Silver Lining in the Clouds
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While the markets have been stormy lately, there is a silver lining in the clouds. One company that fits the silver lining bill nicely is Silver Wheaton (NYSE: SLW). While the S&P 500 fell nearly 2.5% last Friday, Silver Wheaton gained over 4.5% and is up over 15% in the past few weeks.
There are three reasons that Silver Wheaton is a good pick for investors even in the current market conditions:
- Increased demand for silver
- Compelling valuation
- Solid business model
Let’s examine each of these further.
Increased Demand for Silver
Silver Wheaton’s stock rises and falls with the price of silver. Greater demand for silver translates to higher stock prices for the company’s shares. Yearly demand for silver has increased by nearly 20%, according to data published in the World Silver Survey 2012. More important for investors are the sources of the demand. The chart below shows the 2011 silver demand sources using information from The Silver Institute.
The largest source of demand for silver is in industrial applications. These applications include virtually every electronic device such as cell phones, laptops, tablets, and appliances. These represent strong growth markets.
Photovoltaic cells used in generating solar power use silver also. The use of silver for this purpose is expected to consume over 100 million ounces by 2015. That amount would be nearly 10% of all silver produced in 2011.
Demand for silver in coins and medals has increased over 370% since 2002. However, that growth pales in comparison to the increased demand by investors. Investment demand for silver has more than quadrupled since 2004. This demand was driven in large part by the introduction of the iShares Silver Trust ETF (NYSEMKT: SLV). Formed in 2006, this ETF currently has assets of over $10 billion.
Investment demand for silver is poised to rise even more if the Federal Reserve Board decides that more pump priming is needed for the U.S. economy and renews its quantitative easing approach. Similar actions by governmental financial bodies in other countries could also drive investors to purchase precious metals including gold and silver.
Silver Wheaton shares have been beaten down with the drop in silver prices in 2011. However, this is good news for investors because the stock is now at an attractive price point. The forward P/E is less than 12. In comparison, Silver Wheaton’s average P/E was 23 in 2011, 50 in 2010, and 42 in 2009.
With a low P/E and strong growth estimates, Silver Wheaton’s PEG ratio stands at 0.63. Earnings growth projections would need to be way off base for the company’s shares to not go up over time. Could the estimates be far too optimistic? Maybe, but I think it isn’t likely that they are considering the demand drivers discussed earlier.
In addition, from a technical viewpoint there does appear to be a solid level of support for silver prices in the $26 to $27 per ounce range. The current silver price is just above this support level.
Solid Business Model
Maybe you’re at least partially convinced that silver prices are likely to go up and that silver companies with attractive valuations are good potential buy candidates. But why is Silver Wheaton the best silver company to buy?
The answer lies in the company‘s business model. Silver Wheaton is the largest silver streaming company with more silver reserves than any other company. However, Silver Wheaton doesn’t actually own any mines. None. Instead, it owns a stake in silver production of 19 mines across the globe.
Silver Wheaton’s business model is to provide upfront capital to miners in exchange for the option to purchase silver production (and some gold production). Most of its agreements with miners are for the lifetime of the mine and lock in prices of around $4 per ounce with small inflationary adjustments. In a sense, buying Silver Wheaton is like buying options on silver. The beauty of this model is that the company has no ongoing capital or exploration costs.
How does this business model position Silver Wheaton against its competitors? Take a look at the metrics below.
Hecla Mining (NYSE: HL) appears on the surface to be valued more attractively with a forward P/E of 9.04. However, its PEG is much higher and the company has a low free cash flow. Similarly, Silverwork Metals (NYSE: SVM) has an appealing forward P/E but a high PEG and low free cash flow.
Pan American Silver (NASDAQ: PAAS) is the strongest contender with a low forward P/E of 8.56 and reasonable PEG of 1.09. The company also has a solid profit margin and return on equity. However, in terms of growth potential, Silver Wheaton emerges as the winner.
The premise of the old adage that every cloud has a silver lining is that there are bright spots even in difficult times. The market is surely encountering difficult times with continued European woes, a potential slowdown in China, and troubling U.S. unemployment numbers. There are bright spots, though.
Silver Wheaton looks like it could be the silver lining in the clouds. With strong demand and price support for silver, a low current stock valuation, and an excellent business model that positions it well against the competition, Silver Wheaton is worth consideration for inclusion in investors' portfolios.
Keith Speights (www.keithspeights.com) has no positions in the stocks mentioned above. The Motley Fool owns shares of Hecla Mining Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.