When investors are looking for stable, low volatility income stocks, they rarely look in the direction of precious metals producers. In particular, silver stocks tend to be quite volatile given the massive price swings the metal can exhibit in the market.
However, that doesn’t mean these stocks should be ignored outright. The share prices of these companies tend to overshoot to the upside and downside when metal prices are moving up or down, respectively. This can create opportunities for bold investors willing to stomach a bit of volatility.
That’s the situation we find today with Wheaton Precious Metals (WPM), a metals streaming company. In this article, we’ll take a look at Wheaton’s recent financial results, its prospects for growth, and its dividend to assess its viability as an investment today. We see Wheaton as having overshot sizably to the upside, meaning the stock is very expensive, and should be avoided until a meaningful pullback is seen.
Recent Financial Results
Wheaton is different from mining companies in that it streams metals rather than actually pulling them out of the ground. In essence, this means that Wheaton makes agreements with mining companies to acquire metal production for an initial upfront payment, plus an additional cash payment for each ounce or pound of metal that is delivered. This is predetermined in the contract and is generally at or below the prevailing market price for the metal. This model wherein Wheaton purchases metal production and then resells it, somewhat akin to the way a retailer buys and resells product for a markup, affords it tremendous operating leverage in both directions when metal prices move.
Wheaton posted its most recent earnings results on 8/8/19, marking the halfway point in the company’s fiscal year. Results were largely in line with expectations as Wheaton produced $189 million in the second quarter. Sales volume came to 90,100 ounces for gold, 4.2 million ounces for silver, and 5,300 ounces of palladium.
Wheaton’s primary source of revenue is gold streaming, but it has significant exposure to silver as well, producing several million ounces annually. In addition, it recently began streaming palladium in a bid to diversify away from gold and silver, although palladium volumes are still quite low at the moment.
Revenue was off 11% from the year-ago period when it produced $212 million thanks to a 29% decline in silver volume, as well as a 10% decline in average realized silver price. This weakness was partially offset by a 3% boost to gold volume, as well as slightly better average realized gold price.
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Average costs rose in Q2 for gold and silver, which resulted in lower operating margins. Gold cost per ounce was up to $420 from $407 in the year-ago quarter. Silver followed suit with a sizable increase from $4.54 to $5.14 per ounce. Cash operating margin per ounce was $900 for gold, $9.79 for silver, and $1,134 for palladium.
Adjusted net earnings were $0.10 in Q2, up from a loss of $0.16 in last year’s Q2. We believe Wheaton will produce $0.53 in earnings-per-share this year.
Wheaton’s growth over time is heavily dependent upon the market price of the metals it streams given that its production costs are largely fixed.
Source: Investor presentation, page 8
This slide from a recent investor presentation shows how Wheaton’s cash operating margins move up and down over time given that its operating costs don’t move a great deal, but metal prices certainly do. This means that earnings move wildly over time as metal prices move up and down.
Wheaton’s growth is also dependent upon production volume, another factor over which it has no control. We see 7% annual growth coming for Wheaton in the next few years as it funds new production, and as metal prices have performed very well of late.
There is additional cash available for reinvestment given that Wheaton had a small number of mines shift production or cease production in 2018. That cash is being used to fund new agreements, which should push volumes higher in the coming years. Indeed, management believes strongly that production volumes will rise meaningfully in the coming years, including the eventual ramping up of palladium production.
To reiterate, investors should note that Wheaton is beholden to metals prices more so than economic conditions or any other sort of external factor. The amount of each metal that is streamed, in addition to the sale prices the company can achieve determine how much money it can make. This model works beautifully in times of rising metals prices, but can be quite harmful when prices turn down. Because of this, growth will be nonlinear.
Wheaton pays 30% of its past four quarters of cash generated by operating activities in the form of dividends. That means the payout rises and falls sharply at times, but we see the current $0.36 payout as sustainable. That is good for just a 1.2% yield on the current share price following a sharp rally in 2019.
That rally has also extended the valuation to what we view as unsustainable levels. Today, shares trade for 56 times this year’s earnings estimate, more than double our estimate of fair value at 25 times earnings. That introduces an enormous headwind to total returns as the stock’s valuation should come well off of its current levels over time.
Given the mid-teens headwind from the valuation, the diminutive yield, and ~7% earnings growth estimate, Wheaton is poised to produce solidly negative total returns in the coming years.
Given an unfavorable total return outlook driven by an untenable valuation, we rate Wheaton a sell. The stock has favorable fundamentals and a strong earnings outlook today given that it has cash to invest and metals prices are performing well. However, this is already priced into the stock and then some, meaning investors have to pay far too much today to gain access to this growth. We like Wheaton’s model, but suggest investors wait for the share price to come down closer to our mid-teens fair value price from $30 today.