Here's a quick and dirty fundamental analysis of Silver Wheaton (SLW).
Story: SLW is a silver royalty company providing pretty pure leverage to the price of silver without depending on the futures and options exchanges.
The business model is that they help finance mines (usually where silver is just a byproduct) with up front payments and in return SLW gets an option to buy all or a fixed fraction of the mine's silver production at $3.90 per oz. Once the deal is done, SLW is insulated from rising mining costs and non-silver falling metal prices up to the point where either or both cause a mine closing. Being diversied across more than a dozen mines and several mining friendly countries reduces company risk. SLW typically receives whatever brownfield exploration up-side associated with the finding and mining of more silver on the same basic property as the original mine. This is a non-trivial upside.
SLW has a nice Warren Buffet-style moat that protects it from direct competition. SLW receives a premium P/E valuation over all other metals (especially base metals). This allows SLW, as the only "silver streaming" business the ability use its own high valuation to more attractively provide financing to these other-metal mines than ordinary financial companies. Being the only (and quite sizable) "silver streaming" business they have the ability to use their size to compete against any "silver streaming" startups. In fact, they just acquired Silverstone (SST.V) which was their only (and much smaller) silver streaming competitor. This competitive "moat" is another significant upside to SLW valuation although this analysis does not factor it in.
SLW is a "wealth in the ground" (James Dines) play.
The basic approach I'm going to take is a price to underlying value ratio valuation. We want this to be as low as possible and be under 1.00. To properly value SLW's assets we need assumptions about:
- What the price of silver will be over time - by making a convenient assumption about this I'll be avoiding having to estimate when silver is produced and discounting it to get an NPV.
- How much silver SLW will eventually extract. This will be based on SLW's proven/probable reserves for a conservative outlook (without any accommodation for brownfield exploration). Another view, which has an allowance for brownfield exploration, is provided by using SLW's NI43-101 Measured And Indicated resources (after estimated recovery) as an estimate of exploration upside. This may or may not be conservative. NOTE: I'm not including premature mine closures or the nationalization of mines. This is a real risk, but it is diversified across SLW's portfolio of mines which are located in multiple countries and is based on multiple different metals as the mine's primary product.
Price Of Silver Outlook
My outlook is pretty bullish. The sky-high (or negative) P/E ratios of virtually every primary silver producer is an indication that current prices are barely able to cover extraction costs. I expect extraction costs to increase as:
- Money-supply based inflation really kicks in. This inflation should raise the dollar price of silver but not raise SLW's $3.90/oz cash cost of silver.
- Peak-Oil kicks in increasing the cost of just about everything related to mining exploration, extraction and refining.
Demand fundamentals for silver seem strong to me as:
- photographic demand has fallen about as far as it can,
- electronic and other industrial applications are growing faster than the world economy (and thus faster than the supply of metals that are the primary product of SLW's mines) and
- investment (monetary)
demand rises as an inflation / currency hedge as sovereign (and other) debt triggers more central
The existence of the Ted Butler uncovered big silver shorts provides a possible source of a spike in silver prices (if the big shorts ever have to cover). Silver Wheaton is immune to a potential COMEX default as its contracts are for silver delivery from the silver miners themselves and do not depend on indirect derivatives.
Valuation Basics (Price And Liabilities):
18$, Stock Price Per Share
355M, Fully Diluted Shares
6.390B$, Market Cap
426M$, Liabilities (Debt)
Valuing SLW Assets
For this analysis we assume that the price of silver grows from the base in the valuation table below at the same rate as a risk-free treasury-bond. Whether you accept this or not depends on your outlook for silver. This assumption eliminates the need to do a discounted cash flow analysis of SLW production over time.With this simplifying assumption and the estimated silver price we can estimate the net present value of each silver oz that SLW will eventually receive at the silver price minus SLW's $3.90/oz cash cost.
Now, how many oz does SLW have? They claim they have 924.8 million (MM) oz of contained proven / probable silver. However, when you factor in the recovery rates its quite a bit smaller. This calculation requires about a half-an-hour of spreadsheet manipulation (not included in this post). The recovery rates can be kind of smallish because the silver is a byproduct and the focus of the mill is not on maximizing silver recovery. With this factored in the the proven-probable falls to 558 MM oz. The fact that a half-an-hour of spreadsheet manipulation is required to get the true facts about proven / probable oz gives you a little read (not very flattering) on the transparency and character of SLW management.
Using the same overall estimated recovery against the entirety of SLW's Measured and Indicated oz yields 793 million (MM) recoverable oz.
With all that in mind (and without including any additional accretive acquisitions, unexpected mine closures, etc.), here's the table that provides an estimated price to underlying value ratio for SLW.
The $12.00 starting price of silver column shows that SLW can withstand a 33% reduction in the long-term price of silver and still be not too-bad off provided it can get enough brownfield exploration to turn the M&I oz into proven/probable oz. I consider this to be significant long-term down-side protection.
The $18.00 (current) starting price of silver column shows that SLW is reasonably undervalued on this post's price to value basis even with the conservative proven/probable oz based asset estimation and is significantly undervalued should brownfield exploration convert much of the M&I extra oz to proven / probable.
The $24.00 and $36.00 columns show that SLW is leveraged to nominal rises in the price of silver (its valuation rising faster than silver) and that multibagger potential exists should that happen.
Overall, I think the situation is attractive provided the price of silver holds up or increases and I'm reserving a bunch of shares at $15.00/sh having bought Jan 2011 call options.
What am I missing and how would you improve this analysis? Do you buy my "price of silver rises with the risk-free treasury bond" assumption? Leave me a comment.
P.S., SLW is a much larger-cap company than most that I cover. I'm such a small-fry that any kind of positive review I provide will do nothing to move the stock price. This post is just another case where I'm using this web site to get my own investment case clear for myself and anyone else (you dear reader) who might possibly benefit from my thinking.