Silver Wheaton: Buy This Analyst Darling Now

by Doug Ehrman

The stock market's worst day of 2012, which was triggered by a dismal jobs report from the U.S. Board of Labor Statistics, has given commodities investors a glimmer of hope that the bottom and reversal they have been looking for may be at hand. While these speculations have most heavily involved the gold market, they equally apply to silver. The prices of precious metals have been in a bit of a slide for an extended period, but last week's decline in the broader market was tempered by a bounce in commodity stocks. If the slide in gold and silver prices can stabilize, many industry insiders and technical analysts foresee a reversal that will lead to an uptrend.

Using this as a backdrop for perspective, it may be time to cash in on silver's higher volatility and greater profit potential. For any investor ready to make this play, there is no better option than industry-darling Silver Wheaton (SLW). Research articles covering the stock released in the last several days have referred to the stock as "cheap," as "one of the more unusual silver companies in the world," and as the "silver lining in the clouds."

While each makes a slightly different argument regarding the company, they all share a common theme: Silver Wheaton is a strong company and the stock is currently trading at attractive levels. In the third of the above three referenced articles, Keith Speights cites three principle reasons that he likes the stock at current levels: increased demand for silver, a compelling valuation and a solid business model. Examining each of these reasons will be helpful in establishing a framework in which to consider the stock.

Silver Demand

Mr. Speights correctly cites rising industrial demand as one of the principle drivers of price for this commodity. Components of most consumer electronics contain silver, healthcare equipment is reliant on silver, and many alternative energy devices are dependent on silver. When coupled with ever-creasing investment demand, it is clear that silver shall remain central to the economy for the foreseeable future. In just the iShares Silver Trust (SLV), the largest silver exchange-traded-fund (ETF), there is over $10 billion; this is only one of many silver ETFs.

Valuation Amongst Its Peers

While it is somewhat difficult to properly classify Silver Wheaton amongst its peers due to its very unique business model (discussed in more detail below), when one considers the valuation of the stock relative to its growth expectations, it stands far above other silver companies.

Silver Wheaton has a price-to-earnings over growth ratio (PEG) of 0.64 relative to 1.09 for Pan American Silver (PAAS), 2.0 for BHP Billiton (BHP), no PEG for Grupo Mexico SAB de CV (GMBXF) and 1.42 for Compania de Minas Buenaventura SA (BVN). Generally speaking, a PEG below 1.0 is considered attractive because it suggests that the relationship between price, earnings and growth is favorable for the realization of future profits. This is a great metric because it combines several important factors - namely price, earnings and growth - and, in this case, it shows a very bullish stance for Silver Wheaton relative to its peers.

A Model Business

Unlike most silver companies that carry significant operating exposure given the volatile nature of mining, Silver Wheaton is the ultimate middleman. The company makes its profits by contracting with various other mining companies and locking in a base price at which it may acquire the silver that is produced by a given mine. In certain cases, the company may have to outlay some amount of cash to lock-in a deal, but this is not always the case. The bulk of these contracts give the full mine yield to Silver Wheaton at a predetermined price. Under its current contracts, the company commands nearly 800 million ounces of un-mined silver with an average cost to the company of $4 per ounce. With this level of reserve, the company has the largest silver reserve on the planet by quite a large margin.

Another way to consider the efficiency of the company's operation is to look at its operating margin relative to its peers. This figure for Silver Wheaton is 76.7% relative to 41.9% for Pan American Silver, 44.9% for BHP Billiton, 45.3% for Grupo Mexico and 42.2% for Compania de Minas Buenaventura. What this highlights is that while all of the companies in the sector operate very efficiently, Silver Wheaton stands above its peers. This is another function of the business model employed by the company. Because Silver Wheaton does not actually operate any mines, it is able to keep cost very low and position itself quite strongly.

Conclusion

While maintaining an allocation to precious metals is always prudent, current conditions appear to be very attractive for commodity investors. Despite the usual focus on gold, there is a compelling case for silver and for Silver Wheaton specifically. With this context of rising demand for silver and attractive valuation levels, the company uses a business model which gives it a distinct advantage.

While the stock does not offer the dividend yield of a diversified company like BHP Billiton, which pays 3.5%, the 1.3% dividend yield of Silver Wheaton is higher than Pan American Silver at 0.8%. The income element should be considered a bonus on an otherwise attractive stock. Overall, Silver Wheaton should be a member of nearly everyone's core portfolio and the time to buy is now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.