$449M (+98.7% YtD). Additionally, it has up to US2B available under a revolving credit facility, which was recently extended in July 2027. In August 2022, WPM announced that it has reached an agreement with subsidiaries of Glencore (OTCPK:GLCNF) to terminate the silver streaming agreement for Yauliyacu Mine for a cash payment of US$150M, which increases the cash position of WPM even more. That considerable liquidity position of over US$2.5B will be put towards expansion.

expansion

WPM’s expansion deals (WPM)

During the last year and a half, the company has entered into streaming agreements worth about US$1.5B, which are expected to boost production by more than 150k GEOs annually. In addition to other prior commitments, WPM has obligations of slightly below US$2.3B as of Q2’22 with a bit more than US$800M of it expected to be paid by 2024. The company projects 5-year average production to reach 800k GEOs in 2026 and 850k GEOs in 2031.

liquidity

WPM’s projected liquidity (WPM)

As the company continues to generate cash and the already available liquidity surpasses current commitments, there are is an opportunity for additional streaming agreements to be entered into. I see the current environments as very suitable for good deals. On one hand, mining companies are getting their margins squeezed, hence lowering the internally generated funds. On the other hand, as interest rates are being raised and central banks signal tightening of the monetary conditions, the cost of financing rises. This makes the streaming agreement a more attractive alternative to traditional funding sources such as equity offerings and debt.

Share price and valuation

Chart
Data by YCharts

Looking at YtD performance, WPM has significantly underperformed the SPDR Gold Trust ETF (GLD), which tracks gold prices, but has slightly outperformed the VanEck Vectors Gold Miners ETF (GDX). This is logical, since WPM has leverage on the gold price and Au has fallen since the beginning of the year. However, looking at longer horizon of 5-years, WPM has significantly outperformed both.

Chart
Data by YCharts

So is the company an attractive opportunity? Looking at the ratios at which the stock is currently trading could give us an answer. The initial impression that one may get at first glance is that the company is severely overvalued – after all it is trading at massive premium, compared to the sector. But one has to remember, that has always been the case, since “the sector” consists of primarily miners, which have much higher risk, hence trade at lower multiples. For that reason, I’ll judge WPM based on the comparison of its current multiples to their 5-year averages.

multiples

WPM’s ratios (Seeking Alpha)

Based on the current data, WPM appears to trade at a modest discount to its own 5-year historical average multiples, which makes me consider the stock more as a “buy” than a “hold”. That being said, this stock likely won’t yield exponential returns. So high-risk appetite investors within the precious metals space may want to look into individual stocks such as Aris Mining (OTCQX:TPRFF), which I covered here. Of course, then the very real threat of rising production costs alongside other risks gets back in the picture.

Risks

The business model of WPM really minimizes or straight out eliminates some of the risks that a typical mining company faces. First of all, the costs of the company are largely fixed, which is a big advantage, especially in times like today, when miners are hit by significant cost inflation. In addition, a streaming company will generally not bear any exploration or permitting risk, as the bulk of payments to the miners are paid as construction of the project is already started and progresses. Moreover, the assets of WPM are spread around multiple jurisdictions, which minimizes political risk. All of these reasons give Wheaton Precious Metals a far superior risk profile than a miner would have. However, there are still some risks that WPM faces.

Key asset risk

Although WPM has a diverse portfolio of assets, one particular asset – Salobo stands out with its significant share in total revenue. In a typical year, it accounts for 55%-60% of total gold production, which translates into 27%-30% of total revenue. This is quite significant exposure for a streaming company, especially considering that WPM plans to invest further US$646M in Salobo’s expansion in 2023-2024, so the mine will have even bigger share in total production and revenue. If such key asset faces operational challenges, just like it did in H1’22, the overall performance of WPM will suffer considerably.

Interest rate risk

The inverse relationship of precious metals and interest rates is well known. For that reason, an environment of raising interest rates, such as the current one is expected to negatively affect the prices of those commodities. Moreover, higher interest rates lead to higher required rates of return and lower valuations as a result. However, I’d argue that higher interest rate environment could also have benefits for WPM, as the company could enter into lucrative deals, since miners are faced by higher borrowing costs and more dilutive equity offerings.

Conclusion

WPM offers a diversified and leveraged exposure to precious metals, compared to the commodities themselves. Currently, the stock is trading below its 5-year historical average ratios. Unlike mining companies, it has largely fixed and very predictable cost profile. The strong balance sheet and high levels of available liquidity provide an opportunity for further expansion. WPM looks as a suitable instrument for investors, who don’t want to pick individual stocks and bear higher risk, to achieve exposure to the precious metals sector.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Top Ex-US Stock Pick competition, which runs through November 7. This competition is open to all users and contributors; click here to find out more and submit your article today!

Be the first to comment

Leave a Reply

Your email address will not be published.


*