Analysts: Tax Dispute Settlement Positive for Mining/Streaming Company

BMO Capital Markets analyst Andrew Kaip reported on Wheaton Precious Metals Corp.'s (WPM:TSX; WPM:NYSE) tax settlement with the Canada Revenue Agency (CRA), in two research notes dated Dec. 14, 2018, one pre and one post conference call with the company's management.

Before the conference call, Kaip described the outcome of the agreement as "holiday presents come early for Wheaton" as the dispute got resolved with "only minor impacts on past earnings and tax implications going forward" for the company. Another benefit is it removes the overhang on Wheaton's stock.

The analyst presented the highlights of the settlement. The bottom line is that foreign income on revenue generated by Wheaton's international subsidiaries, Wheaton International, will not be subject to tax in Canada, retroactively and in the future. Transfer pricing penalties for the tax years 2005 to 2010 will be removed, with interest adjusted accordingly.

However, Wheaton is to increase the service fee it charges Wheaton International to 30% from 20% retroactively from 2010 and include costs incurred for fundraising for those companies. The increased fee will lead to greater domestic revenue for Wheaton, which is taxable in Canada.

"After the application of noncapital losses, Wheaton does not anticipate any additional cash taxes will arise in respect of the 2005 to 2010 taxation years as a result of the settlement," Kaip wrote.

Following the conference call, Kaip reported the comments of management. The team estimates that for the years 2010 through 2017 it will have to pay about US$5 million on revenue from the increased mark-up on the fee charged to its subsidiaries. For example, for 2017, consequent to the tax settlement, taxable income will increase about US$3 to 4 million with about US$1 million additional tax paid to Canada. "The net result is a cash outlay for all past taxation years of less than US$10 million," the analyst clarified.

The total impact of the agreement on Q4/18 after-tax earnings, including current and deferred taxes and costs, Kaip relayed, should be about US$30 million. "Given the irregularity of these charges and their one time nature, we would expect headline earnings per share (EPS) to be impacted but adjusted EPS to be more reflective of the underlying operations," he wrote.

Looking forward, the company indicated how it now plans to use capital. First, it will put it "back into the ground," Kaip reported. The second use is to strengthen the balance sheet. Third, it will consider using it for a dividend increase.

Finally, Kaip reported, management highlighted that Wheaton most likely will surpass its 2018 production guidance.

BMO has an Outperform rating and a US$27 per share target price on Wheaton.

Analyst Chris Terry with Deutsche Bank expressed similar impressions of the tax settlement. In a Dec. 14, 2018, research note following Wheaton's conference call, he described it as "a significant step" because the dispute's resulting overhang on the company' share price has been the second biggest headwind for it next to the outlook for precious metals prices.

"However, we are now comfortable with the agreement and are removing this tax penalty, resulting in average free cash flow (FCF) yield of about 7% over the next three years (compared to about 3% previously including the tax penalty)," Terry reported.

Additionally, Deutsche Bank expects FCF, excluding monies from new transactions, to increase to US$628 million in 2021 from US$480 million in 2019, an approximately 8.5% versus 6.5% yield. Wheaton will most likely use the increased cash to finance transactions and pay down debt.

Per the agreement, Wheaton will pay an estimated US$30 million adjustment in Q4/18, including about US$15 million of deferred taxes plus interest and legal costs. That calculates, Terry said, to a -US$0.04 impact on EPS that quarter.

Deutsche Bank has a Buy rating and a US$25 per share price target on Wheaton, which remains undervalued, Terry indicated. The company is one of only two among the bank's precious metals coverage with such a rating.

Analyst Target Prices on Wheaton Precious Metals After Dec. 14 Announcement:

Several analysts reported their firms increased their target price on Wheaton. Analyst Trevor Turnbull with Scotiabank was one.In a Dec. 14, 2018, research note, he reported the new target price of US$35 per share versus the old, US$31, is due to the tax settlement's removal of the overhang on the stock. Scotiabank maintained its Sector Outperform rating on Wheaton.

The bank's net asset value 5% (NAV5%) assigned to Wheaton remains the same at US$13.46 per share, as Scotiabank has "maintained the view that Wheaton would prevail over time."

Before the settlement, the mining company was trading at 1.23x Scotiabank's NAV5%, compared to Royal Gold at 1.97x and Franco-Nevada at 2.18x. However, with the tax dispute resolved, Turnbull purported, Wheaton's "massive discount to peers should close."

The analyst clarified that Wheaton "has always and will continue to pay taxes on income earned in Canada." The changes Wheaton must make consequent to the settlement relate only to foreign income.

Macquarie Research also raised its target price on Outperform-rated Wheaton, analyst Michael Gray reported in a Dec. 14, 2018, note, to CA$41 from CA$35, as it "expects strong performance from Wheaton with this key stock overhang now removed."

Gray described the tax settlement as a "home run for Wheaton," which could positively impact other Canada-based streaming companies with foreign income but not in terms of share price, as they were little affected, if at all, compared to Wheaton.

Future catalysts for the stock, Gray noted, include release of Q4/18 financials and additional accretive streaming transactions.

Wheaton remains a Top Pick for Macquarie. Investors should buy it, Gray said, for its portfolio of high-quality assets with more than 95% in the lower half of the cost curve, its potential for production expansion from streams without having to pay capex, its solid management team and its high, or 30%, dividend payout ratio.

Analyst Matthew Murphy reported that Barclays, too, increased its target price on Wheaton, by 5% to US$22 from US$21 following the announcement the tax dispute was resolved.

In his Dec. 14, 2018, research report titled "Christmas Comes Early for WPM," he indicated that the settlement "looks to us to be a best case scenario" and "a significant positive for Wheaton." The reasons are that it eliminates the overhang on the company's share price at a low cost, "allowing the investor and management focus to return to Wheaton's business and its attractive valuation."

Murphy described that Barclays' worst case scenario for the tax dispute result was a liability of about US$1.3 billion with about US$300–600 million already priced into the stock. This compares to Barclays' revised liability estimate now about $20 million.

Canaccord Genuity raised its target price on Wheaton as well, reported analyst Carey MacRury in a Dec. 14, 2018, research note. The revision, to CA$41 from CA$38.50, also follows the news of Wheaton's tax settlement, which, MacRury noted, is "a significant win" for the company. The changes Wheaton has to make pursuant to the agreement "will be immaterial" to it, he added.

MacRury pointed out that the streaming sector benefits from the CRA-Wheaton settlement in that it will not have to make adjustments to be able to pay Canadian taxes on foreign income. "As a result, we believe the offshore streaming model will retain its competitiveness as a source of project funding versus traditional equity or debt funding," he commented.

Canaccord Genuity has a Buy rating on Wheaton.

More positive comments about Wheaton's tax settlement came from analyst Michael Jalonen of Bank of America Merrill Lynch. In his Dec. 14, 2018, research note, he stated it was "good news" for Wheaton, particularly since Bank of America Merrill Lynch estimated the streaming firm would wind up paying about US$1.2 billion in total taxes, interest and penalties for the years 2005 through 2015 upon resolution of the case, significantly more than the actual result.

Jalonen highlighted that the tax case with the CRA, ongoing since 2011, had a "profoundly negative impact on Wheaton's valuation versus its streaming peers," with the stock trading at about a 39% discount on price:NAV in comparison. Now, however, in light of the settlement, "we expect a multiple lift," he added.

Bank of America Merrill Lynch has a Buy rating and a US$23.50 per share target price on Wheaton.

Similarly, analyst Dan Rollins with RBC Capital Markets called the tax case outcome "very positive news," in his Dec. 13, 2018, research report, and with it, the "lingering tax cloud dispersed."

First, he explained, the settlement "provides much needed clarity" regarding taxes on past and future foreign income generated by Wheaton International.

Second, Wheaton does not foresee having to pay cash taxes for the years 2005 to 2010 given noncapital losses, and those going forward should be minimal based on the agreement terms.

Third, the stock should benefit greatly with the overhang on it decreasing materially or going away entirely, Rollins noted, as it has "been a key obstacle for many potential investors." Also, the discount between Wheaton and its peers should narrow. "With clarity provided, we see little to justify the current valuation discount, especially when considering the strength of Wheaton's portfolio of streams, which are predominantly backed by low cost and long life mines," he added.

RBC has an Outperform rating on Wheaton.

At the close of the stock markets on Thursday, Dec. 13, the day prior to the settlement news, Wheaton Precious Metals was trading at around US$16.59 and CA$22.16 per share. On Dec. 18, shares are trading around US$19.62 and CA$26.34 per share.

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