If you'd bought Silver Wheaton Corp. (NYSE: SLW) stock in its 2005 IPO and reinvested all dividends, you'd be holding on to a five-bagger today. That's incredible, given how volatile the precious-metals business can be. Silver Wheaton's dominant position in the precious-metals streaming business has certainly worked in its favor, and shareholders have been rewarded richly over the years.
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Going by Silver Wheaton's strong asset base and best-in-class margins, I wouldn't be too concerned about its growth potential. But there is one thing that could affect growth if it's not addressed in time: declining silver production.
When Silver Wheaton reported its fourth-quarter numbers some weeks ago, what struck me was the 26% slump in its year-over-year attributable silver production. Deliveries from some of the company's primary mine sources declined substantially, including Goldcorp's (NYSE: GG) Penasquito and Primero Mining's San Dimas mine.
Image source: Getty Images
For fiscal 2016, Silver Wheaton's silver production was down about a percentage point to 30.4 million ounces. That's not a big deal, but the problem is the streamer's projections: It expectsfiscal 2017 silver production to come in even lower at 28 million ounces, and thereafter to average 29 million ounces for the next five years. The question is: How will Silver Wheaton grow if production declines or stagnates?
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Why is Silver Wheaton's production falling?
As a streaming company, Silver Wheaton doesn't extract metals. It buys silver and gold streams from other miners in return for upfront financing. So if production at any of the third-party mines declines, Silver Wheaton suffers.
For example, silver production at Penasquito, which is primarily a gold mine, dropped almost 25% in Q4 because of lower grade. Through its streaming agreement with Goldcorp, Silver Wheaton is entitled to 25% of the silver produced for the life of the mine.
It's not that Silver Wheaton is the only one to have been hit, or that Penasquito has run out of valuable ores. Royal Gold's (NASDAQ: RGLD) deliveries from Penasquito have also tumbled in recent quarters, with its attributable year-over-year gold and silver production declining nearly 32% and 27%, respectively, during the six months ended Dec. 31. The pit is in a stripping phase that could last up to three years, after which production is expected to pick up. Meanwhile, Goldcorp has initiated extensive exploration studies in the region.
Another point to note is that mines have a limited life, and not all streaming agreements are for the life of the mine, which is why Silver Wheaton strives to build a diverse portfolio of streams. Silver Wheaton's 10-year contract on Capstone Mining'sCozamin mine, for example, is expiring this month. Likewise, its agreements with Barrick Gold (NYSE: ABX) entitle it to silver from the Lagunas Norte, Veladero, and Pierina mines only untilMarch 31, 2018. It doesn't help, either, that production at Barrick's Pascua-Lama, which was touted to be one of Silver Wheaton's most valuable mines, has remained halted for several years now. These examples also highlight the major risks with Silver Wheaton's business, which otherwise is lucrative and doesn't face traditional mining risks.
So does that mean Silver Wheaton could soon run out of revenue sources? Not quite.
What's in a name?
As its name suggests, Silver Wheaton primarily deals in silver. But soon enough, the company might rename itself Wheaton Precious Metals Corp., to reflect its decreasing reliance on silver. And that's exactly what's going to take care of the streamer's silver production concerns: The company expects gold to make up nearly half its production through 2021.
Despite lower silver deliveries, Silver Wheaton ended fiscal 2016 with record silver equivalent ounces as gold from Vale SA's (NYSE: VALE) Salobo mine jumped sharply. Just in August last year, Silver Wheaton had extended its agreement with Vale to buy an additional 25% of the gold produced from Salobo over and above its existing 50% entitlement for the life of the mine. Having interest in Brazil's largest copper mine with proven and probable reserves sufficient to support 50 years of mining at current production levels is no small potatoes.
In fact, Salobo can largely be credited for Silver Wheaton's transformation into a silver-gold streaming company from a primary silver streaming company, as evidenced by the green portion, which denotes Salobo, in Silver Wheaton's production profile chart:
Image source: Silver Wheaton's corporate presentation, April 2017.
It's never great to see a company's core revenue source under pressure, but Silver Wheaton's total production and revenue should remain stable in the coming years thanks to the company's increasing stake in gold. Meanwhile, Silver Wheaton might even enter new agreements or Pascua-Lama could be revived, both of which will boost its production further. While investors should watch the company's silver production closely, they needn't worry too much.
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