Silver Monthly 2012 Stock Profile: Silver Wheaton (SLW)

Silver Wheaton CEO, Randy Smallwood

Silver Wheaton is not a silver miner. It’s ticker, SLW, does not represent an exchange-traded fund. And yet, Silver Wheaton is described by some analysts as a “pure unhedged paper proxy on silver prices.” How is this possible?

Unique Business Model

Silver Wheaton has a unique business model. Rather than investing millions in the development of mines, it merely supplies a portion of the costs to other mining companies. In return, Silver Wheaton gets contractually guaranteed discount silver in the future. Thus, Silver Wheaton has very low operating costs, but it still benefits when the price of silver goes up.

Silver Wheaton makes its money by selling silver at a profit. This is especially easy to do when Silver Wheaton currently gets silver for as little as $3.90 per ounce! These rates are locked in, adjusted for inflation, for years to come. What’s more, Silver Wheaton is headquartered in the Cayman Islands, and thus pays virtually zero tax on its profits.

Financials

Silver Wheaton CEO, Randy Smallwood

Over the past three quarters, Silver Wheaton has grown earnings per share by the astounding pace of 197% per quarter – that means the firm has nearly tripled its earnings from the same quarter last year, for three straight quarters. If that’s unclear, I’ll explain in the paragraph below. If you already understand how quarterly growth is measured on a year-over-year basis, then you can skip ahead.

Companies measure their profits, also known as earnings or (net) income, on a quarterly basis. A quarter is a three-month period. Rather than comparing the second quarter of 2012 to the first quarter of 2012, growth is measured on a year-over-year basis – so the second quarter of 2012 is compared to the first quarter of 2011. This helps adjust for seasonal differences. If this adjustment weren’t made, then retailers would always see a big drop-off from the last quarter of one year to the first quarter of the next year, thanks to increased revenue during the holidays. Other businesses have similar seasonal shifts, and that’s why earnings are measured on a year-over-year basis.

Last quarter, however, earnings fell about 10% shy of analysts’ projections, and were up by “only” 21% — which is still pretty darn good! What isn’t so good, though, is that management guided expectations for the current quarter lower to +2%. Clearly, Silver Wheaton’s growth is decelerating, and that’s a bearish sign for the stock — but there are plenty of bullish signs to weigh against this earnings-growth deceleration.

Silver Wheaton has three straight years of annual earnings growth, and estimates call for 2012 to make it #4. Management is calling for roughly 18% growth, which would bring Silver Wheaton’s 2012 earnings to around $649 million. Earnings came in at $550 million in 2011, up hugely from $290 million in 2010, $118 million in 2009, and just $17.25 million in 2008.

Sales were up 26% last quarter, which is great, but not as good as Silver Wheaton’s three-year average of 81% growth per year. In 2011, sales totaled $730 million. This was up from $423 million in 2010, $239 million in 2009, and $167 million in 2008.

Fundamentals

Last year, Silver Wheaton had a pretax profit margin of 76.5%. This is awesome, but especially good since the firm is headquartered in the Cayman Islands, and thus pays virtually no tax on its profits. Silver Wheaton produces a very solid 22.4% return on equity for its investors, and it has fifty times as much equity as it has long-term debt, which is excellent.

Silver Wheaton has a 15.7 price-to-earnings ratio (also known as P/E ratio, or just P/E), which means that its current share price is 15.7 times its most recent quarter’s earnings per share. P/E ratio is a popular measure of a stock’s fair value. A low P/E is seen as a bargain, while a high P/E is seen as overpriced. However, reality is much more complicated than that, as high-growth stocks deserve high P/Es and vice versa. And what is a low or high P/E? Well, one way to tell is by comparing the stock’s P/E to the P/E of other stocks in its industry. In the case of Silver Wheaton, its P/E of 15.7 is a bit higher than the industry average of 14.2. However, over the past five years, Silver Wheaton has averaged a P/E of 48.7, which means that at their current valuation of 15.7 times earnings, Silver Wheaton’s shares are trading at a 67.8% discount to their historical value.

Earnings is not the only measure by which the fair value of a stock can be measured. Other ratios include price-to-book, price-to-sales, and price-to-cash flow. We’ll examine each of those below.

Price-to-book ratio compares the stock’s current share price to its “book value,” also known as its “net-asset value” or “equity.” This is what you get after adding up all of the companies assets and subtracting its liabilities. When you divide the stock’s net assets (or book value, or equity – all the same thing) by its total number of shares, and then compare its share price to that, you get its price-to-book ratio. Silver Wheaton’s price-to-book ratio is 3.3. The industry average is 2.0. But again, Silver Wheaton’s five-year average for price-to-book ratio is 3.9, which means that it is overvalued compared to its peers, but undervalued compared to its own historic valuation.

Price-to-cash flow does the same thing as price-to-earnings, only it looks at a stock’s cash flow per share instead of earnings per share or book value per share. Cash flow is like earnings (or net income or profit – again, all words for the same thing), but different in that it does not consider non-cash expenses like amortization and depreciation, which are accounting concepts. Sometimes, a company can be “unprofitable” with zero or negative earnings, but still produce cash flow. A cash flow that’s higher than earnings can be good, since companies have to pay tax on their earnings, not their cash flow. Anyway, Silver Wheaton’s price-to-cash flow ratio is 13.7, which again, is higher than the industry average (11.4), but lower than its own five-year average (29.1).

Conclusion

On February 28, 2012 Silver Wheaton closed at $39.90. As of May 24’s close, the stock was down to $26.35 – 34% from its late-February high. Is now the time to buy?

Silver Wheaton certainly looks cheap. On a forward basis (which means using future earnings instead of past earnings to calculate a ratio), its price-to-earnings ratio is just 11.4, and when adjusted for future growth rates, this works out to a PEG ratio of 0.2! Stocks with PEG ratios of 1.0 are considered bargains, and this means that Silver Wheaton’s share price could quintuple and it would still be considered a bargain stock by many investors! In the meantime, Silver Wheaton pays a 1.2% dividend, which isn’t bad either.

Is Silver Wheaton really going to see its share price quintuple from $26.35 to $131.75? I wouldn’t doubt it. But even a more modest gain of, say, 30% over the next year would be good. There’s no better place to put your money than in physical silver, but if you have an IRA or 401(k) through your work, and you can’t use a custodian that allows you to have precious metals, Silver Wheaton is among your best alternatives.