RGLD - Wheaton Precious Metals: Growth With Risks (Rating Downgrade)

2023-12-07 13:03:05 ET

Summary

• Wheaton Precious Metals Corp. released its Q3 earnings, reporting $223 million in revenue, $171 million in operating cash flow, and $116 million in net earnings.
• The company has a strong cash balance of $834 million and no debt, with an additional $2 billion available under its revolving credit facility.
• Wheaton recently made several acquisitions, including streams from Ivanhoe Mines' Platreef Project, BMC Minerals' Kudz Ze Kayah Project, and a gold stream from Dalradian Gold's Curraghinalt Project, adding complexity and potential risks to its production.

Wheaton Precious Metals Update

In the latest update on Wheaton Precious Metals Corp. ( WPM ), the company recently released its latest earnings report along with the announcement of an exciting $500 million streaming deal.

Reflecting on my previous coverage from March, I had a positive outlook on Wheaton's stock. Despite facing challenges at the Salobo mine and others, Wheaton has consistently demonstrated stability in the gold and silver industry. Bolstered by a strong cash balance of $696 million and the absence of debt, the company is well-equipped to actively pursue additional streaming and royalty agreements, boasting a notably robust balance sheet.

Looking ahead, Wheaton's prospects remain highly optimistic. The company forecasts a significant 27% growth in average annual production over the coming five years, with the potential for even greater expansion, particularly with the development plans at Salobo. Wheaton is targeting a long-term goal of reaching or exceeding annual production of 900,000 ounces of gold equivalent.

However, the recent $500+ million streaming deal does add risk to Wheaton’s production, and this is a risk investors need to consider carefully. Let's delve into what has changed since the last update.

Wheaton Precious Metals' Earnings

Wheaton published its Q3 2023 financial results on Nov. 9.

To summarize, it was another strong quarter for the company:

• Wheaton generated $223 million in revenue, $171 million in operating cash flow, and $116 million in net earnings.
• The company's financial health has significantly strengthened, with a cash balance of $834 million and no debt - plus an additional $2 billion available under its revolving credit facility.

Ultimately, I believe the most important metric investors of Wheaton should be following is cash flow and cash flow per share. Here’s why: As a high-margin business, Wheaton generates substantial cash flow from its streaming agreements, with most of its cash flow being free cash flow due to minimal expenses.

This quarter's $171 million in operating cash flow represents a $17 million increase from the last quarter. On a per-share basis, cash flow rose to $0.378 from $0.342, despite an 11.9% decrease in gold equivalent ounce production, primarily due to a labor dispute at the Penasquito mine in Mexico.

The company was also pretty active lately on the acquisition side of things.

Following the quarter's end, the company announced a definitive agreement with Waterton Copper, acquiring a silver stream on the Mineral Park mine for $115 million. And, Wheaton acquired a 0.50% NSR royalty from Liberty Gold Corp. on the Black Pine Oxide Gold Project for $3.6 million, along with a $5 million equity investment in Liberty Gold shares.

Overall, my perspective on Wheaton’s Q3 financial performance remains positive. Although there was a temporary dip in production, the company’s ability to generate significant cash flow and maintain a strong balance sheet is impressive and bodes well for its prospects.

New Deals Add Growth - With Risk

Wheaton Precious Metals recently expanded its portfolio by acquiring three new streams , but these deals have introduced some complexities to its production profile.

Wheaton committed $530 million for these acquisitions, which include streams from Ivanhoe Mines' Platreef Project, BMC Minerals' Kudz Ze Kayah Project, and a new precious metals purchase agreement for a gold stream from Dalradian Gold's Curraghinalt Project.

While the Kudz Ze Kayah and Curraghinalt streams appear promising, the Platreef acquisition poses potential concerns. This project, operated by Ivanhoe Mines in South Africa, is currently under construction, with commercial production expected by the fourth quarter of 2024.

Wheaton's share from Platreef is projected to average over 13,000 ounces of gold and 8,500 ounces of each palladium and platinum annually for the first decade, potentially increasing in the subsequent years. This is a huge contributor to its annual growth.

My Concerns

Investing in a South African mine carries some big risks, given the numerous challenges prevalent in the region's mining sector. These include, but are not limited to: Labor disputes, deep-level mining safety issues, environmental impact concerns, and social and community challenges.

The Minerals Council of South Africa has also identified several critical challenges in the nation's mining sector, including rising operating costs, utility supply issues, and labor skill shortages.

While the Platreef Project may not necessarily face all the challenges prevalent in South Africa's mining sector, the risks it presents are significant and worth considering. Any operational delays or production shutdowns would negatively impact Wheaton’s output and returns from the mine.

There's a viewpoint I hold that Wheaton might have been better off allocating its resources differently. Options like share buybacks, dividend increases, or investing in less risky mining jurisdictions like Australia, the U.S., or South America might have been more prudent, for example.

Even though investments in these top-tier jurisdictions typically come with higher costs, the reduced risk could justify the expense.

A good example of jurisdiction risk is Franco-Nevada's ( FNV ) recent experience with its Cobre Panama stream in Panama, which has suspended production and caused Franco’s shares to fall by 14% over the past month.

According to the Fraser Institute's mining survey, Panama was ranked in the bottom ten mining jurisdictions in 2021 and was not included in the 2022 survey. This scenario underscores the potential pitfalls of investing in higher-risk areas.

While South Africa boasts a much longer mining history and is arguably a more favorable business environment than Panama, it still carries significant risks.

This is again reflected in the Fraser Institute’s 2022 survey, where South Africa ranked in the bottom ten in terms of both policy and mineral potential in the Investment Attractiveness Index, highlighting the need for careful consideration in such investments.

Valuation Not That Attractive

Another concern I have here is regarding Wheaton’s current valuation. Despite Wheaton's impressive growth prospects, its stock valuation raises some concerns.

Seeking Alpha rates Wheaton's valuation as an F , primarily due to its high Price-to-Earnings (P/E) ratio of 40.76 and an Enterprise Value to EBITDA (EV/EBITDA) ratio of 32.05.

This valuation significantly surpasses industry medians, which are typically around 16 times earnings and 9 times EV/EBITDA.

While this comparison predominantly includes mining stocks rather than pure streaming and royalty companies, Wheaton's valuation still appears high even when compared with its streaming peers. For example, Royal Gold trades at lower multiples despite having a similar growth profile to Wheaton.

Meanwhile, Franco-Nevada, once holding the highest valuation in this category, has seen a decrease in its valuation, particularly following issues with its Cobre Panama stream.

The Better Bet: Osisko Gold Royalties

Wheaton is still a solid company with long-term growth potential, and it owns some fantastic assets. But currently, Osisko Gold Royalties Ltd ((OR)) stands out as a potentially better investment choice.

Osisko not only offers a more attractive value but also presents a more favorable balance of risk versus reward. Osisko's growth trajectory is particularly impressive and arguably surpasses that of other companies in the streaming sector, including Wheaton.

Looking ahead to 2027, Osisko is on track to achieve significant growth. The company has set its sights on producing between 130,000 to 140,000 GEOs annually based on its existing assets, a big jump from approximately 90,000 ounces this year.

It’s also highly probable that Osisko will continue to expand its portfolio by acquiring more royalties and streams, potentially pushing its GEO production beyond the 140,000-ounce mark by 2027. The long-term prospects are even more promising, with the potential to exceed 150,000 ounces per year.

Importantly, much of this growth is expected to come from high-quality assets in top-tier mining jurisdictions like Canada and Australia, adding an extra layer of security to the investment.

Given the current scenario, I recommend investors exercise caution with Wheaton Precious Metals Corp. stock, considering its higher valuation and associated risks mentioned above. I believe that Osisko, with its robust growth trajectory and assets in top-tier mining jurisdictions, presents a more balanced and potentially rewarding investment opportunity in the streaming and royalty sector.

For further details see: