It was early 2011. Wheaton Precious Metals (NYSE: WPM) shares soared above $40, riding on the back of silver prices that had shot to multiyear highs. The stage was set for the making of a multimillionaire stock, except that it never happened.
Silver prices soon lost ground, and so did Wheaton. Since the company depends heavily on the precious metal for revenue, Wheaton shares have, unsurprisingly, mirrored the trend in silver prices over the years. Meanwhile, rivals Franco-Nevada (TSX:FNV) and Royal Gold (NASDAQ:RGLD) have been able to generate hefty returns for shareholders.
But with Wheaton's management now trying out new things to bulk up its margins, could the stock pick up slack and make investors rich in coming years?
Wheaton's golden leap: From 12% to 49%
Wheaton Precious Metals was always known to be a silver play, but the company has silently transformed into something much bigger in recent years.
Wheaton first took the gold leap in 2013 when it struck an agreement with mining giant Vale (NYSE:VALE) to buy 25% of the gold produced from its Salobo mine in Brazil for the life of mine, as well as 70% of the gold produced from its Sudbury mines in Canada for a 20-year term. Wheaton paid $1.9 billion to Vale in addition to stock warrants for the deal.
As a reminder, Wheaton is a precious metals streaming company that doesn't own and operate mines but buys metal streams from miners under streaming agreements at prices below spot rates in exchange for financing them up front.
Back then, Wheaton got only around 12% revenue from gold and projected it to go up to 25% in the next five years. The company soon raised the stakes by extending its agreements with Vale in 2015 and 2016, bagging the right to buy an additional 50% of gold from Salobo, or a total of 75% of Salobo's gold production. In fiscal 2017, Wheaton's sales from gold shot up to 49%.
For all that gold, Wheaton will pay $400 per ounce, adjusted for 1% inflation, beginning 2019, or the spot gold price, whichever is lower. That should mean strong margins even if gold prices were to fall 20% from here. Wheaton's operating margins are already in line with those of its peers.
Just weeks ago, Wheaton also added another important gold stream to its portfolio under a deal with First Majestic Silver for 25% of gold and gold equivalent to 25% of silver from its San Dimas mine for a price of the lower of $600 per ounce of gold, adjusted by 1% for inflation, or spot gold price.
Factoring in its other gold interests, here's what Wheaton's revenue mix should look like between 2018 and 2022.
Assuming silver and gold prices of $17 per ounce and $1,350 an ounce, respectively, Wheaton could generate operating cash flows worth more than $2.5 billion between 2018 and 2022. For perspective, it generated roughly $538 million in operating cash flow in fiscal 2017.
On the right track
It's important to understand why Wheaton's decision to look beyond silver is a step in the right direction.
Silver is primarily used for industrial purposes and hence doesn't enjoy as much attention from investors as gold, which is considered a safe-haven asset and a hedge against economic uncertainties. On top of that, demand for gold in the form of jewelry from two of the most populous nations, China and India, makes it a much bigger market than silver. That's one reason silver has traditionally underperformed the yellow metal, limiting Wheaton's growth as compared to gold-dominant streaming players like Royal Gold and Franco-Nevada.
It would also be fair to say that diversifying was unavoidable as there are limited opportunities in the silver space, more so because silver is primarily a byproduct of zinc, lead, and copper mines. Wheaton is a stickler for low-cost streams, so unless exploration spending at low-cost base metal miners take off, Wheaton may not find lucrative investment opportunities. That may also explain the company's latest move that has taken the market by surprise.
Wheaton makes an interesting move
Wheaton's latest streaming agreement has nothing to do with silver or gold. It's a bet on electric vehicles (EVs). Yes, you read that right.
As a Tesla car owner, Wheaton CEO Randy Smallwood sees a bright future for EVs. To exploit the potential, Smallwood struck a new streaming deal with Vale on its Voisey's Bay mine, entitling it to 42.4% cobalt production from the mine up to 31 million pounds and 21.2% thereafter, beginning 2021. Cobalt is a key input for electric-vehicle batteries.
While companies like Franco-Nevada have diversified into platinum and oil, Wheaton is the first to invest in a cobalt stream. We won't really know how beneficial the deal is until Wheaton starts getting cobalt deliveries, which is still some years away. Nonetheless, it's an intriguing move, one that reflects management's zeal to take risks where required to expand its portfolio.
As a company with the most balanced exposure to silver and gold, Wheaton is a great pick for investors in precious metals. The stock won't grow like a weed, but given that it's currently trading cheaper than Royal Gold and Franco-Nevada in terms of book value and operating cash flows, I expect the stock to be a winner in the long run.