Analysis for www.metalaugmentor.com.
Introduction
Since my last article in November 2007, a lot has happened in the markets and the world economy. I will not discuss any of that here, except to say that I continue to believe that precious metals in general, and silver in particular, are an excellent place to be invested over the coming 3-4 years. With the fall season upon us, when trading activity typically picks up and mining share prices generally improve, I thought it would be worthwhile to do an update and present new information and analysis on silver mining shares that could prove useful for investors.
I have decided to limit this article to cover only those companies that will have substantial silver production in 2009; that is, more that just test mining. Therefore, of the eleven companies covered in November 2007, I have chosen to drop ECU Silver and Genco Resources, while adding Hecla and Coeur D'Alene. This is not to say that the dropped companies should not be owned, and in fact I still do, only that they are primarily in the development rather than the production phase of their growth process. I chose to retain Impact and Silver Eagle, although I realize they are just on the borderline of my criteria. I added Hecla and Coeur D'Alene because they are primarily silver producers, and I wanted to have more large producers to compare to the others.
Operating Margin Ratio
With my focus being on production, I decided to build my analysis around developing an estimate of the silver miners' operating profit margin for 2009. The results are shown in Table I below. My data sources include studying financial reports, talking to their investor relations personnel by telephone, and my own data files collected over the last several years.
Please note that all the numbers shown are denominated in ounces of silver produced, not silver equivalent ounces. The cash cost per silver ounce is shown in Table I and was derived by subtracting the forecast of byproduct revenue from the total cash cost of production and then dividing by the total silver ounces forecast to be produced for 2009. To clarify, cash cost of production means that non-cash items like depreciation and depletion are not included, and of course no overhead items like head office salaries, interest, etc. Exploration costs are also excluded.
The cost of transporting, smelting, and refining the ore concentrate for all the metals sold is included in the cash cost number shown in Table I. An interesting side note on this is that every company but Endeavour Silver contracts out all their smelting and refining. As a result, Endeavour Silver's transporting, smelting, and refining cost is the lowest as you might imagine. The next lowest is Coeur D'Alene, and this is probably the case because as you can see in Table II both Coeur and Endeavour have no lead or zinc byproduct to process. The average cost for smelting and refining was around $3/oz. of silver produced excluding these two companies. A higher percentage of base metals generally results in higher transporting, smelting and refining costs due to the larger volumes of material to be processed.
I made the assumption that the average silver price in 2009 would be $18/oz. and used it to calculate the revenue forecast for each company. Given the current environment, that price may very well not be achieved, but a decrease in the realized price would similarly impact the financial results, ratios and comparables of each company. Subscribers to The Metal Augmentor service at www.metalaugmentor.com will have access to a special page where the silver price can be updated with different what-if scenarios. They will also have access to expanded reports where my strategy will be applied to other silver miners and gold miners as well. For now, readers can download an Excel spreadsheet of the tables in this report at www.metalaugmentor.com/mss.php along with a full copy of the entire report in an easy to read and print PDF format.
For the next part of my analysis, I calculated the June 30, 2008 market capitalization of each company by multiplying the share price by the outstanding and fully diluted shares. I then divided the market cap by the operating margin to arrive at the comparison ratios shown in the final two columns of Table I. This number is the multiplier value the market is placing on each dollar of estimated operating margin for 2009 (as of June 30, 2008). To see the how the silver mining shares have been impacted by the recent market turmoil, you are invited to download the Excel spreadsheet at The Metal Augmentor website referenced above where prices can be updated in real-time.
As the reader can see, the companies are listed in Table I in order of descending market cap. In general, the market multiple of operating margin appears proportional to the market cap.
Coeur D'Alene does not fit that pattern, but please note that they are forecasting a silver production increase of nearly 100% from 2008 to 2009. I think the market is skeptical of their ability to achieve this, however, and thus the lower multiple than their size would otherwise imply.
Great Panther appears to be more highly valued than its peer group, but they have recently drilled some very high grade ore at their Guanajuato mine, and also made significant upgrades to their operations there. Thus, the market appears to be expecting lower cash cost or greater production than I have shown. If their cash cost was $7 per ounce of silver produced, which is similar to the other juniors shown, their multiple would fall to 5.3, which is close to the others as well.
Fortuna was included in this study but I was unable to obtain the necessary data to calculate the production figures. As shown on Table II, their percentage of revenue from silver will be below 50% in 2008 (it was just 18% in 2007). However, they claim that they will be mining from more silver-rich veins at their Caylloma mine in Peru next year. And if their San Jose project in Mexico comes on line as projected in 2010 or 2011, they should then have significantly more than 50% of their revenue from silver.
Another important fact to note about my data is that it is not just dependent on the accuracy of my average silver price of $18/oz. for 2009, but also on the prices of byproduct metals. Looking at the first column of Table II, the reader can quickly determine the extent to which each company's profit is dependent on byproduct metal prices. I was not able to obtain the price assumptions being made for byproduct metal prices by any of the companies, but I believe they are in the range of $800-900/oz. for gold and $.80-1.00/lb. for lead and zinc.
A final point to keep in mind regarding the analysis shown in Table I is that the pre-tax income of each company will include overhead items and explorations costs, while the operating margin does not include these costs. Since overhead and exploration costs will in most cases be a smaller percentage of revenue the larger a company gets, this may explain in part why the larger companies have a higher multiple of operating margin. That is, companies with higher net income will naturally have a higher multiple of operating margin.
Ore Grade and Resources Still Matter
The ore grade data shown in the second column of Table II was provided by each company and represents the grade of ore currently being mined. In the case of Silvercorp, however, I found that they are currently mining ore containing about 450gpt silver while their resources are claimed to contain 1,200gpt silver. Apparently they will soon be mining more of the high silver grade ore but the company did not provide a projection. So the silver ore grade shown in the table is my best guess for what they will mine in 2009.
This same effect will probably also be true for Great Panther and Silver Eagle since each company has found much higher grade ore on their property than what they are currently mining. Still, I did not venture a guess as to what their ore grade might rise to in 2009 and instead used the 2008 estimate.
Significant increases in the grade of ore being mined will of course increase profits, so I will continue to track these numbers for all the miners I am following.
Please note that Table II also shows the currently claimed NI 43-101 resources for each company. I divided the silver production forecast for 2009 into the resource number to arrive at a rough mine life estimate. Interestingly, the larger companies all show mine lives of around 20 years, and they also have the highest multiples of operating margin with the exception of Coeur D'Alene. Conversely, all the juniors except First Majestic have estimated mine lives of less than ten years. This appears to go a long way in explaining their lower multiples.
The Market for Silver Mining Shares
I show select trading for each company in Table III. I have not seen this studied anywhere else, and I was curious. As you can see, the trading volume as a percentage of total shares outstanding is typically larger by several multiples when the company has a listing on a U.S. exchange. Of all the junior silver miners only Endeavour is traded on a U.S. exchange, and its trading volume is more than double any of its junior peers.
Finally, the average daily trading volume shown in Table III was taken from Yahoo! Finance and represents the rolling average for the previous three months. This trading data was collected in early August 2008 so it does not line up perfectly with the June 30 share price, but differences in trading volume are expected to be slight. The average daily trading volume indicates to an investor how easy it would be to buy or sell a specific number of shares without significantly impacting the stock price. The smaller the volume, the more important it is that an investor use limit orders. Also, well-heeled investors may want to spread their trades out over several days or weeks if the total order amount is in the range of the daily trading volume.
Don Hansen is a private investor with an interest in silver mining shares. He has not been compensated to write this report although he has been invited to be a contributing member of The Metal Augmentor at www.metalaugmentor.com. Don Hansen and the editors of The Metal Augmentor own shares in most of the companies mentioned in this report.
