Investing in precious metals can be difficult as the performance of companies in this sector is often highly correlated to the price of the metal.
The precious metal investors are likely most familiar with is gold. Investors looking for access to gold can either purchase shares of an exchange-traded fund that tracks the price of gold, such as the SPDR Gold Trust (GLD), or buy shares of gold mining companies.
Gold has actually outperformed the S&P 500 this year. The SPDR Gold Trust has gained 18.6% since the start of 2019, while the index is up 13.2%.
While there are several gold stocks we find attractive, one company operating in this sector that we feel investors should avoid is Wheaton Precious Metals Corp. (NYSE:WPM).
Wheaton Precious Metals, formerly known as Wheaton Silver, was founded in 1994. It is the largest metal streaming company in the world. As a streaming company, Wheaton does not have outright ownership of mines. Instead, the company purchases the right to buy gold and silver at low fixed costs from mine operators.
The company has agreements with 20 mines, most of which are located in North and South America. Wheaton has lease agreements with some of the most well-known names in the mining industry, such as Vale SA (NYSE:VALE) and Barrick Gold Corp. (NYSE:GOLD). The company trades with a market capitalization of $13.5 billion and generates $860 million in annual revenue.
Recent financial results
Wheaton reported second-quarter earnings results on Aug. 8. The company earned 10 cents per share, which was in line with the average analysts' estimate, but declined 38% from the previous year. Revenue was lower by almost 11% to $189.5 million. This was $5 million below expectations.
The company saw declines in several areas. Gold equivalent fell 2.7% in the quarter, while silver equivalent dropped 1.5%. Silver production declined 19.1%, while ounces sold was lower by 29%. For the year, silver volumes are down almost 31%. Operating margins for silver was down 18.3% to $9.79 per ounce.
Wheaton's average costs for gold and silver production increased during the quarter. For gold, cost per ounce grew to $420 from $407 in the previous year. Silver costs per ounce increased to $5.14 from $4.54.
In positive news, Wheaton's gold production grew 11.3% year over year to 100,500 ounces. Gold ounces sold improved 3.4% to 90,100. The company's cash operating margin for gold improved 0.2% to $900 per ounce. Gold volumes sold were up 30.5%. Wheaton also reiterated its belief that it will reach its gold production guidance for 2019 of 690,000 ounces. The company still sees annual gold production of 750,000 ounces by 2023.
Due to improvement in the operating margin and volumes, gold revenues were up 4.5%. Unfortunately, these gains were more than offset by a 36% drop in silver revenues.
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Wheaton grew earnings per share at a rate of just 2.4% over the last decade. We expect the company to earn 53 cents per share in 2019. If achieved, this would represent a 10% increase from 2018.
Several of Wheaton's mines shifted or ceased production in 2018, but the remaining mines are expected to increase production in the coming years. As such, we feel the company should be able to grow earnings per share at a rate of 7% per year over the next five years.
Past results and dividend analysis
While recent results were mixed, Wheaton's business performance over the years concerns us.
- 2012 earnings per share results: $1.65
- 2013 earnings per share results: $1.05 (36% decrease)
- 2014 earnings per share results: 55 cents (48% decrease)
- 2015 earnings per share results: 53 cents (3.6% decrease)
- 2016 earnings per share results: 62 cents (17% increase)
- 2017 earnings per share results: 63 cents (1.6% increase)
- 2018 earnings per share results: 48 cents (24% decrease)
Even accounting for a 3.8% annual increase in the number of shares outstanding, Wheaton still isn't more profitable than it was in 2012. Our earnings expectations for 2019 are still far below the company's result from 2012. We highly doubt it will be able to create a new earnings per share high in the near future.
Steep declines in profitability have also impacted the company's ability to pay dividends to shareholders. Wheaton first initiated its dividend in 2011. Since then, the company has cut and raised its dividend several times.
- 2011 dividends per share: 18 cents
- 2012 dividends per share: 35 cents (94% increase)
- 2013 dividends per share: 45 cents (29% increase)
- 2014 dividends per share: 26 cents (42% decrease)
- 2015 dividends per share: 20 cents (23% decrease)
- 2016 dividends per share: 21 cents (5% increase)
- 2017 dividends per share: 33 cents (57% increase)
- 2018 dividends per share: 36 cents (9% increase)
While the dividend has increased over the past three years, Wheaton was forced to cut its dividend several times. Investors looking for consistent growth should avoid owning shares of the company as they will likely be disappointed in its dividend increases. Shares yield 1.2% today.
Valuation and total expected returns
It's not just recent mixed results and historical earnings per share and dividend growth that cause us to advise investors against owning shares of Wheaton. The stock is overvalued right now.
Shares of Wheaton closed the most recent trading session at $29.41. Using our expected earnings for the year of 53 cents per share, the stock has a price-earnings ratio of 55.5. This is the type of valuation normally reserved for high-growth stocks, not those that have posted declining profitability.
We feel that a price-earnings ratio of 25, which is in line with many other companies in this sector and slightly below the stock's 10-year average valuation, is a much more appropriate target. If shares were to revert to this target price-earnings ratio by 2024, the valuation would reduce total annual returns by 14.7% over this period of time.
Total annual returns for Wheaton would consist of the following:
- 7% earnings per share growth.
- 1.2% dividend yield.
- 14.7% multiple reversion.
We expect Wheaton to lose 6.5% annually over the next five years.
Wheaton's stock has increased nearly 50.6% year to date, which is almost four times as much as the S&P 500. This rapid increase in value has given shares a very expensive valuation. In fact, returning to our target valuation by 2024 would more than offset our projected earnings growth and dividend yield.
We encourage investors still holding shares of Wheaton to consider taking profits.
Disclosure: No positions in any stocks mentioned.
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This article first appeared on GuruFocus.
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