Silver Wheaton buys half of Constancia’s gold output

Silver Wheaton (TSX: SLW; NYSE: SLW) has inked a second offtake agreement on Hudbay Mineral’s (TSX: HBM; NYSE: HBM) Constancia polymetallic project in southern Peru: this time for its gold output.

The Vancouver-based company — which in 2012 agreed to buy 100% of the mine’s total silver production — is now purchasing 50% of Constancia’s life of mine gold production for an initial payment of US$135 million. As a result, it has combined the gold and silver streams under one revised agreement.

Silver Wheaton’s president and CEO Randy Smallwood described the gold stream deal, announced after markets closed on Nov. 4, as a “win-win” for both companies. It gives the Toronto-based miner a little extra cash to finish building Constancia and adds to Silver Wheaton’s growth profile.  

Constancia is more than 40% complete and slated to start production in late 2014, before reaching full production in mid-2015. Silver Wheaton’s annual share of gold should average 35,000 oz. over Constancia’s first five years and 18,000 oz. over the mine’s 16-year life.

Salman Partners analyst David West, who covers Silver Wheaton, said he finds the deal attractive because the streaming firm is already familiar with the Constancia project and has the option to make the upfront US$135 million payment in either shares or cash. If Silver Wheaton elects to pay in shares it could maintain the liquidity level on its balance sheet, he notes.

Under the agreement, Silver Wheaton will make that initial payment once Hudbay has spent US$1.35 billion developing the estimated US$1.78 billion copper-molybdenum-gold-silver mine at Constancia. Silver Wheaton will then buy each gold ounce produced for the lesser of US$400 plus an inflationary adjustment or the prevailing market price.

Gold recoveries have been set at 55% for the Constancia deposit and 70% for the recently delineated higher-grade Pampacancha deposit. “Should actual recoveries not hit those targets, HBM could end up delivering more than 50% of payable gold produced,” cautions Raymond James analyst Alex Terentiew, who has a $9 target and “market perform 3” rating on Hudbay. 

Silver Wheaton explains the gold stream is required to meet the existing completion test that was in the 2012 agreement. This means if the Constancia processing plant is not completed to 90% of expected throughput and recoveries by the end of 2016, Silver Wheaton will continue to receive 100% of the gold produced from Hudbay’s 777 mine in northern Manitoba. Moreover, if the completion test is not fulfilled by the end of 2020, Hudbay would have to return a certain portion of Silver Wheaton’s investment. The streaming company may also be entitled to compensation if there’s a delay in achieving completion or mining at the Pampacancha deposit after 2018.

Despite all the terms to safeguard Silver Wheaton’s investment at Constancia, not all analysts believe the recent deal was the best move for Silver Wheaton.

“From our perspective, Constancia is not an especially attractive project and remains subject to significant development risk, especially in light of some early challenges in its construction,” said TD analyst Daniel Earle in a note. He writes he dislikes the idea of streaming or royalty companies acting as a “safety net” for their partners whenever they need cash as it leads to “over-concentration in single assets” and lowers diversification.

Earle believes the market would have preferred Silver Wheaton to stick to strengthening its balance sheet after signing the US$1.9 billion gold streaming deal with Vale (NYSE:VALE) in February. But, he adds the Constancia deal is relatively small and could be easily funded and includes the potential of the high-grade Pampacancha deposit.

Salman Partner’s West comments the only drawback in his view is that the recent deal doesn’t increase Silver Wheaton’s exposure to silver. Given there are few pure silver plays out there, he believes the company “going forward will be better served to concentrate more on the silver side than the gold side.”

West has a $35 target and “buy” on Silver Wheaton.

The Vancouver-based firm is guiding production of more than 33.5 million silver equivalent oz. in 2013 and has lowered its previous 2017 target by 13% to 42.5 million silver equivalent oz. The decrease is mainly due to Barrick Gold’s (TSX: ABX; NYSE: ABX) move to temporarily stop construction at its Pascua-Lama gold-silver mine, where Silver Wheaton has agreed to buy 25% of the mine’s total silver output.