Silver Wheaton suffers collateral damage from Pascua-Lama delay

It wasn’t just Barrick Gold (ABX-T, ABX-N) and its shareholders that took it on the chin yesterday after news that construction on the Chilean side of the Pascua-Lama project had been suspended in response to environmental and regulatory concerns.

Shares of Silver Wheaton (SLW-T) fell $1.67 or 5.50% to $28.71 on the news with 3 million shares trading hands. Macquarie Capital Markets has cut its 12-month target price on the stock by 5% from $42 per share to $40 per share.

Silver Wheaton entered into a silver purchase agreement with Barrick in September 2009 to acquire 25% of the life-of-mine silver production from Pascua-Lama, as well as 100% of the silver production from their Lagunas Norte, Pierina and Veldaero mines until the end of 2013.

Under the agreement Barrick also provided a completion guarantee that requires it to complete Pascua-Lama to at least 75% of design capacity by Dec. 31, 2015. Silver Wheaton is also entitled during 2014 and 2015 to silver production from Laguna Norte, Pierina and Veladero mines to the extent of any production shortfall at Pascua-Lama, until Barrick satisfies the completion guarantee. If Barrick does not satisfy the guarantee, Silver Wheaton can terminate the agreement. If that were to happen, Silver Wheaton would be entitled to the return of the upfront cash consideration of US$625 million, less a credit for silver delivered up to the date the contract was cancelled.

In addition, Silver Wheaton has a five-year right of first refusal on any further metal stream sales from Pascua-Lama, where more than 50% of the value is from silver.

Macquairie analysts Tony Lesiak and Matt Griffiths estimate that if Silver Wheaton were to cancel the contract, it would receive a net payment of about $200 million. As a result, they argue, “there is a very strong rationale for Silver Wheaton to not cancel the contract if they believe Pascua-Lama will ultimately enter commercial production,” adding that if the project is delayed beyond 2015 the streaming company will not receive any silver deliveries, which the Toronto analysts estimate is currently about 2 million oz. or 5% of 2015 sales.

Lesiak and Griffiths forecast that it will be late 2015 until commercial  production gets off the ground at Pascua-Lama, and that ramp-up will likely continue into 2016. First full-year production, they speculate, will come in 2017.

“With the delay we forecast 2015 silver production will decline 10% to 45.6 million silver-equivalent ounces from 50.7 million silver-equivalent ounces,” which results in a 6% decline to their net asset value estimate to $32.97 per share from $34.94 per share.

In a separate research note to clients on Barrick, the analysts maintain that “the likelihood that the project is terminated is low…however given the opposition to the project and numerous challenges (dust, glaciers, water management) we view the probability of a delay of 6-12 months as high.”

They also estimate that the project will need another $200 million in capital for potential remediation and reengineering.

The mining analysts have lowered their 12-month target price on Barrick by 7% to $33.50 per share from their previous target price of $36 per share.

“In light of the suspension of construction in Chile, the constitutional challenge, and regulatory issues,” they write, “we recommend investors wait for further clarity on the development timeline of Pascua-Lama.”

At presstime in Toronto Barrick was trading at $25.00 per share and Silver Wheaton at $28.36 per share.