Description

Company Overview

Wheaton Precious Metals (NYSE:WPM) is a large cap precious metals streaming company with interests in 19 operating mines and 9 development projects (See Table 1). The company is focused on pursuing precious metal opportunities that provide exposure to long-life, low-cost assets and returning capital to shareholders through its cash flow-linked dividend. To better understand how WPM operationally compares to its peers, the differences between royalties, streams, and offtakes must be made clear: 

• Royalty – a contract that gives the owner the right to a percentage of commodity production or revenue in exchange for an upfront payment. 
• Stream – a contract where the mining company agrees to sell the stream owner a set percentage of the metal produced. The price per ounce is either a set price determined by a significantly lower gold price or a percentage of spot prices. 
• Offtake – a contract that behaves similarly to streaming, however the difference is that they are more associated with base metals and prices in the contract must include a variety of costs associated with making the product suitable to end users. 

WPM focuses solely on the streaming business model, meaning that they make large initial investments in exchange for metal delivery at a fixed price or certain percentage of spot. Inclusive in said contracts are negotiated purchase prices, the length of the stream agreement, and the timing for capital deployment. Upon metal production, the respective metals are delivered to WPM at various locations where the company can choose to stockpile the metal in hopes of a higher spot price, or to sell the metals at spot. Streaming companies bare lower operational risk which leads them to be focused on mine production and resource-to-reserve conversion as opposed to cost metrics such as all-in sustaining cost (AISC) or total cash cost (TCC). 

Table1: Select Core Assets

External Analysis

Spot gold (US$1,689/oz) and silver (US$15.08/oz) prices are up 34.7% and 7.9%, respectively, over the last year. Gold demand has largely been influenced by discretionary purchases in India, central bank purchasing, and demand from other investment instruments. Central Banks and ETFs have increased their physical exposure to the metal with the hopes of being able to rely on it as a store of value, but this notion has been challenged given volatility throughout March. It must be noted that gold thrives during times of macroeconomic uncertainty, not market "Armageddon", which is why demand has been pulled back as large market movements force the perceived risk of all investment classes, outside of cash, to increase. Additionally, India, one of the largest consumers of gold, has invoked a national shutdown to curb the spreading of COVID-19. Not only has this curbed demand from end-consumers, but it forced Titan Co., India's largest jeweler, to close all stores. 

From the supply-side, companies are implementing independent or state-enforced measures to help curb the spread of the virus. For example, governments in Peru, Argentina, South Africa, and Canada have all ordered shutdowns to all non-essential services (which in some cases means mining). Furthermore, access to mine sites typically requires fly-in fly-out transportation for workers, so some companies such as Glencore, Vale, and Newmont have taken precautions to place these mines on care and maintenance. Conclusively, mine shutdowns will restrict the ability for companies to make headway on exploration projects on top of being unable to mine more metal to keep a level supply. Thus, the supply-demand balance in the current precious metals market seem to be robust enough to support long term gold and silver prices of $1,400/oz and $18.00/oz, respectively (See Graphs 1 & 2). 

Current strength in precious metals prices bodes well for WPM as the company’s revenue mix is 53% gold and 40% silver, the remainder made up of cobalt and palladium production. Strong precious metal prices also support the advancement of greenfield and brownfield exploration efforts where said projects or companies may seek out royalty or stream agreements to secure initial non-market funding. However, many stream agreements in WPM’s portfolio are tied to the byproduct production of base metals. For example, Hudbay’s Constancia produces copper, but gold and silver as a byproduct. Weak base metal prices are supported by large projects coming online, such as First Quantum’s Cobra Panama mine, and diminishing global demand as a result of COVID-19. Thus, the likelihood of new base metal projects coming online may decrease. This impacts WPM directly as it lowers the likelihood of current non-producing streams from coming online (ie. Rosemont); forcing the company to seek out primary precious metal streams where development is supported by buoyant precious metal prices. 

Graph 1: Gold Price Forecast                                  Graph 2: Silver Price Forecast

Investment Thesis

Thesis 1: Underreaction to CRA Settlement

Due to the nature and complexity of royalty and streaming companies, as well as the emergence of pure-play royalty or streaming companies in the 2000s, taxation has always been unclear. In July 2015, WPM disclosed it received a proposal from the Canadian Revenue Agency (CRA) with regards to the company’s earnings in the 2005-2010 period that should have been taxed through the Canadian entity as opposed to foreign ones. The back taxes amounted to $1Bn; dwarfing WPM’s 2018 revenue of $800M. As a result, the company’s share price closed the year 41.1% lower than where it had started in 2015. Between then and when a settlement was reached in December 2017, the company traded very similarly to its peer group, however at a steep discount, which indicates that fundamentally, investors were still pricing in asset strength while being cognizant of the potential risks of back taxes. Upon a settlement being reached which was seen as a mere slap on the wrist, the company continued to trade similarly to its peers, but still remained at a discount. There was no reversion of their share price back to its original trajectory seen pre-CRA investigation as a result of the settlement, which is a strong indicator that the market is mispricing the security. 

Prior to the CRA investigation, WPM had traded at a large premium of 13% and 17% to its closest peers, Franco-Nevada (FNV) and Royal Gold (RGLD), respectively. Although it is fair that the share price declined as investors feared the worst as the company could have been insolvent if forced to pay $1Bn in back taxes, the settlement reached did not force the company to make any large one-time payment. The investigation proved to be non-fundamental to the core of the company’s business operations and did not impact metal being received from mining companies. There should have been a “correctional value release” that saw value unlocked tied to no tax uncertainty and the strong asset base the company is invested in. A lack of this “correctional value release” is still observed as the company trades at a discount to FNV and a slight premium to RGLD. 

To quantify the value of the unrealized “correctional value release”, a regression was performed against FNV as well as the larger peer set to see where WPM would have traded if the CRA had not investigated the company (See Graph 3). As observed, there is roughly 13-25% of value still left to be unlocked as a result of the settlement. Beyond this, it would be rational to think that the value discrepancy (as reflected by P/NAV, see comparable companies analysis) should close even further as if WPM was filling taxes incorrectly, than there is a looming threat that the CRA may investigate other peers as well; something that isn’t being reflected in the performance of other royalty and streaming companies. 

Graph 3: WPM Share Price Regression

Thesis 2: Strong Strem Portfolio

WPM is being inherently undervalued despite the strength of its streaming business model on top of the assets it remains invested in. WPM has worked hard to diversify its portfolio from silver and focus on a more equitable metal mix with gold while also exposing itself to palladium and cobalt. Gold and silver diversification allows WPM to naturally hedge against commodity price fluctuations. Exposure to palladium and cobalt, on the other hand, allow the company to participate in the strong supply-demand fundamentals that will keep these prices strong. 

Not only does WPM have a diversified portfolio of investments, but the assets the company invests in are low-cost and long-life. The company has a projected TCC of $421 and $430 per ounce in 2020 and 2021, respectively, while also focusing on driving gold equivalent production to a sustained 750 thousand ounces (koz) over the next five years (See Graph 4). Additionally, the company has the longest reserve life at 32 years, as compared to FNV’s 20 years and RGLD’s 14 years (See Table 2). Reserve life is very important and is an underlying driver of value for the business as it is indicative of robust and sustainable cash flow generating ability. Furthermore, as noticed in Table 2, this long reserve life is 60% higher than FNV’s, but FNV has 2.8x more operating and 3.9x more exploration assets. Conclusively, the projects WPM has invested in are owned by companies who have conducted extensive drill testing and focused on resource-to-reserve conversion to grow the amount of ore that is proven and probable to be pulled from the ground. 

This thesis point also further supports the first thesis point by showing that, fundamentally, the asset fundamentals of WPM are much stronger than FNV and RGLD. A continued focus on fundamental asset strength and the continued acquisition of Tier 1 streams should serve to support continued share price appreciation; especially given the robustness of precious metal prices. 

Table 2: Reserve Life                                                   Graph 4: Forecast Production & TCC

Thesis 3: Robust Capital Structure Management

The final thesis point explores how WPM is in the best position to inorganically grow its production in the future while still being able to maintain strong asset fundamentals and remaining healthy as a company. The company’s balance sheet remains robust with ample current liquidity to pursue moderate to large stream investments, with ample room to raise capital (See Graph 5). 

From a leverage standpoint, the company has a Total Debt / EBITDA of 1.20x, which although is higher than its peers at 0.86x, is still a healthy amount which the company plans to delever by 2022 and target a negative net debt position. Conclusively, with a plan to delver using operating cash flow, which is forecasted to be ~$700 million per year, the company should be well positioned to achieve its net debt goal. From a liquidity standpoint, the company is very strong with immediate liquidity of $1.23 billion ($104mm in cash and $1.13Bn in undrawn credit). Furthermore, the company recently announced a $300 million equity program which it may plan on acting upon opportunistically should access to further credit be unavailable. Combined with an operating cash flow projected to be ~$700 million annually, it could be said that WPM has access to $2.23 billion of liquidity and would use that to pursue investments in other moderate to large streams. 

The foundation of this thesis is founded in a robust balance sheet, but the realization and upside of it is based on the company’s pre-existing ability to manage billion-dollar investments with significant leverage. In 2015/2016, WPM participated in what was a wave of precious metal stream and royalty transactions totaling $5.5 billion. WPM spent $2.6 billion in that year to acquire two Vale streams and one Glencore stream. The company financed said transactions with debt and, over time, was able to organically de-lever their balance sheet while remaining cash flow positive (See Graph 6). Given their history of large investments, they have been able to truly fuel growth in a sustainable fashion and will be well positioned to take advantage of depressed base metal asset valuations and acquire streams on these large assets at a very opportunistic time. 

Graph 5: Leverage & Liquidity                           Graph 6: Historical Leverage

Valuation

Comparable Companies Analysis

WPM trades at a premium to its peer set across all major metrics; namely P/NAV and P/CF. However, FNV is its closest peer due to market and portfolio size as well as duration of existence. Thus, when looking at valuation multiples, it can be noticed that WPM trades at a steep discount to its closest peer despite having historically traded at a 13% premium pre-CRA investigation. It has already been established that there has been no “correctional value release” which can help partially explain the P/NAV and P/CF value discrepancies. This value discrepancy can also be explained by the one-turn difference between WPM and FNV leverage multiples, but does not explain the full picture as WPM has stronger assets and has shown an ability to manage their balance sheet responsibly; a component of the company that does not seem to be priced into their valuation. Finally, it seems as if the longevity of reserve life and other robust fundamental components of the company’s investments are being mispriced. It seems as if investors are only pricing in current cash flow generating power and not how long these companies can do it for. As well, the market is failing to fully price in assets such as Rosemont and the Salobo phase III processing facility upgrade which has restricted P/NAV multiple expansion. Conclusively, the value discrepancy observed between WPM and FNV is unjustified and the market continues to misprice WPM. 

Intrinsic Valuation

Using a long term gold price of $1,450/oz and a long term silver price of $18.00/oz and an equally weighted P/NAV and P/2020E CF multiple, a target price of $39.64 is arrived at implying an upside of 23.9%. Tying this back to thesis one, it can be observed that intrinsically the market is underpricing WPM intrinsically and are not giving full value to net assets. Sensitivity has been conducted to assess the change in valuation if commodity prices fluctuate as well as if certain multiples are achieved. 

Risks

• COVID-19 Impact – The recent health pandemic has created a headwind on the demand-side, but can expect to also create some on the supply-side. Penasquito, Constancia, Yauliyacu, and Voisey’s Bay were all forced to shut down as the countries that they operate in consider mining to be non-essential. If COVID-19 continues to spread in these countries, it can be expected that mines will continue to shut down, metal will cease to be delivered to WPM, and exploration will halt. Although WPM could remain solvent in such an event where all mines close, it would inhibit the company’s goals of achieving 750koz of gold equivalent production and eliminating debt. 
• Regulatory Approval – Regulatory issues pose a large threat to projects with the scale and scope of Rosemont. Hudbay has been trying to move the asset through the regulatory process for a long time and is currently at a standstill awaiting results on their appeal on an environmental ruling. However, intrinsic valuation for WPM employees a 10% instead of 5% discount rate to the asset and assumes that the mine will come online in 2023, which means that the overall impact to total NPV is minimal. 
• Commodity Price Fluctuations – Given that WPM is largely focused on precious metal byproduct streams, the company is inherently tied to both base and precious metal price fluctuations. Should copper prices, for example, remain subdued due to a lack of global demand, then this may inhibit exploration and development projects from moving to production. Similarly, should continued market skepticism occur, investment altogether may flock from gold to cash as investors seek safer and more liquid investments. This, combined with weakening demand from India, would place tremendous downward pressure on gold prices. 

Catalyst

Catalysts

• Advancement of Current Pipeline – WPM has a number of streams that are scheduled to commence production in 2021 and 2022 that will significantly impact the company’s top-line. Hudbay’s Rosemont asset was scheduled to commence construction in 2020, but ran into a final regulatory hurdle that the company is currently appealing that would have allowed construction to commence. Once producing, Rosemont is expected to be one of the largest copper producing mines in the world with significant gold and silver byproduct production. Voisey’s Bay, Vale’s cobalt mine, is expected to commence production in 2021 and will lend WPM exposure to the cobalt market where upward pressure on prices is expected due to technological advancements in transportation. Finally, Salobo is expected to commence construction of phase III of its mill expansion which will increase processing capacity 12Mt to 36Mt. This will increase affective gold output from 300koz to 330koz; significantly impacting WPM’s top-line. Conclusively, regardless of opportunities that may materialize or not inorganically, WPM still has significant growth potential given its current streams. 
• Further De-leveraging of Balance Sheet – The company forecasts that it will pay off all of its debt using operating cash flow by 2021. By doing so, the company will revert to peer average with respect to leverage and will be able to focus on its goals of opportunistic inorganic growth and returning value to its shareholders via a strong cash dividend. Upon de-leveraging, investors will begin to realize the full value of WPM’s streams which will drive multiple expansion. 
• Aggressive Inorganic Growth Strategy – The possibility of accretive acquisitions in the future will enable not only the company to increase its NAV, but will also call for multiple expansion as its portfolio becomes filled with more Tier 1 investments and is able to yield more metal production. The company has been able to generate $2Bn in excess free cash flow as a result of experiencing an exceptional 17.5% return on its investments. The company can further convert on their investments by using their investment intuition and management experience to ensure all investments are NPV positive and have high IRRs.