Description

Buy Wheaton Precious Metals for the following upside value drivers:

• CRA tax case to be addressed alleviating valuation discount realtive to peers

• Gold/silver ratio rerating driving silver prices higher, and therefore Wheaton Precisou Metals outperformance

• Market appreciation of significant development portfolio and therefore earnings growth (i.e. Solobo, Rosemont)

• Position for a potentially stronger precious metals environment amist growing macro economic tension, by a lower-risk, growing precious metals streamer (i.e. reduce operating risk)

Core rationale for the value case and potential upside is as follows:

CRA tax concerns provide a rerating potential of 31%:

• The dispute with the Canadian Revenue Agency reacts as overhang on the stock. If WPM trades up to its peers (FNV and RGLD) an upside of +31% is possible

• WPM has a very strong case with CRA and is the primary reason for WPM’s trading discount given WPM’s low-cost, diversified streaming portfolio

• Cameco tax ruling in next 3-6 months will provide a positive catalyst for WPM’s tax situation

Gold / Silver ratio rerating potential of a further 14%:

• WPM’s revenue generation is ~50% silver – assuming average historical gold/silver ratio since 2000 of 63x, the implied silver price would be US$20.87/, providing an increase in NAVPS of $2.11 or an upside of 14% upside (based on current P/NAV)

Longer term production growth from development pipeline implies further upside of 26%:

• San Dimas restructured and ramping up to 3,000tpd in 2020 for 17yr mine life

• Rosemont might be built in 2021

• Salobo +12Mtpa in 2023

• Pascua-Lama

• Other smaller early stage deals

Gold upside: A scenario with higher gold prices is likely in our view but was not assessed as the base-case reason for the investment

 1.       Business Description

Business Description:

Wheaton Precious Metals Corp. is a well-diversified precious metals streaming company with approximately 20 long-term purchase agreements on both operating and development assets. The company typically purchases silver and/or gold streams from first-quartile cost mines where those metals are not the primary product. Wheaton has a strong balance sheet, significant free cash flow, and significant liquidity to add more streams.   

Low cost producer: WPM has the lowest cost profile amongst its peers:

2018 production guidance weaker than expected on both gold and silver: WPM is guiding to 22.5Mozs of silver and 355kozs of gold. Weaker silver production is largely driven by Antamina of 5.3Mozs, slightly offset by Penasquito of 6.5Mozs. Lower gold production expectations driven by Salobo. Weaker guidance drove share price weakness in Q1 from which it has now recovered.

3.      Capitalization

• Strong balance sheet provides comfort in any commodity price environment

• As at 31 March 2018, WPM had US$115.6m in cash (ex-dividend) and US$663.0m of debt outstanding under its US$2bn revolving credit facility (which attracts an interest rate of Libor plus 120-220bp and matures in February 2022), such that it had net debt of US$547m overall

• Average daily traded value of US$41.5m over the past 3 months

• Reasonable leverage at ~1.0x net debt/EBITDA LTM

• FCF generation of US$543.2m in 2018 is expected - +5% FCF yield

5.      Valuation

5.1.            Base Case / Conservative Value

5.2.           CRA Situation

5.2.1.   Elimination of Tax Overhang

• As background, WPM notes that the CRA’s position is that the transfer pricing provisions of the Income Tax Act (Canada) in relation to income earned by WPM’s foreign subsidiaries should apply “such that the income of Silver Wheaton [sic] subject to tax in Canada should be increased by an amount equal to substantially all of the income earned outside of Canada by the company’s foreign subsidiaries for the 2005-2010 taxation years”. Should this interpretation be upheld, we would expect it to have potentially profound consequences for Canada’s status as a supplier of finance and capital to overseas destinations in general (ie not just for the mining industry).

• In 2017, WPM’s CEO, Randy Smallwood, was quoted as saying that the company is willing to settle its tax dispute with the CRA via a payment of C$5–10m “with gritted teeth”, but still believes no payment should be required. As such, the C$5–10m quoted should be interpreted not as an admission of guilt, but rather an appreciation of the costs involved in going to a full trial and also of the effect that the issue is having on WPM’s share price rating relative to its peers. In the meantime, WPM remains in the case ‘discovery process’ with the CRA, designed to provide both sides with the opportunity to arrive at an out-of-court settlement before formal proceedings commence. If a ‘principled’ settlement cannot be reached, however, the Tax Court of Canada has now scheduled the trial for mid-September 2019 for a two-month period.

• The market is heavily discounting a worst-case tax scenario with respect to future taxes on Wheaton's international-based streams when considering the company's valuation relative to its peers (FNV and RLGD):

• Although the trial is only scheduled for September 2019, a positive resolution of Cameco’s tax dispute any day would be a good precedent for WPM and would provide a positive catalyst for the valuation discount unwind.

• Cameco is a Canadian uranium miner that is facing a similar but arguably more challenging case with the CRA – the court ruling on this case is anticipated to occur at any moment

5.2.2. Downside Case (Absolute Worst Case Scenario – Highly Unlikely)

5.3.           Silver / Gold Ratio Rerate

Gold / Silver Ratio Re-Rating

5.4.           Asset Uplift

 6.      Relative Valuation

Comps of Royalty Companies (Consensus)

• WPM vs Comps – P/NAV – WPM trades below its peers and has a high FCF yield

• P/NAV: WPM trades 15% below its closest peers (FNV and RGLD)

7.      Sell-Side Analyst Commentary

RBC – Outperform – TP $25/sh

• We believe Wheaton provides investors with an attractive risk/reward opportunity with the market appearing to be pricing in a worst-case tax outcome. Our view is supported by Wheaton's valuation relative to Franco-Nevada and Royal Gold. At spot prices, we estimate Wheaton trades at a 30% discount to its closest peers on our base case NAV

• Strong free cash flow: With strong operating margins and limited outstanding capital commitments, we expect Wheaton to generate significant free cash flow. We forecast average free cash flow of $585M ($1.32/sh) at long-term gold ($1,300/oz) and silver ($17.50/oz) prices through 2020 implying an average yield of ~6%.

• Long-term optionality: Wheaton could surface additional long-term value through potential development of Rosemont, Pascua-Lama and Navidad.

• Insulated cost structure: Given its relatively fixed cost structure and fixed capital outlays, Wheaton is less influenced by the operating/capital cost pressures which can impact the profitability of its producing peers.

• Robust sustaining cash margins: At spot prices we forecast an average sustaining cash margin of ~65% through 2020.

CIBC – Outperform – TP $25/sh

• We derive our $25 price target by taking the average of short-term and longer-term valuation metrics. The short-term valuation is calculated at 20x the average 2018–2020 cash flow estimate of 1.32/share (at spot prices) while the long-term valuation is calculated at 2.0x the $10.55/share net asset value (NAV) (at 5% discount using spot prices).

• The 20x cash flow multiple is higher than the average of where Wheaton Precious Metals shares have traded over the past three years and higher than its peers. The P/NPV of 2.0x is higher than the average calculated for the past year and slightly below the peer group average.

• Risks: Most of the risks specific to Wheaton Precious Metals relate to the silver price and to the company’s lack of control over its operating assets. Wheaton Precious Metals has no influence over any production, exploration or capital expenditure decisions made at the operations. Any reductions in output would adversely impact the company’s valuation. Wheaton Precious Metals’ debt balance remains sizable at this time, with large annual principal repayment obligations

Macquarie – Outperform – TP $28.17/sh

• Buy WPM for its attractive 2018 dividend yield and valuation metrics. WPM announced the first quarterly dividend for 2018 of US$0.09/share, corresponding to 30% of the average operating cashflow generated over the previous four quarters (up from 20% in 2017). This equates to a competitive 1.6% annualized 2018 dividend yield.

• WPM also trades at a 47%, 27%, 13% discount to Franco Nevada on a P/CFPS, EV/EBITDA, P/NAV basis and is delivering strong operating margins of 68% and 73% for gold and silver, respectively.

Scotiabank – Outperform – TP $24.00x/sh

• Our net asset valuation (NAV5%) increases slightly to $14.09 per share based on long-term gold and silver prices of $1,300/oz and $19.25/oz respectively. There is no material update on the Canadian tax dispute with a trial still expected to take place this year and a ruling likely in 2019.

8.     Dividends

Dividend linked to operating cash flows: With its quarterly dividend linked to 30% of average operating cash flows over the prior four quarters, Wheaton provides investors with direct income exposure to silver and gold, however the dividend yeild is currently low at 1.68%.

Catalyst

Near-term catalysts:

• Any day now: Cameco CRA trial decision is expected any day now. A likely positive outcome would be a good precedent for WPM and could have a positive effect on the share price

• San Dimas Operations: San Dimas restructuring: With First Majestics as the operator and reduced encumbrances on the mine, analysts see the potential for the asset to operate well and exceed their estimates mine plan. Closing of the transaction has been completed with potential upside surprise beginning Q2.

• Ongoing: Accretive stream deals. Positive market reaction to accretive deals which bolster cash flow, provide resource optionality and can be funded internally.

• Within next 12 months: Study on Salobo III to expand to 36Mtp by 2023

Long-term catalysts:

• 2019 -  On the CRA tax reassessment, Macquarie do not expect a court decision until 2019

• 2020 - San Dimas benefits from significant expl/capital investment, getting back on track and ramps up the operation to 3,000tpd in 2020.

• 2021 - Rosemont might be built in 2021

• 2023 - Salobo will expand via phase 3 in 2023 to 36mtpa (FS expected by end of 2018/beginning 2019)