Will Silver Wheaton Deal With Vale for Salobo Gold Mine Pay Off?

NEW YORK (TheStreet) -- Silver Wheaton (SLW), the world's largest silver (SLV) streaming company, hasn't entered into new streaming contact in over a year. The last big streaming agreement was in February 2013 with Vale (VALE). Under this agreement, Silver Wheaton will acquire a quarter of the yield from the Salobo Mine's in Brazil for the life of the mine, and 70% of the gold output of Vale's Sudbury Mines in Canada for 20 years.

This agreement looked much better in early 2013, when gold (GLD) prices were at $1,600 per ounce. But the low gold prices have made this agreement less profitable for Silver Wheaton. Tuesday, gold was trading at $1,288 an ounce.

So what do investors need to know?

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Since the Salobo Mine is the bigger-producing mine, let's use it to see the potential profit or loss this contract offers to Silver Wheaton. For the mine's output, Silver Wheaton paid $1.33 billion. In exchange, the company will receive gold streaming for the life of the mine (let's say 30 years) at a very low cost of $400 per ounce of gold (with 1% annual inflation).

Up to the end of the first quarter of 2014, Silver Wheaton sold a total of 27,000 ounces of gold and has an attributed production of 38,000 ounces of gold from Salobo.

At the end of last year, the mine's proven reserves -- the amount of metals estimated with reasonable certainty from the analysis of geologic data -- were over 2.1 million ounces of gold. Moreover, Vale plans to ramp up production capacity by 2016.

Based on these figures, Silver Wheaton should receive over 30 years an average of 70,000 ounces of gold starting in 2016, as indicated in the table below.

Source of data: Silver Wheaton's Web site

You can also see the cost of one ounce of gold will reach $534 by 2045 under the 1% annual inflation.

But the current price of gold at under $1,300 puts this investment in the red. Under a very generous discount rate of 5% (for precious metals mines the industry average is 8.5%), the present value of the net cash stream comes to $985 million.

Since the company paid $1.33 billion for this stream, this asset will bring a loss of $344 million over the next 32 years.

Source of data: Silver Wheaton's Web site

This means that Silver Wheaton may not profit from this streaming agreement unless the price of gold picks up again. Just to break even, gold prices need to be at $1,600 per ounce.

Tuesday, shares of Silver Wheaton rose by 0.23% to $26.10 at market close; Vale sank by 1.84% to $13.89 per share. Shares of Royal Gold (RGLD), a precious metals royalty and streaming company, also increased by 0.39% to $76.86.

This all means that Silver Wheaton could remain in the sidelines without entering into new streaming contracts until gold prices start to pick up again.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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TheStreet Ratings team rates SILVER WHEATON CORP as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate SILVER WHEATON CORP (SLW) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, expanding profit margins and increase in stock price during the past year. However, as a counter to these strengths, we also find weaknesses including feeble growth in the company's earnings per share, deteriorating net income and weak operating cash flow."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • SLW's debt-to-equity ratio is very low at 0.29 and is currently below that of the industry average, implying that there has been very successful management of debt levels. To add to this, SLW has a quick ratio of 1.98, which demonstrates the ability of the company to cover short-term liquidity needs.
  • The gross profit margin for SILVER WHEATON CORP is currently very high, coming in at 77.57%. Regardless of SLW's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, SLW's net profit margin of 48.25% significantly outperformed against the industry.
  • Compared to where it was a year ago today, the stock is now trading at a higher level, regardless of the company's weak earnings results. Despite the fact that it has already risen in the past year, there is currently no conclusive evidence that warrants the purchase or sale of this stock.
  • The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Metals & Mining industry. The net income has significantly decreased by 40.2% when compared to the same quarter one year ago, falling from $133.42 million to $79.81 million.
  • Net operating cash flow has decreased to $114.83 million or 30.66% when compared to the same quarter last year. In conjunction, when comparing current results to the industry average, SILVER WHEATON CORP has marginally lower results.

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