Understanding Silver Wheaton (SLW)

Silver Wheaton (SLW) closed at $40.84 on December 6th, 2010.  Over the past year, SLW has traded in the range of $13.04 to $40.99.

SLW is the world's largest silver streaming company.  Silver streaming is when a company buys the rights to all or part of a mine's silver production.  There are three main benefits to silver streaming, a low fixed rate cost per ounce, no operational risk, and no further capital expenditures (after the initial agreed payments).

Why would a company sell streaming rights?  In most cases, the streaming rights are to a byproduct such as silver and the upfront payment can immediately be used to invest in the mine.

Let's take a look at the agreement SLW made on September 8th, 2009 with Barrick Gold Corp(ABX). 

SLW made an initial upfront payment of $350MM with two additional payments of $137.5MM required on the second (2011) and third (2012) anniversaries of the agreement for a total of $625MM.  SLW agrees to purchase 25% of silver production at a cost of $3.90 per ounce of the Pascua-Lama project (life of the mine) and 100% of silver production of 3 mines (Lagunas Norte, Pierina and Veladero) until 2013. 

As part of the agreement, ABX is required to complete Pascua-Lama of at least 75% of operational design by December 31st, 2015.  If there is any shortfall during 2014 and 2015, SLW would be entitled to silver from the 3 mines referenced above until the shortfall is met by completion.

For the above agreement, SLW is forecasting 9MM ounces per year starting in 2013 for the first 5 years.

During the prior month of the agreement, silver traded in a range of $13.50 to $15.00.  Now we can look at the economics of the deal for SLW starting in 2014.  

9MM ounces at a cost of $3.90 per ounce

Low price of previous month $13.50, gross profit $9.60 per ounce or $86.4MM.  Payback period (625/86.4) is 7.25 years.

High price of previous month $15.00, gross profit $11.10 per ounce or $99.9MM.  Payback period is 6.3 years.

Current price (11/29/2010) $27.00, gross profit $23.10 per ounce or $208MM.  Payback period is 3 years.

This simplistic analysis does not take into account the time value of money or other costs associated with the company.  For this post, the goal was to understand the business and in the follow up article I will take a more thorough look at valuation.


Reference:

3Q 2010 Results
http://www.silverwheaton.com/Theme/SilverWheaton/files/2010_Q3_Financial_Statements_and_MDA_-_FINAL.pdf

Company Fact Sheet
http://www.silverwheaton.com/Theme/SilverWheaton/files/docs_company%20fact%20sheet/2010-10-08_October_2010_Fact_Sheet_FINAL__for_web_.pdf