2022 was a tough year for the Gold Miners Index (GDX) and while 2023 started out strong, we’ve seen a sharp retracement since the highs for the index. The poor performance on a trailing three-year basis for gold producers isn’t that surprising, given that most of the margin benefit from strength in the gold price was eroded by ($1,800/oz vs. $1,400/oz) inflationary pressures (fuel, electricity, labor, steel, cyanide, etc). Hence, the increase in the gold price from Q1 2020 to Q1 2023 has led to minimal margin expansion. Plus, we’ve seen higher share counts for many companies because of share-based acquisitions and or capital raises to fund growth projects.

Some investors have argued that the Gold Miners Index was too cheap near $34.00 in Q1 2023 (30% below its highs at $45.00 in July 2020) with the gold price trading only 6% lower. However, this is a superficial argument when we have seen meaningful share dilution among producers (and even some royalty/streaming companies) and limited margin growth on balance. In fact, AISC margins sector-wide declined 30% from FY2020 to FY2022 and that is despite a slightly higher average realized gold price. So, while one might believe gold producers should trade substantially higher if the gold price is at higher levels, this argument is only valid if that benefit actually flowed through to their bottom line (which it didn’t).

Fortunately, this unfavorable setup for most producers has not applied to the royalty/streaming companies, which have steered clear of the margin compression and capex blowouts or significantly higher sustaining capital because of their superior business models. The reason is that they pay up front for a portion of mineral production over the life of the mine, meaning that producers must bear the brunt of higher consumables/labor costs and higher than expected sustaining and growth capital. An example of one of these resilient business models is Wheaton Precious Metals (NYSE:WPM), and, as we can see, it has maintained strong margins (cash costs: ~$445/oz) despite the unprecedented challenges faced by producers. Let’s look at the company’s 2022 results below:

Q4 & FY2022 Production

Wheaton Precious Metals (“Wheaton”) released its Q4 and FY2022 results last week, reporting quarterly attributable production of ~70,100 ounces of gold, ~5.35 million ounces of silver, and ~148,300 gold-equivalent ounces [GEOs]. This translated to a 20% decline year-over-year from a gold-equivalent ounce basis, impacted by lower gold (~87,300 ounces), silver (~6.36 million ounces) and cobalt production and palladium/cobalt production, with lower contributions from several key assets on a year-over-year basis. Some examples included Salobo (a decline in throughput and grades due to lower plant availability), San Dimas (lower grade development ore from Perez Vein and difficult ground within the Jessica/Regina veins), Antamina (lower grades), and Penasquito (lower grades and recoveries in line with mine sequencing).

Besides the lower production at these assets, Wheaton was up against headwinds related to the sale of the Yauliyacu silver stream ($150 million in proceeds) and the Keno Hill stream ($135 million in stock), plus Stratoni and the 777 Mine moving into care & maintenance. Unfortunately, this was combined with much weaker average realized metals prices in the period (gold: $1,725/oz vs. $1,798/oz / silver: $21.52/oz vs. $23.36/oz), resulting in a 15% decline in quarterly revenue to $236.1 million, and a 12% decline in operating cash flow to ~172.0 million. This was obviously disappointing from a headline standpoint, but one quarter is relatively insignificant in the grand scheme of things for a business with exposure to well over 15 years of future production at some assets, and Wheaton was certainly up against headwinds.

On a full-year basis, we saw a moderate decline in annual GEOs as well, with attributable production coming in at ~638,100 GEOs, down 6% year-over-year, resulting in an 11% decline in revenue to ~$1.07 billion with no help from metals prices. However, even in this challenging year for the sector, Wheaton exited the year with ~$700 million in cash, a $2.0 billion undrawn revolving credit facility, and operating cash flow of ~$743 million. Notably, this was despite putting capital to work in Q1 with the Goose and Curipamba gold streams, which are expected to contribute a combined ~30,000 ounces of gold starting in 2025 for the first five years with additional silver contribution, helped by sales of other streams assets.

Wheaton’s significant war chest in a period of weakness for the sector could prove quite valuable and the company noted that it’s actively pursuing “a number of new accretive opportunities”. However, the company also reassured investors that it will not be overpaying for royalties and streams even if we have seen some low single-digit IRR deals completed over the past 18 months. Wheaton noted that most opportunities available are on the smaller end and are in the sub $300 million range, but these can still move the needle for Wheaton with the Goose deal being a small one for $125 million but still adding exposure to nearly 12,000 GEOs per annum .

Hence, I would not be surprised if Wheaton exited the year with a larger portfolio and another stream or two, augmenting what’s already a solid growth profile with the company guiding for an average attributable production profile of 850,000 GEOs from 2023 to 2033, representing 35% growth from FY2023 guidance. This is an enviable position to be in for Wheaton vs. some other companies that will have to dilute heavily or take on high-cost capital to transact like the junior royalty companies such as Gold Royalty (GROY) and Metalla (MTA), and even some larger royalty/streaming companies that are focused on reducing leverage after a busy 12-18 months.

Recent Developments

Moving over to recent developments, the Rio2 (OTCQX:RIOFF) Fenix ​​Project disappointment was obviously not ideal, with an EIA rejection in mid-2022 for the Chilean Project. However, this was the smallest deal done by Wheaton in a string of deals valued at ~$1.5 billion and the company has knocked it out of the park on its other deals and is looking very smart. In British Columbia, where it secured a gold/silver stream on Blackwater, Artemis (OTCPK:ARGTF) was awarded the BC Mines Act Permit last week, setting the project up for late 2024 production. Meanwhile, Generation Mining’s (OTCQB:GENMF) Marathon Project also received federal approvals in Q4 2022, with first production by 2025.

Just as significant, Sabina Gold & Silver was getting ready to begin major construction after Goose in Nunavut after successfully transporting material by sealifts last year and making solid progress on underground development at Umwelt. And, Sabina has enjoyed considerable exploration success, adding to what’s already a nearly 10.0 million ounce gold project. However, the most recent development is that B2Gold is likely to take over construction and eventual operations following a takeover bid by the company last month. This is a meaningful upgrade given B2Gold’s experience in frigid climates (Kupol in Russia) and its experience with project construction and large assets, with it having operated a ~500,000 ounce per annum project in Mali for years (Fekola).

Not only are these key assets moving along nicely and set to help push Wheaton’s annual attributable GEO production to north of 760,000 GEOs in FY2025 with the combination of successful commissioning and a full ramp up of the Salobo III Expansion in late 2024 (first concentrator line started up in Q4 2022), but these three assets provide a nice boost to Wheaton’s attributable production from Tier-1 jurisdictions and reduce concentration to Salobo in Brazil, an asset that can lead to volatile quarterly results due to how significant it is as a portion of total revenue and cash flow. Let’s look at WPM’s valuation below:

Valuation

Based on ~453 million fully diluted shares and a share price of $40.50, Wheaton trades at a market cap of ~$18.3 billion, second only to a few other names in the precious metals space. This represents a large discount to Franco-Nevada’s (FNV) valuation despite similar production profiles, and Wheaton having a more attractive organic growth profile vs. Franco-Nevada. This is largely justified because of Franco-Nevada’s superior margin profile and increased diversification (112 producing assets vs. 20 producing assets), with increased optionality with a deeper portfolio of hundreds of royalties in different stages vs. 32 streams (35 including those closed or in care & maintenance) and two royalties owned by Wheaton.

An investor might argue that Wheaton is undervalued when looking at Franco-Nevada’s valuation, with WPM trading at ~23.0x FY2023 cash flow per share estimates vs. FNV at ~25.0x estimates and a 15% plus discount on a P/NAV basis. While a fair point, I would argue that some premium for Franco-Nevada is justified. Plus, FNV continues to trade near the mid-point of its historic valuation range (16-38x cash flow), so while we can argue WPM is cheap relative to FNV, we are comparing this to the company with the richest valuation sector-wide . Hence, it’s hard to make a case for WPM significantly undervalued here, even if this is the case from a relative basis to its closest peer.

Looking at the chart above, WPM’s 5-year average cash flow multiple is 23.7, and I would argue that a conservative cash flow multiple for the stock is 26.0 given its peer-leading growth and improved diversification after a busy two years of transactions. If we multiply this conservative cash flow per share multiple by FY2023 cash flow per share estimates of $1.81, we arrive at a fair value for the stock of $47.05. This points to a 16% upside from current levels but assumes limited upside from metals prices, so there’s certainly upside to this target. That said, I prefer a minimum 25% discount to fair value to justify starting new positions, meaning that WPM would need to decline below $35.30 to head into a low-risk buy zone.

Summary

Wheaton Precious Metals is easily one of the top-12 ways to get exposure to the precious metals sector, given its unique business model, strong development pipeline, and an experienced management team with the discipline to only transact on the right assets with relatively low risk when it puts significant capital to work. One example is the prescient deal with Sabina Gold & Silver, to purchase 4.15% of payable gold production (dropping to 2.15% after 130,000 ounces have been delivered) which will now be built and operated by a more experienced operator and a top gold producer, B2Gold, an upgrade from the previous setup. With B2Gold at the helm, this could be a larger mine down the road with a 20+ year mine life, providing a nice payback for Wheaton on its $125 million investment.

That said, while this is a very solid business model, I believe it’s best to pay the right price or not buy at all, especially in a cyclical sector where we can see significant downside volatility if commodity price doesn’t cooperate over the short run . So, while I see WPM as a very attractive buy-the-dip candidate, I don’t see a low-risk buying opportunity just yet, especially with no strong support until the US$35.00 level. To summarize, I remain on the sidelines for now, but would be much more interested in starting a new position in WPM if we saw the stock pull back to fill its November 9th gap on its chart where it would trade at a more attractive valuation.