Silver Wheaton (SLW +1.88%) has revolutionized precious-metals investing by giving its shareholders exposure both to silver prices and improving production output without direct exposure to the challenges that running a mining operation involves. My premium report on Silver Wheaton explains the silver streamer's business model and how it has produced massive profits during silver's bull run.
But it would be a mistake to conclude that the company doesn't have any chance of doing worse in the future. Let's take a look at some of the specific risks that Silver Wheaton faces right now.
1. Failing to meet high expectations.
Silver Wheaton hasn't been shy in its confidence about its future growth. In a recent presentation to investors, the company projected massive growth in its production, rising from an estimated 28 million silver-equivalent ounces for 2012 to 48 million ounces by 2016. Much of that growth is expected to come from Barrick Gold's (ABX +0.72%) Pascua-Lama mine, which is on track to come on line next year, as well as from the 777 and Constancia mines of Hudbay Minerals (HBM +2.32%). But the projections also assume relatively constant production from its existing partners, including Primero Mining's (PPP +0.00%) San Dimas mine and Goldcorp's (GG +0.00%) Penasquito mine.
Admittedly, Silver Wheaton does its best to identify mines that have low costs and long lives so as to maximize the chance of consistent and growing production. In fact, the company is aiming to lengthen the average lifespan of the mines for which it finances streaming deals, with the share of production coming from mines with anticipated lives of 20 years or more set to almost double by 2016. But in the end, if Silver Wheaton's clients fail to meet anticipated production targets, then it could jeopardize Silver Wheaton's growth, and a disappointment could hurt the shares.
2. Falling silver prices.
Silver Wheaton is proud of the fact that it represents a leveraged play on silver prices, noting that between mid-2009 and mid-2012, silver prices nearly doubled, but Silver Wheaton's shares more than tripled and its cash flow per share rose by more than 440%.
For the company's part, it continues to believe that silver is underpriced. Pointing to historical average price ratios between gold and silver of 37 to 1, the prevailing price of gold would imply fair value for silver of about $46.50 per ounce, about 45% above silver's actual current price. Moreover, with silver bullion increasingly diverted to bullion ETFs, government and private silver inventory levels have steadily declines for more than 20 years.
Nevertheless, as we saw both during the financial crisis, as well as in its dramatic pullback from multi-decade highs in early 2011, silver prices can be volatile in both directions. Leverage can work both ways, and investors need to be prepared for what could be even more dramatic declines in Silver Wheaton's share price if a correction or bear market in silver comes about.
3. Competition.
At first glance, Silver Wheaton's business model may appear not to have any moat at all. At some level, all it takes to do a silver streaming contract is to have the money to invest in client miners and the wherewithal to negotiate deals that are potentially lucrative.
As a practical matter, though, Silver Wheaton's expertise is hard to replicate. With so many small mining companies scattered throughout the world, Silver Wheaton has developed a reputation for dealing with potential clients both big and small, and that's arguably attractive to smaller players who want an equitable deal. Silver Wheaton understands that a good deal makes both parties winners, and it would be difficult for a new entrant to the space to develop that kind of reputation quickly.
