Wheaton Precious Metals Corp.: The Bear Case From a Bull

I often urge precious metals investors to look beyond traditional miners and consider streaming companies like Wheaton Precious Metals (NYSE: WPM) because of their superior business model. Of course, that's not to say that miners like Barrick Gold (ABX 0.01%) aren't worth your money. Wheaton Precious Metals and Royal Gold (RGLD 0.01%) continue to outperform their peers -- Wheaton Precious Metals, for instance, is up 15% in the past year when pure silver and gold plays like First Majestic Silver and Barrick are both in the red.

Recently, I even outlined 10 reasons why Wheaton Precious Metals (known as Silver Wheaton until some weeks ago) makes a great long-term buy. However, no stock is risk-free, and Wheaton Precious Metals is no different. This streaming company faces its share of challenges that could turn its bullish investment thesis upside down. Here are some of the biggest risks. 

Running out of silver

The most primary concern for Wheaton Precious Metals right now is its declining silver production. Production dropped about a percentage point to 30.4 million ounces in the fiscal year 2016, which isn't as worrisome as the company's projections of 28 million ounces for FY 2017 and an average of 29 million ounces for the next five years. In short, Wheaton Precious Metals' silver production is stagnating.

Declining silver production is among Wheaton Precious Metals' biggest risks. Image source: Getty Images.

It's important to understand that by "production" here, I mean the metal streams that Wheaton Precious Metals secures from miners. As a streaming company, it doesn't own or operate mines but buys metal streams from other miners at low rates in exchange for funding them up front. So, for example, a 25% slump in silver production at Goldcorp's (GG +0.00%) Penasquito mine during the fourth quarter last year was one of the biggest factors why Wheaton Precious Metals' deliveries declined. Wheaton Precious Metals is entitled to 25% of the silver produced from Penasquito for life per its streaming agreement with Goldcorp.

Some of Wheaton Precious Metals' silver contracts are also due to expire soon, including those attached with Barrick's Lagunas Norte, Veladero, and Pierina mines. As I'm writing this, there is news about workers at Veladero going on a strike http://www.reuters.com/article/us-barrickgold-mine-argentina-idUSKBN18P1I3. The mine is already in trouble for its recent cyanide solution spills.

Needless to say, Wheaton Precious Metals has to find replacements for these expiring agreements to maintain revenue. That, again, is a challenge as it's harder for streaming companies to strike deals when precious metal markets are improving because miners usually tap them for financing during down cycles when their sales are under pressure and raising capital or debt isn't easy.

As if temporary production hiccups like the one at Penasquito aren't enough, two of Wheaton Precious Metals' vital streaming agreements are also in question.

Two key assets in trouble

Streaming miners naturally desire deals with major mining companies. Investors were euphoric when Wheaton Precious Metals signed a streaming agreement with Barrick in 2009 for 25% of its silver production from its Pascua-Lama mine. Unfortunately, construction at Pascua-Lama was suspended in 2013 because of regulatory hurdles and remains status quo. Wheaton Precious Metals could never unlock value from what was touted to be among its most valuable assets.

Meanwhile, Primero Mining Corp (PPP +0.00%) is struggling with its flagship mine San Dimas in which Wheaton Precious Metals is entitled to 100% of the silver produced up to six million ounces and 50% in excess thereof per year. San Dimas contributed 9% http://s21.q4cdn.com/266470217/files/doc_downloads/annual_information/AIF-for-year-ended-December-30-2016_FINAL.PDF 
Page 22 "Silver production from San Dimas represented approximately 9% of Silver Wheaton's total silver equivalent production for the year ended December 31, 2016." to Wheaton Precious Metals' total silver equivalent ounces production in FY 2016.

Image source: Getty Images.

While internal inefficiencies hit production at San Dimas in 2016, a union strike halted operations for nearly two months earlier this year. San Dimas is also caught in a web of legal proceedings, including one from previous owners seeking title to the property and another from the Mexican tax authorities. At a time when Primero is struggling to steer the mine to profitability, any ruling against it in either of the cases could jeopardize San Dimas' progress, dealing a huge blow to Wheaton Precious Metals.

Tax disputes remain a threat

Wheaton Precious Metals has tax disputes with the Canadian Revenue Agency (CRA), regarding income from foreign subsidiaries earned between 2005 and 2010. The reassessed tax amount http://s21.q4cdn.com/266470217/files/doc_downloads/annual_information/AIF-for-year-ended-December-30-2016_FINAL.PDF Page 10 "the Company received Notices of Reassessment (the "Reassessments") from the CRA totaling Cdn$353 million" is 353 million Canadian dollars, which is more than the net income Wheaton Precious Metals earned in the trailing 12 months. If CRA finds faults and decides to reassess Wheaton Precious Metals' income for later years as well, the company's total tax liability from 2005-2016 could amount to more than CA$800 million.

For now, even a CA$353 million payment could burn a hole in Wheaton Precious Metals' cash flows and hit its dividends.

Foolish takeaway

Wheaton Precious Metals is doing its bit to offset slumping silver production by focusing on gold -- hence the name change -- and has the leeway to add more assets to its portfolio in the coming years. Nonetheless, investors should be aware of the risks the company faces, so they don't get caught on the wrong foot if things turn for the worse.