Silver Wheaton's High Profit Margins

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( Trefis) -- Silver Wheaton ( SLW) is the world's largest silver streaming company and competes with silver manufacturers like Silver Standard Resources ( SSRI), Pan American Silver ( PAAS), Bear Creek Mining ( BCM) and Endeavor Silver ( EXK).

It purchases silver from mining companies that produce silver as a by-product, typically gold and copper mining companies. The company currently has fourteen silver purchase agreements and two purchase agreements for precious metals like gold.
Silver

Moreover, the company also has the right to purchase all or a portion of the silver production attributable. This gives it an edge over the conventional mining companies as it does not incur any kind of operational losses in volatile market conditions. Moreover, since the company does not own any of the mines, it does not incur any operational and capital costs associated with the production.

We recently launched coverage of Silver Wheaton with a $50 Trefis price estimate for the company's stock. Based upon the company's silver purchase agreements, we have broken down our analysis of Silver Wheaton into seven business segments: Primero, Barrick Gold, Goldcorp, Capstone, Glencore, Lundin, and Other.

High Profit Margins

Under Silver Wheaton's business model, the company provides some of the necessary capital to other mining companies via an upfront payment to assist in building the mine. In return, it gets a portion of the silver for the life of the mine at a fixed cost. Most of the mining companies that Silver Wheaton works with produce silver as a by-product of their mining operations and so is a win-win arrangement for both the participating companies.

On average, Silver Wheaton pays $3.90 for an ounce of silver procured from the mining companies. This fixed price is subject to change based on inflationary pressures. The company does not have to pay for any additional cost for development of the project after the initial payment. Silver Wheaton sells silver at spot market prices and does not hedge it. These fixed price contracts help Silver Wheaton attain high margins of close to 70% across all its divisions.

The expected upside to silver prices provides the company with significant upside with regards to profit. By 2015, it is expected that the company's EBITDA margins may touch the 80% levels.

In 2005, China was a net exporter of silver, with more than 3,000 tons of silver exported. As internal restrictions on silver exports from China took hold, gross silver exports declined to 1,575 tons in 2009, down 58% from the previous year. In 2010, it imported nearly 5,159 tons of silver, a surge of approximately four-fold from the prior year imports. The growing middle class and domestic demand in emerging economies of India and China has fueled the growth in demand for silver.

With gold prices hitting record highs, it has become increasingly difficult for the common man in these countries to continue to buy gold for jewelry or invest in gold, and so many see silver as a rising asset class driven by many of the same drivers as the demand for gold.

See our full analysis and $50 price estimate for Silver Wheaton here .

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