As with most metal and mining stocks, Silver Wheaton Corp. (WPM -3.69%) was on a wild ride this year until about three months ago, when it started losing favor with investors as precious metals fell. Silver Wheaton is down almost 35% in the past quarter, as of this writing, leaving investors jittery about what lies ahead.
Volatility, however, isn't anything new for investors in precious metal stocks. What matters is whether Silver Wheaton can reward shareholders in the long run. For the record, you'd be sitting on 500% total returns (including dividends) today if you'd bought the stock during its initial public offering, in 2005. While past performance doesn't guarantee future returns, I believe Silver Wheaton could continue to generate solid returns, and remains a top stock to buy and never sell. Here are 10 reasons why.
1. Enviable lead in a unique business
Silver Wheaton's offbeat business model is also its biggest competitive advantage. Instead of mining metals, Silver Wheaton buys silver and gold from miners at a fixed cost under "streaming agreements" in exchange for up-front payment to fund their capital projects.
The biggest risks in the mining business revolve around exploration and operation of mines. Silver Wheaton doesn't face those risks as it doesn't own any mines, which means its business carries lower risk than that of a traditional miner. What's more, Silver Wheaton dominates the industry: It is the world's largest precious metals streaming company.
2. Exposure to both silver and gold
While most precious metal companies specialize in either silver or gold, Silver Wheaton exposes you to both. Its gold equivalent ounces have grown manifold in the past five years, with the company now targeting 45% of its revenue to come from the yellow metal through 2020.
So by investing in Silver Wheaton, you're getting near-equal exposure to both gold and silver -- something other miners or streamers don't offer.
3. Strong, bankable asset base
Silver Wheaton's streaming agreements currently cover 22 operating mines and eight projects under development. Some of its biggest operating projects include:
1. Goldcorp's mine at Penasquito, Mexico's largest gold-producing pit
2. Barrick Gold's mines in Argentina and Peru
3. Vale's largest copper mine at Salobo, Brazil
4. Primero Mining Corp's San Dimas mine at Mexico
5. Antamina mine in Peru, jointly owned by BHP Billiton, Glencore, Teck Resources, and Mitsubishi Corporation
As you may have guessed, Silver Wheaton's asset base is of top-notch quality as it counts leading miners among its partners. Moreover, most of Silver Wheaton's streaming agreements are for the life of mine, which means the company stands to gain from all future expansions at these mines without additional costs. Silver Wheaton, however, isn't relying entirely on existing miner partners for production growth. It is also aggressively acquiring streams.
4. Growth potential via acquisitions
Silver Wheaton's biggest recent investments have been in gold streams. For example, it paid $800 million this past August to acquire additional 25% gold production from Vale's Salobo mine, now entitling it to 75% of the gold produced from the mine for life. Not surprisingly, Silver Wheaton's gold production hit record highs in Q3. The streamer now estimates average annual production of 330,000 ounces of gold and 31 million ounces of silver through 2020.
I expect Silver Wheaton to continue to diversify its portfolio across miners and geographies in the future to mitigate risks while strengthening its asset base further. Increased focus on the yellow metal could also mean higher margins in coming years.
5. Low costs = High margins
Silver Wheaton's expenses are significantly lower than those of traditional miners as the streamer doesn't incur any costs associated with exploring or operating of mines. To top that, Silver Wheaton secures bullion streams from miners at prices significantly below spot rates: Its average purchase cost is only about $4 per ounce of silver and $400 per ounce of gold. As a result, Silver Wheaton's operating margins are among the best in the industry, even better than those of streaming peers Royal Gold (RGLD -1.75%) and Franco-Nevada (FNV -1.78%).
The chart also proves that streaming is a more profitable business than pure mining.
6. Strong cash flows
Thanks to predictable costs, Silver Wheaton has quadrupled its cash flow from operations in the past decade. While its net income has grown only marginally during the period, operating cash flow gives a clearer picture of the health of its operations as non-cash charges like depletion eat into profits and present a gloomier picture.
The strong growth in cash flows reflects Silver Wheaton's ability to generate enough cash to sustain and grow its operations throughout the commodity cycle. In fact, if it weren't for these cash flows, Silver Wheaton wouldn't be paying a dividend at all.
7. Dividend growth potential
Silver Wheaton doesn't pay out a flat rate or a fixed amount of dividend like miners. Instead, it pays out a quarterly dividend that equals 20% of the average operating cash flows generated in the trailing four quarters. So the higher the cash flows, the greater the dividends. Last month, the company boosted its dividend by 20% as recovering precious metal prices drove its cash flows higher. So while Silver Wheaton's dividends may fluctuate, investors are spared steep cuts, making this dividend safer than that of a miner.
8. Best amongst its peers
As the largest streamer, Silver Wheaton has the strongest hold in the streaming industry. Silver Wheaton estimates that it represents half of the cash flows generated between Franco-Nevada, Royal Gold, and itself -- the three biggest streaming companies. Here's a chart from the company's Analyst Day presentation that shows how Silver Wheaton leads from the front.
So if you want to bet on a precious metals streamer, there's no better choice than Silver Wheaton. In fact, it is also the cheapest stock among its peers right now.
9. Cheapest valuation
Whether you see it from an earnings, cash flow, or book value basis, Silver Wheaton is substantially cheaper than both Franco-Nevada and Royal Gold.
Silver Wheaton looks particularly attractive at a price under 15 times its operating cash flow when you consider the potential of a cash windfall if precious metal prices continue to rise. Long-term investors might have a nice entry point here.
10. Strong gold and silver fundamentals
One of the biggest arguments in favor of SLW, of course, is that gold and silver will likely remain preferred safe-haven investments during times of uncertainty. Moreover, the fundamentals for both precious metals look strong. While fellow Fool Sean Williams laid out a solid bullish case for silver, the World Gold Council recently pointed out that "institutional investors with no previous history of investing in gold" are increasingly initiating positions, indicating a gradual shift from consumer-centric demand for jewelry, which tends to fluctuate.
Investing in Silver Wheaton not only leverages you to higher gold and silver prices, but does so with co significantly lower risks than buying a pure-mining stock. Given the streamer's growth in the past decade, I wouldn't underestimate its future potential.