3 Challenges Facing Silver Wheaton

Here are three challenges for Silver Wheaton investors to consider.

Jul 22, 2014 at 3:45PM

Even though Silver Wheaton (NYSE:SLW) is considered less risky than other silver-related investments (mainly because it's a streaming company and not a producer), the worldwide leading silver streaming company still faces several challenges that could impede its progress in the future.

1. Progress in developing projects
Silver Wheaton partners with big precious metals producers, and for partial ownership in projects, the company receives a stream of gold and silver at a low fixed price. But if the partner's progress in a certain project gets delayed, it could result in a delay for Silver Wheaton in receiving its stream. At the very least, there is always the risk of a producer not completing the development of a mine. Case in point: Barrick Gold (NYSE:ABX) had to delay construction in its Pascua-Lama mine because of environmental reasons. This impediment didn't cause Silver Wheaton any losses because it revised the contract with Barrick Gold -- the latter will provide the former a stream of precious metals from its other projects. So, even though this delay didn't impact Silver Wheaton this time, it could if Barrick Gold were to face additional challenges, or even if it drops this project. 

2. Silver prices
The main uncertainty for Silver Wheaton doesn't come from its operating costs, but from its revenue -- specifically the fluctuations in the price of silver. Last year, the plunge in the price of silver slashed its profit margin to 55%. In comparison, back in 2012, its profit margin was 70%. 

The progress in the price of silver also affects the company's dividend payment, which is linked to its operating cash flow. If the profit margin continues to fall, Silver Wheaton's cash flow from operating activities is likely to follow. In such a scenario, the dividend payment and annual yield could also contract. 

Conversely, other streaming and royalty companies don't link their earnings to their dividends. Royal Gold (NASDAQ:RGLD) didn't reduce its annual dividend even though gold and silver prices dropped in the past year, which substantially slashed the company's earnings. Therefore, as silver prices come down and other royalty and streaming companies maintain their dividends, Silver Wheaton's stock will become less attractive.

3. Reaching annual guidance
This challenge has less to do with Silver Wheaton and more to do with its silver producing partners. If these companies don't deliver the precious metals on time, Silver Wheaton doesn't sell silver and gold, and its revenue suffers. This impediment isn't likely to impact the company's valuation, as precious metals will be delivered at a future date, but this could reduce the dividend paycheck and the amount of cash generated from its operations. The main issue is also meeting the annual guidance to keep its investors happy. Failure in reaching this goal might steer investors away from this company.

Foolish takeaway
There are several aspects of Silver Wheaton's business that put its operations at risk. Nonetheless, its business is less risky than other silver-related alternatives, and for investors seeking to expand their portfolio with precious metals, Silver Wheaton is still among the least risky investments in this category.

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Lior Cohen has no position in any stocks mentioned. The Motley Fool owns shares of Silver Wheaton. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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