Silver Producers Enter Profitable Phase


"Recent reports confirm a phase of sustainable profits."

The latest quarterly (Q2, ended June 30, 2010) results from a number of producers confirm that they are now entering a phase of sustainable profits. We will look at several companies and try to make sense of the numbers as well as make an EPS projection for the calendar year 2010. This particular selection of companies was not meant to be a comprehensive overview of the entire group of silver producers, yet our intention was to provide a meaningful representation of it. Frankly, these companies are doing better than most of the rest of the group in terms of absolute earnings and comparative rate of growth versus prior years. Notable omissions include Fresnillo (LSE:FRES), Hochschild Mining (LSE:HOC) and Polymetal (LSE:PMTL) mainly due to time constraints and access to data. Companies in the table below are listed in alphabetical order.


*Earnings projections for the year 2010 are ours

There are a few wrinkles that (may) skew some of the numbers in either direction which always makes these types of summaries tricky and diminish their potential utility, but overall we tried to get as close to "apples-to-apples" basis as possible. These "irregularities" have to do with the format in which companies report their numbers. For instance, some companies report equivalent ounces of production, while others report cost per ounce net of by-product credits. Some companies expense their drilling costs while others capitalize them, still others differentiate between exploration and production drilling and split the costs accordingly. Silvercorp and Hecla report negative cash cost per ounce of silver production. This, of course, is impossible and is accounted for with by-product credits. Then again, Silvercorp shows an "average cost per ounce of silver" at $3.00 elsewhere in the financials where they also report the unit cost of production of gold, lead and zinc. We were not able to find this level of detail from Hecla so we had to backtrack and resort to using the "negative cost" number. That in turn forced us to ignore by-products completely for the rest of the companies in order to arrive at a semblance of a common denominator for the whole group. Incidentally, Silvercorp also happens to have a financial year that does not match the calendar year so we just used the latest two quarters reported. In other words, this table is far from perfect, but we hope it is useful in getting across the point we're trying to make. It was not designed to compare companies to each other, but rather demonstrate the earnings proficiency of the group.

Coeur d'Alene Mines (NYSE: CDE, TSX: CDM)
At first glance Coeur does not belong in this table as they lost a lot of money in the given period. However this company has seen perhaps the most aggressive transformation in its asset base in recent years and demonstrated a remarkable turn-around in both production numbers and health of its balance sheet. Losses shown here are necessitated by accounting standards related to its hedge book, not actual loss of funds. Lastly, due to dramatic changes in the operations Coeur has been on a roller-coaster ride in terms of its financials. E.g. in the first 6 months of 2009, CDE reported EPS of $0.27. Overall, Coeur has not answered all questions yet, but it has dug itself out of a hole it was in just a few years ago with, so is worth keeping an eye on.

Endeavour Silver (AMEX: EXK, TSX: EDR)
Endeavour's performance has been gaining steam and the numbers are looking very impressive, especially this year. The company is well on its way to clear the 4 million ounces of annual silver production mark from its existing operations next year. Endeavour also made no secret that it is on the hunt to acquire another producing or near producing mine still this year. It should also start posting better earnings since major capital expenditures on its current operations have been made.

First Majestic Silver Corp. (TSX:FR; OTCQX:FRMSF)
Perhaps the fastest growing mining company (Fortune magazine, take note), it certainly is in the silver space, particularly on profits basis. First Majestic just posted a blockbuster $0.10 EPS in Q2. Short of any serious mishap FR is looking capable of achieving earnings of $0.40/share or better in the next 12 months. Combine that with its share price of around $4.0 as of this writing and you can come up with a P/E ratio that compares very advantageously to that of Eldorado Gold (50) and most other companies in its peer group. Better yet, First Majestic has all the ingredients to double its production again from projects it already owns in the next few years without further dilution.

Fortuna Silver Mines Inc. (TSX:FVI; Lima Exchange:FVI)
Fortuna is another junior silver producer that is coming into its own as it gears up to start production from its San Jose mine in Mexico later this year. Already sporting a very attractive P/E, Fortuna is living up to its name and looks poised to make a fortune for its shareholders in the near future. It should record another significant bump up next year when San Jose starts contributing to the bottom line. We reckon the reason why both FR and FVI are overlooked by investors is their relatively small market cap, short profitability track record and absence of listing on a major US exchange. But that is changing before your eyes so don't expect these two companies to be valued as they are presently beyond this year.

Great Panther Silver Ltd. (TSX:GPR)
Great Panther Silver has also been clawing its way into profitability. While its production currently is still under 2 Moz/year, GPR is already profitable and has made tremendous progress from where it was a couple of years ago. The company is putting a lot of money into development of its mines and has reported some encouraging gold intercepts from recent drill programs. The company is also attractively valued relative to its peer group and is looking to grow its production. Inversely, if Great Panther continues to be valued at present levels, it may become an acquisition target itself, which would spell good news for shareholders.

Hecla Mining (NYSE: HL)
In our opinion, Hecla is the perennial under-achiever of the group (during this cycle). It missed numerous opportunities to take leadership in the silver sector that we are aware of. That said, the company is doing fine, thank you very much. The acquisition of the balance of Greens Creek from Rio Tinto - though costly at the time - is now paying off handsomely for Hecla, its greater (over 50%) exposure to base metals notwithstanding. The company has a solid balance sheet, well established name and history, long time NYSE listing and is profitable again. Despite losing some of its top brass in recent past, the company still retains a deserved reputation of one of the best underground miners. In this investment environment Hecla finds itself in an enviable position relative to the rest of the market.

Pan American Silver (NASDAQ: PAAS, TSX: PAA)
We have long since christened Pan American Silver "the Cameco of silver sector." That is more subtle than it may first appear. Cameco is the undisputed leader of primary uranium producers and has been for years. While Pan American may not have the same level of influence in the silver space, it has been the leader of the group, especially in the current cycle. Pan American is likely to emerge as the consolidator in the silver sector gobbling up smaller companies along the way. It started to pay dividends to shareholders this year - another sign of maturity and prosperity. For the moment we can't find many faults with this PAAS and hope it will stay that way.

Silvercorp (NYSE: SVM, TSX: SVM)
Silvercorp is a story of remarkable success and another candidate for the fastest growing mining company title at least with respect to previous five years. The company makes loads of cash and pays one of the highest dividends among precious metal companies. The only problem Silvercorp has is sustaining the same growth rate as it enjoyed in the past, and that is a good one to have. In the last couple of years the company has been actively working to diversify its asset base geographically into North America and possibly South America. Expect surprises on the upside from SVM.

Silver Wheaton (NYSE: SLW, TSX: SLW)
Silver Wheaton is an old favorite with the least well-understood business model in mining. Why? Because they created it, literally devised it. In essence it's a royalty company that, in addition to initial purchase of the royalty, was smart enough to cover the cost of production of by-product silver at the time of delivery, also known as COD. Thus greasing the wheels towards many deals that would otherwise be closed to traditional royalty transactions, SLW has amassed a substantial portfolio of - what it calls royalty streams or silver "streams," which is again, silver produced as by-product of mining other metals, such as copper, gold, zinc, etc. We think the reason Silver Wheaton has been so successful is because they made the transaction easy for the seller to consummate and execute. They made the process clean and simple in accounting terms AND they cover your expenses when you actually pay up (deliver the silver). Silver Wheaton deserves more ink than we can give it here, but at last count they had pre-paid for some 40 Moz. of annual silver production for years to come, for which they will have to shell out an additional US$4/oz. COD. Not a bad gig considering that silver is trading at $18 and is sooner going to $50 than $5. From here on it's an accounting exercise, there is not much else to do, if they so chose. If they closed shop (of a total of dozen people at last count) tomorrow and instructed their banker to direct-deposit incoming checks SLW should reach 40 Moz. of annual silver production (in the sense that they will receive it) by 2013. And that is the "minimum" case scenario. After all, these chaps didn't get there by sitting on their hands. They will find ways to add value. Just in case we're not clear on this one, we're biased towards SLW. We started liking it when it was still Chap Mercantile. We like it more today than we did back then. So what if Argentina is trying to pull the rug from under Barrick's Pascua Lama project? Barrick is still on the hook to deliver the silver.

To Sum It Up

You probably figured from this discussion that we're bullish on silver price in the longer term, but we're even more bullish on silver stocks in the intermediate term. That is to say, we're not sure when the next move up in silver will come about, but we're on record forecasting that during the next leg up silver should register a high somewhere between $30 and $50. Sure, it's laughable. They also laughed when we called silver to get above $10 an ounce. The beauty of this situation is that these days you don't need to be a silver bug to invest in these companies. You don't need to convert, become a "believer." Simply check those earnings and stick with the one(s) that rub(s) you right. See where else in the market you can find profitable companies and for how much longer. The silver party is just getting started.

Sean Rakhimov

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P.S. This writer is still uneasy about the general market at present. While we endorse the silver sector, all else including strategy and market timing are beyond the scope of this missive.

Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. It is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed herein are those of the author and are subject to change without notice. The information herein may become outdated and there is no obligation to update any such information. The author, entities in which he has an interest, family and associates may from time to time have positions in the securities or commodities discussed. No part of this publication can be reproduced without the written consent of the author. Copyright 2010 by Sean Rakhimov.

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