Silver Wheaton Corp. (USA) (SLW +7.35%) is a precious-metals company, but it's not a miner. That's a very important distinction right now, because debt-heavy balance sheets are weighing down so many miners. That's not a big worry at Silver Wheaton, though. To understand why, you need to understand what makes this company different from a miner.
Miners in trouble
A miner builds a mine, pulls material from the Earth, processes it, and sells it. It's a pretty expensive business model and new mines can take years to complete before any money comes in the door. Thus, miners often rely on debt to fund the big capital expenditures needed to get a new mine up and running. That makes sense and is no different from a company that funds a new factory with debt.
However, commodity prices are often very volatile. And that can make debt service a problem if the bottom falls out from under a given market -- for example, gold and/or silver, which is what Silver Wheaton specializes in.
In fact, expansion efforts at the peak of the commodity market have gotten more than one miner in trouble recently, including Freeport McMoRan (FCX +5.57%), a miner whose financial troubles are getting it in the headlines for all the wrong reasons. Freeport loaded up on debt to diversify into oil and gas just before that market tanked, following along with the previous drop in gold and copper that was already straining its finances.
But that's just one example of a miner that's trying to make ends meet now that commodity prices are in the tank. There are plenty more. But Silver Wheaton isn't one of them because it is a streamer rather than a miner. Its revenues come from selling silver (roughly 60% of the top line) and gold (40%), but it doesn't actually own or operate any mines. And it's remained solidly profitable despite the drop in precious-metals prices that started in 2011.
Streaming and the balance sheet
Silver Wheaton provides upfront financing for miners so they can build mines. In exchange, it receives a portion of the silver and gold the mine produces at a preset, and usually quite low, price. For example, its silver cost is around $4 an ounce, and its gold cost is around $400 an ounce.
A virtuous cycle? Source: Silver Wheaton.
Silver has recently been trading hands in the low teens and gold at around $1,100. Do the math and you'll see that Silver Wheaton is making money even though these precious metals are in the doldrums, stressing the finances of miners where the cost of pulling an ounce of gold or silver out of the ground may be frighteningly close to current spot prices.
But how does Silver Wheaton come up with the cash it advances to miners? It taps the capital markets. That means making use of debt and equity. Taking a quick look at the company's consolidated statement of cash flows for the first half of the year shows perfectly what the company does. It took on $800 million worth of bank debt, sold $800 million worth of stock, and paid down its bank debt by over $1 billion.
All of that activity supported a $900 million deal with Vale (NYSE: VALE) in which Silver Wheaton gave the giant international miner an upfront $900 million payment in exchange for "25% of the life of mine gold production from its Salobo mine, located in Brazil." That brings its total streaming rights at this mine up to 50%. The cost of the gold to Silver Wheaton? A measly $400 an ounce with a 1% inflation adjustment.
The summary of a deal. Source: Silver Wheaton.
Vale is struggling right now, so it looks like a well-timed investment for Silver Wheaton. And it really shows how the company uses its balance sheet to grow. In fact, the company's active use of its balance sheet almost makes it look like a specialty finance company, except that it gets paid in gold and silver, which it then sells to generate revenue, which makes it a precious-metals company without all the hassle of running mines.
Dig a little deeper
If you own or are thinking about owning Silver Wheaton, it's important to understand how it differs from a miner -- and why it's so important to keep a close eye on the company's financial activities, which will show up on the balance sheet and in the statement of cash flows. Earnings are important, of course, but it's the other two statements that will show you how Silver Wheaton is growing its business.
