Image Source: Wheaton Precious Metals Corporation – IR Presentation
By Callum Turcan
Gold and silver prices have been on an upward trend of late and that has worked wonders for Wheaton Precious Metals Corporation’s (WPM) stock price. Shares of WPM trade near ~$26.70/share as of this writing, well above our fair value estimate of $21/share and the upper end of our fair value range of $26/share. Our intrinsic valuations are based on our fastidious approach to enterprise cash flow analysis. We model out the expected future free cash flows of publicly traded companies under reasonable assumptions and discount those free cash flows at the appropriate rate (the estimated weighted average cost of capital). As Wheaton Precious Metals has gotten ahead of itself in our view, we aren’t interested in shares here given that they may continue pulling back after upward momentum turned negative in early-September. Shares of WPM yield 1.4% as of this writing.
In July 2018, Wheaton Precious Metals announced an agreement with Sibanye Gold Ltd (SBGL) to gain the rights to (its more like putting down a deposit as these funds are utilized later to reduce the initial price Wheaton Precious Metals pays on a volume basis for metals) a gold and palladium stream in the Stillwater and East Boulder mines in Montana for an upfront advanced cash payment of $0.5 billion while also agreeing to purchase a certain amount of future gold and palladium production at predetermined rates (please note those rates initially take the upfront cash into consideration until that balance has been completely drawn down, then generally speaking, the rate Wheaton Precious Metals pays on a percentage of a benchmark basis goes up).
A month earlier, Wheaton Precious Metals agreed to gain the rights to a cobalt stream from Vale SA’s (VALE) Voisey’s Bay mine in Canada for an upfront advanced cash payment of ~$0.4 billion along with agreeing to purchase a certain amount of cobalt at a predetermined rate. Wheaton’s business model requires very modest capital expenditures outside of making upfront payments to lock in streaming rights, keeping in mind the upfront cash payment is really more like a deposit.
As an aside, due to Cobalt 27 Capital Corp (OTCQX:CBLLF) getting acquired by Pala Investments Limited in June 2019 (keeping in mind Cobalt 27 also owns streaming rights at the Voisey’s Bay mine), Wheaton Precious Metals was forced to take an impairment charge relating to the value of its streaming rights in the second quarter. Here’s an explanation why, from Wheaton Precious Metal’s latest quarterly report:
On June 18, 2019, Cobalt 27 announced that it had entered into an agreement with Pala Investments Limited (“Pala”) whereby Pala would acquire 100% of Cobalt 27’s issued and outstanding common shares. The estimated implied price paid by Pala for Cobalt 27’s streaming agreement on the Voisey’s Bay mine was significantly lower than the original upfront cash payment paid by Cobalt 27 to Vale at the time their agreement was entered into. The implied purchase price paid by Pala to acquire Cobalt 27’s Voisey’s Bay stream was determined to be an indicator of impairment relative to the Company’s Voisey’s Bay PMPA. The Voisey’s Bay PMPA had a carrying value at June 30, 2019 of $393 million. Management estimated that the recoverable amount at June 30, 2019 under the Voisey’s Bay PMPA was $227 million, representing its FVLCD and resulting in an impairment charge of $166 million.
Impressive FCF Growth Potential
Down in the graphic below we highlight our estimated free cash flows for Wheaton Precious Metals over the next five fiscal years and its historic free cash flows over the past three fiscal years, keeping in mind we define free cash flow as net operating cash flow less capital expenditures. This graphic is from our 16-page Stock Report covering Wheaton Precious Metals. Forecasted net operating cash flow growth is key here, which averaged ~$0.5 billion per year from 2016 – 2018. New streaming rights will help push that up closer to $1.1 billion by 2023 in our view.
Image Shown: We expect material free cash flow growth at Wheaton Precious Metals over the coming years. However, that growth still isn’t strong enough to justify its current stock price.
In 2018, the company spent $133 million on its dividend payments and we generally like Wheaton Precious Metals’ payout coverage. The firm’s expected free cash flows should be able to easily cover its future payouts but we caution that management has been actively considering making another big streaming acquisition. Wheaton’s per share dividend payout hasn’t grown much since 2017 and we expect that will continue being the case going forward due to the company’s focus on growth (which will drive up capital expenditures in an uneven way).
Management thinks that any future streaming deal could be covered using Wheaton Precious Metals’ $2.0 billion revolving credit facility. Streaming deals being considered are in the $0.5 billion to $1.0 billion range. While we like that Wheaton’s net debt load fell from $1.2 billion at the end of 2018 to $1.0 billion at the end of June 2019, we caution that its expansion plans and related net debt load are hampering its potential dividend per share growth. Net debt competes with dividends for uses of future free cash flows.
What We Think
Here’s what we have to say about Wheaton Precious Metals, from our 16-page Stock Report:
Wheaton Precious Metals is the world’s largest precious metal streaming company and keep in mind the company does not own or operate any mines; streaming allows the firm to purchase a fixed percentage of silver, gold, palladium, and now cobalt produced from mining operations at a predetermined price. The firm is still very much exposed to fluctuations in commodity prices and the state of the global economy. While Wheaton Precious Metals generates some of the highest cash operating margins in the industry, but we’re not sure that such hefty margins are sustainable in the long run. Around 90% of its production comes from assets in the lowest half of the cost curve.
The expected relationship between supply and demand for any commodity will always create price volatility. Wheaton does not hedge its long-term exposure to commodity prices. While silver and gold have industrial uses, their value primarily rests on the eye of the beholder. Cobalt is key for making batteries and palladium is used to make catalytic converters.
From 2019 to 2023, Wheaton Precious Metals expects to derive 51% of its revenue from gold, 42% from silver, 4% from palladium, and 3% from cobalt. Brazil, Peru, and Mexico are expected to represent the three largest sources of Wheaton’s revenue by geographic location during this period. As of July 2019, Wheaton Precious Metals sees its existing asset base having enough reserves to sustain producing operations for more than 30 years. The future of the luxury and automobile industries will play a key role in Wheaton’s financial trajectory.
While Wheaton’s business model is interesting, the industry it’s operating in is tough to crack. Timing is everything in the highly cyclical world of mining and investors can get burned by picking great companies at the wrong time. Here’s how we view the diversified mining industry as it relates to shareholder value generation, from our 16-page Stock Report:
The diversified mining industry is highly cyclical and almost entirely commoditized, with little differentiation from one firm to the next. Rising input costs can only be passed on to consumers if industry-wide prices increase. Exploration and development require large capital investments, which could pressure cash flows during weak economic times. A miner’s position on the cost curve for each respective resource is a critical investment consideration, given the volatility of commodity prices. Though emerging market growth will be a key source of demand for years to come, we don’t like the structure of the group.
Rising geopolitical tensions and the possibility of a lower interest rate environment have acted as powerful tailwinds to the price of silver and gold, which has greatly behooved Wheaton Precious Metal’s stock price. We caution that shares of WPM appear overvalued here given that silver and gold prices would need to keep moving higher to justify its current valuation. There’s a lot to like about Wheaton Precious Metals, but not at this price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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