Option Trade 
Silver Wheaton Corp. (USA) (NYSE:SLW) Puts 
Sunday, August 09, 2015

**OPTION TRADE: Buy the SLW Sep 2015 12.000 put (SLW150918P00012000) at approximately $0.60. Place a protective stop loss at $0.20, and a pre-determined sell at $1.20.

by Ian Harvey

August 09, 2015


On Tuesday, Silver Wheaton Corp. (USA) (NYSE: SLW), a Canada-based mining company which generates its revenue primarily from the sale of silver and gold, is expected to report lower second-quarter profit due to a rise in costs. Analysts expect Silver Wheaton Corp. to post earnings of $0.13 per share for the quarter.

The company pioneered streaming, which involves providing financing to miners for the right to buy a percentage of their future metal production. The focus this quarter will be on a Canada Revenue Agency audit, which could result in Silver Wheaton having to pay $200 million or more in taxes and penalties. CRA is looking to tax the company for income earned by its foreign units between 2005 and 2010.

Also, many analysts are taking a negative view at the moment, with 13 analysts having set the short term price target of Silver Wheaton Corp at C$25.25. The standard deviation of short term price target has been estimated at C$3.66, implying that the actual price may fluctuate by this value. The higher and the lower price estimates are C$31 and C$20 respectively.

As well, Silver Wheaton Corp has received a hold rating for the short term, according to the latest rank of 3 from research firm, Zacks.

Technical Details


Previous Earnings

Silver Wheaton Corp. last announced its earnings results on Thursday, May 7th. The mining company reported $0.13 earnings per share for the quarter, missing the analysts’ consensus estimate of $0.18 by $0.05. The company had revenue of $130.50 million for the quarter, compared to the consensus estimate of $175.11 million.

During the same quarter last year, the company posted $0.22 earnings per share. Silver Wheaton Corp.’s revenue was down 21.1% compared to the same quarter last year. Analysts expect that Silver Wheaton Corp. will post $0.64 EPS for the current fiscal year.

Future Earnings

Shares of Silver Wheaton lost 26% of their value in the past month, in part due to 6% drop in the price of silver. The company's upcoming earnings report could offer some insight behind its progress and see if the management plans to make any changes in the company's direction.

For the Q2 EPS, the current consensus among analysts is $0.13 -- $0.05 per share lower than in Q2 2014. Most of this fall is likely to come from lower precious metals prices, and change in the gold to silver revenue mix. Nonetheless, the company's attributed production is still expected to rise - mainly in gold.

Silver Wheaton's profit margins are expected to be adversely affected by the fall in both gold and silver prices. How much? Based on the average quarterly prices, during Q2 gold and silver have declined by 8% and 17%, respectively, year on year. Even if the company's cash cost slightly declined, the profitability per ounce of gold and silver are still expected to decrease, as you can see in the table below. Nonetheless, silver remains more profitable than gold (on a per ounce basis without considering the investment costs).

But besides prices, the company's revenue will also be affected by the changes in attributed production and more importantly ounces sold.

Back in Q1, even though the attributed gold produced was 55 thousand ounces, the amount of gold sold was only 28 thousand ounces or 52% of total gold produced. This is why the amount of gold and silver produced, but not yet delivered, rose by 1.6 million silver equivalent ounces to 6.5 million ounces. So if the amount of gold and silver sold was, yet again, much lower the amount of produced back in Q2, this could bring down SLW's revenue.

Furthermore, the composition of gold to silver in the revenue mix is expected to slightly change as well so that silver will account for around 60% of the total silver equivalent sold compared to over 70% back in 2014. This shift could reduce the profitability per ounce, but it may also provide a bit more stability in the revenue stream - considering gold prices tend to be less volatile than silver.

SLW is more likely to "double down" at this point and try and find new silver and gold streaming contracts in the coming years. It has become harder for the company to do so - it's harder to reach a streaming agreement at a reasonable price when many miners are scaling back. So even though the company isn't likely to change its direction, it still has a problem of suffering from the low price of silver. When it comes to its dividend, since it's linked to the company's profitability - equal to 20% of the average operating cash flow over the past four quarters - the ongoing fall in silver prices could eventually lead to another fall in its dividend pay.

Silver Wheaton could show higher revenue but lower earnings considering precious metals prices are down and gold accounts for a bigger portion of its revenue mix than last year.

Problems to be Faced!

Silver Wheaton has underperformed sharply in 2015, with the silver streaming company having lost over 35% of its value so far. In fact, in the past one month itself, SLW shares have lost 25% of their value as the probability of an interest rate hike by the Federal Reserve has inched closer. But, apart from the impending interest rate hike that will negatively impact silver and gold prices, Silver Wheaton has other negatives to contend with that might weigh on its financial performance:-

• In July, Silver Wheaton received a proposal letter from the Canadian Revenue Agency for the reassessment of its business operations under the Income Tax Act (Canada). The CRA believes that streaming income earned by the company's foreign units during the period 2005-2010 should be taxed retrospectively.

Now, the CRA is of the opinion that Silver Wheaton's income during this period should be increased by $567 million for taxation purposes, which will lead to federal and provincial taxes of $150 million. In addition, the company will have to bear transfer pricing penalties to the tune of $57 million. Thus, if the CRA indeed applies this tax structure, Silver Wheaton's fundamental position will worsen.

• Additionally, the company's cash position is not in good shape either. Silver Wheaton has just $88 million in cash on the balance sheet, while its debt is relatively higher at $800 million. Meanwhile, in the past year, the company has generated $406 million in operating cash flow. Now, the imposition of the transfer pricing tax and the related penalty, which comes to a total of $207 million, will certainly create a dent in its financial position.

The problem is that Silver Wheaton is already struggling. In the past year, the company has seen an alarming drop in its profit margins.

The drop in its margins is a result of weakness in gold and silver prices, which has negatively impacted the company's cash flow performance as well. Looking ahead, it is likely that the price of gold and silver will decline further, which will create more problems for Silver Wheaton.

• The rate rise in the U.S. will also cause a problem, as interest rates and prices of commodities such as gold and silver are negatively correlated, as they are non-interest paying assets. In comparison, an interest rate hike makes instruments such as Treasury bonds more desirable to invest in, as they yield a higher rate of return as compared to gold and silver. This means that investors will prefer Treasuries from an investment point of view as compared to gold and silver, reducing demand for the commodities, and ultimately hurting pricing.

Analysts Opinions

Dundee Securities decreased their price target on shares of Silver Wheaton Corp. from C$33.00 to C$28.00 and set a “buy” rating on the stock in a research note on Wednesday, July 8th.

CSFB reduced their target price on shares of Silver Wheaton Corp. from C$31.00 to C$30.00 and set a “neutral” rating for the company in a research note on Wednesday, June 24th.

Also, Credit Suisse cut their price objective on shares of Silver Wheaton Corp. from C$31.00 to C$30.00 and set a “neutral” rating for the company in a research report on Wednesday, June 24th.

Finally, JPMorgan Chase & Co. decreased their target price on shares of Silver Wheaton Corp. from C$26.00 to C$25.00 and set an “overweight” rating on the stock in a research note on Wednesday, July 8th.

Harvey’s Options Volatility Indicator


Silver Wheaton shares have been beaten down badly in 2015, and more downside cannot be ruled out, as the company is facing critical problems that can hurt its business. While the review and the impending penalties by the Canadian Revenue Agency will hurt its financial position, weak silver and gold pricing will continue weighing on the company's margins. Hence, Silver Wheaton, as it looks, is set for further downside.

Therefore, based on the facts above, and Harvey’s Options Volatility Indicator, the following option trade is recommended…..

**OPTION TRADE: Buy the SLW Sep 2015 12.000 put (SLW150918P00012000) at approximately $0.60. Place a protective stop loss at $0.20, and a pre-determined sell at $1.20.

”Success is simple. Do what's right, the right way, at the right time.”

Option Tip for your Success!
Options traders are not successful because they win.
Options traders win because they are successful.

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