One of main changes Silver Wheaton (NYSE: SLW ) has implemented over the last year is to expand its gold operations. This move has substantially increased the share of gold out of the company's total sales in 2013. Has the company made the right decision? How will this decision affect the company? Let's examine the advantages and disadvantages of this shift toward gold.
Finding the right mix
The company has increased its gold operations in the past year mainly after purchasing streaming rights from the Salobo and Sudbury mines back at the beginning of 2013. The table below shows the changes in the amount of gold, silver and silver equivalent ounces produced.
Source of data: Silver Wheaton's website
As you can see from the table above, the company increased its gold production but left its silver operations nearly unchanged since 2012. As a result, gold accounted for 75% of the total precious metals produced last year; a similar rate is expected this year. But if the company keeps purchasing additional gold streaming rights, this could improve its precious metals mix and slightly reduce the company's risk, because Silver Wheaton won't solely rely on silver. This could be a positive move for investors because of the lower volatility displayed by the price of gold, compared to that of silver.
The chart below shows the daily standard deviation of the prices of gold and silver in the past year (separated into months).
Source of data: CME Group
As you can see, the standard deviation of the percent change of silver is much higher than gold's. This means, silver has historically been more volatile than gold. In other words, the risk associated with silver is higher than gold. Therefore, the rise in exposure to gold might slightly reduce the risk Silver Wheaton has due to the fluctuations in the prices of precious metals.
Unfortunately, this reduced risk comes at a cost -- lower profit margins.
Profitability may fall
The rise in Silver Wheaton's gold operations has cut down the company's operating profitability. Even though both gold and silver prices tumbled down during 2013, the profitability of silver remained above gold's.
Source of data: Silver Wheaton's website .
The table above presents the average gross profit of gold and silver in 2012 and 2013. It shows that the profitability from selling silver was higher than from selling gold by nearly ten percentage points.
Therefore, if the company keeps increasing its gold operations, the profit margin of Silver Wheaton could diminish. It is likely to come closer to the profitability of companies that mostly sell gold such as Royal Gold (NASDAQ: RGLD ) . Back in 2013, Royal Gold's operating profitability was around 50%, while Silver Wheaton's profitability was at 55%.
The decision of Silver Wheaton's management to expand the company's reach to gold has its advantages, including a better mix of precious metals and a slightly lower price risk. Though, this decision could also reduce the company's profit margin. This means, even if the prices of gold and silver recover to their high levels from back in 2012 and early 2013, the company's profitability won't reach those same profit margins. This development could eventually reduce the company's dividend payment, which is linked to Silver Wheaton's operating cash flow. It's certainly something for investors to keep an eye on moving forward.
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