Silver Wheaton (SLW +4.59%) is what's known as a streaming company, providing long-term financing for silver and gold miners in return for the opportunity to buy precious metals at reduced prices in the future. It's lower risk than owning mines in many ways, but it isn't risk-free. Here are three risks that investors should keep in the back of their minds when looking at Silver Wheaton right now.
Industry growth
Silver Wheaton's business involves giving money to companies such as giant miners Glencore and Vale SA\ (VALE +0.54%) in exchange for the right to buy silver and gold in the future at reduced prices. For example, a recent $900 million deal with Vale provides Silver Wheaton with the right to buy 25% of the gold from the Salobo mine in Brazil for the lesser of $400 an ounce or the prevailing market price for gold (gold is currently trading hands in the $1,000 range).
The Salobo Mine. Source: Vale SA.
Vale inked this agreement because its finances are being hit hard by the moribund commodities markets. Working with Silver Wheaton allowed it to raise cash without the need to tap the capital markets. Silver Wheaton, meanwhile, is taking advantage of the commodity downturn to grow its business. The Glencore deal follows the same logic.
But there's a longer-term issue here. Weak markets lead to reductions in capital budgets. Vale, for instance, cut its capital spending by roughly $2 billion, or about 25%, through the first nine months of 2015 compared with the same period last year. This is an industrywide trend that suggests that the growth of new mines is slowing. Taking advantage of the weakness can only go on for so long before Silver Wheaton will need its customers, the miners, to start spending on new mines if it wants to find new investment opportunities. You'll want to watch this trend.
Kind of a specialty finance company
Silver Wheaton makes its money selling precious metals. However, it isn't a miner. For example, the deal with Vale was financed with a credit facility, and then the credit facility was paid down with proceeds from a stock sale.
That's the basic model. Find a good deal, get it done, and then go to the capital markets to pay off the short-term financing used to consummate the agreement. That works wonderfully so long as Silver Wheaton has ready access to the capital markets. If for any reason it should have a hard time selling shares, this model would start to break down. It could opt for debt, essentially changing from short-term financing to long term, but that's not how it normally does things. That said, if Silver Wheaton can't sell new equity, it might not be able to sell debt, either.
A stack of silver. Source: Silver Wheaton.
So far this hasn't been a problem for Silver Wheaton. But because accessing the capital markets is such an integral part of its business model, you need watch this issue if you own the shares.
The pain of taxes
The last concern is far more current. Silver Wheaton has received notice from Canada that the country believes it owes $265 million in back taxes, interest, and penalties. It's a complicated issue, and Silver Wheaton believes it doesn't owe the money.
However, the sum isn't chump change for Silver Wheaton. The company had GAAP earnings of about $200 million last year. Adjusted for an impairment charge, earnings would have been about $268 million. When silver and gold prices were higher, it earned much more, but they aren't, and these are the numbers Silver Wheaton is dealing with. Essentially, the Canadian tax issue is about a full year's worth of earnings.
Silver Wheaton is going to fight. However, you'll want to keep an eye on the progress here, because it could have a material impact on the company's results over the short-term if it loses this tax case.
Nothing is risk free
Silver Wheaton is an interesting company in the precious-metals space. It offers exposure to gold and silver without the risks associated with owning and operating a mine. But that doesn't mean there aren't big-picture concerns, such as finding new streaming deals and the financing needed to get them done. There are also company-specific issues, notably the tax case, that you'll also want to watch. None of this makes Silver Wheaton a bad investment, but you'll want to make sure you keep the negatives in mind along with the positives if you own or are thinking of owning this one.
