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Silver was recently changing hands at $11.69 an ounce, a level not seen for some two decades. Part of the reason for rising silver prices is that investors are snapping up the precious metal in anticipation of a
soon-to-be-launched silver exchange-traded fund (ETF)
, which will hold 16% of the world's annual silver production.
We believe investors who like investing in commodity stocks and are looking for exposure to silver in anticipation of further price increases should consider a position in
, which was recently trading at $10.82.
Silver is heavily used in photography. However, there are several other applications for the precious metal, including electric conductivity and dental fillings. In addition, a recent research note from research firm CIBC cites new market opportunities for silver, such as in health care and solar cells. Although we aren't taking action for the model portfolio just yet as we already have a full portfolio, we would consider initiating a position in Silver Wheaton in the future if a berth opens up.
Silver Wheaton, based in commodity-rich Vancouver, Canada, is the only mining company that derives 100% of its revenue from silver production, and is therefore the purest play on continued strength in silver prices. We believe the above-mentioned factors, including demand from the health care industry and solar power market, could lead to sustained high silver prices. At $11.69 per ounce, silver is trading 63% above year-ago levels.
Silver Wheaton's largest revenue component comes from the sale of silver it purchases from the Luismin mines in Mexico, which is owned and operated by
. The Luismin mines are comprised of several areas with proven silver reserves of 45 million ounces, or about $525 million in market value at current prices.
To put this in perspective, total annual global silver production is 806 million ounces, so the Luismin mines are quite productive. The Luismin mines have historically converted resources in the ground to proved reserves at a rate of about 90%, and the company feels confident there is at least 25 years' worth of profitable mining ahead for the Luismin mines.
The company also generates revenue from the Zinkgruvan mine, which is located near Sweden's Lake Vattern. The mine has proven silver reserves of about 30 million ounces and produces about 2 million ounces of silver annually for Silver Wheaton to sell. Sweden offers a relatively mild climate that lends itself to longer mining periods, and has seen its total recovered silver grow from 1.33 million ounces in 1998 to 1.87 million ounces in 2005.
In addition, Silver Wheaton has expanded its portfolio of silver sources with an agreement announced Feb. 15 that it will purchase 4.75 million ounces of silver per year for the next 20 years from silver mining company Glencore International. This is 100% of Glencore's total output from its Yauliyacu silver mining operations in Peru.
Terms of the deal call for Silver Wheaton to pay an upfront payment of $285 million, comprised of $245 million in cash and a $40 million promissory note, and $3.90 per ounce of silver delivered under the contract, subject to an inflationary adjustment after three years. At current spot market prices for silver, Silver Wheaton would keep $7.79 per ounce of silver sold.
In the event that silver produced at Yauliyacu in any year totals less than 4.75 million ounces, the amount sold to Silver Wheaton in subsequent years will be increased to make up for the shortfall. This equates to Silver Wheaton having an insurance policy of sorts from Glencore. With the Glencore deal under its belt, Silver Wheaton is expected by analysts to reach its annual silver sales target of more than 15 million ounces in 2006, with total sales reaching 20 million ounces by 2009.
With the amount of silver available for Silver Wheaton to sell on the rise, earnings growth will depend on silver pricing in the market. The introduction of the silver ETF by Barclays Global (BGI), which is waiting on approval from the
Securities and Exchange Commission
(SEC) for trading, should lead investors to realize that near-term global inventories will be depleted by BGI's 129-million-ounce silver purchase to back the ETF.
In addition to demand from the silver ETF, additional demand for silver should be driven by the European Union's (EU) Restriction on Hazardous Substances (RoHS), which takes effect in July and bans the use of lead, among other substances, in products sold in the EU.
The next best alternative for lead in solder, the metal that joins electrical components to circuit boards, is a silver-based alloy. While this is a relatively small market at present, broader global adoption of such a standard could have broad implications for silver supplies that support high silver prices.
Of course, Silver Wheaton's growing sales volumes are not worth much to investors if the company can't deliver profits. That's why we are encouraged that the company's total finding cost, or the cost it takes to find one ounce of silver and mine it, of $3.90 a share is well below the current market price for silver. This leaves plenty of room for Silver Wheaton to deliver profits in the event silver prices decline in the coming year. In addition, the company is completely unhedged, meaning it is not locked into selling silver at a particular price in the future. Should silver continue to rise, the company would receive the full benefit to its bottom line. With silver up 61% since July, Silver Wheaton shares have gained 230% over the same period.
Silver Wheaton has a market capitalization of $1.6 billion and is forecast by analysts to earn 25 cents a share in 2006 on revenue of $129 million, which implies a forward P/E ratio of roughly 40. While in isolation this P/E ratio does not scream value, the company should see its earnings continue to grow as its annual sales of silver increase from recent deals. In addition, the company has shown it can grow its margins. In 2005, Silver Wheaton's earnings before interest, taxes depreciation and amortization (EBITDA) of $31 million, or 43% of sales, marked a 100-basis-point improvement in EBITDA margins from 2004.
If you are bullish on silver prices, Silver Wheaton should make a good addition to your portfolio.
William Gabrielski is a research analyst at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback;
to send him an email.
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