- We’ll discuss the value of the silver First Majestic has in the ground.
- We’ll also discuss the value of the company in relation to silver prices.
- And we’ll discuss the corporate governance and the stories AG’s CEO likes to tell.
AG has been severely hit over the last two years, and it’s now time to look at whether it is a bargain or not, or if the risks are too high.
After the 2015 commodity price slump, AG fell as low as $3 only to explode to over $17 in the subsequent recovery. Since the hype, the stock has fallen to the current trading level of around $7. By looking at the company, its assets, mining costs, and debt structure, we can get a good look at what the value is in relation to different silver prices.
AG is one of the few silver-focused producers, so it’s really a pure silver play. It is also a growth story as the company’s goal is to produce more than 40 million ounces of silver per year.
Revenue in 2017 was $252 million, earnings were negative $52 million, but the operating cash flows were positive at $80 million.
The company now has 7 mines in operation, and two development projects, all in Mexico.
What’s important to note is that mining costs are close to the price of silver which makes AG an extremely leveraged play in relation to silver prices. If silver prices explode, AG will do so as well, but if silver prices decline below $16, AG will be in trouble.
As you can see, the costs can be manipulated by lowering CAPEX, especially sustaining CAPEX which is necessary to keep operations running smoothly. This is also a risk with AG because we don’t know how stretched its CAPEX is to keep the costs lower because operating underground mines is costly.
2018 CAPEX will be at $125 million which is almost 50% of revenue, and the company is increasing its exploration efforts.
The high costs make AG very leveraged against silver as you want high production in case silver prices increase.
The above chart shows how smaller increases in silver prices create huge jumps in AG’s stock price. Similarly, when silver prices decline, AG’s stock price suffers. However, if you want to trade silver, AG is the one to trade.
Apart from the leverage to silver prices, the company expects its catalysts to be the following:
They have invested in new equipment at their La Encatada mine with a net present value of only $5 million which is something important to note. The management is primarily working on cost efficiencies and on integrating San Dimas so as to get a re-rating from the market.
All of this is expected to lead to 40 million silver equivalent ounces produced which should do well if the company actually manages to lower costs.
However, if I’ve learned anything in my investing career, it’s that there is a big difference between what the management is guiding, what the reality is, and what the market’s expectations are, especially in mining.
The most common case is for the company to have huge expectations built into the price which leads to bad returns, but there are some cases—albeit rare—where there is actual value and things are overlooked and undervalued. Let’s dig deeper to see what the case is for AG.
What Has Happened To AG In The Last Two Years.
Let’s first discuss the CEO, Keith Neumeyer.
Neumeyer often claims silver will trade at $100 per ounce, and is often giving interviews where he promotes AG to retail investors. In many eyes, this can make him an expert, but the fact is that he was a stock promoter and investor relations guy for most of his career as he was the Manager of Corporate Relations for First Quantum.
In a 2003 letter to AG shareholders, Neumeyer spoke about how two projects had elephant potential only to be impaired the year after. Further, of all of the company’s projects, Santa Elena is the only one that hasn’t ever been impaired or written off. This is in addition to the company being mostly cash flow negative where shareholders have been diluted more than 30 times since 2002 when Neumeyer took over the helm.
And what did AG do as soon as the stock price rose above $10 in April 2016? It issued more stock.
So, we have to take whatever Neumeyer says with a grain of salt and really look at the value of each mine on our own.
Value Of Mines
Without going through each mine, let’s look at the reserves, attach the average all-in sustaining costs of each, and see what the value left is.
Silver equivalent ounces of proven and probable reserves are 120 million. If AISC (all-in sustaining costs) are around $15 and the current price of silver is $16.5, I come to a value of $180 million if all too he silver were to be mined immediately.
Measured and indicated resources are much less reliable, but are at 137 million silver equivalent ounces. This would add $200 million to my calculation, but this has to be discounted.
The inferred resources are speculative as “inferred mineral resources have a great amount of uncertainty as to their existence, and great uncertainty as to their economic and legal feasibility.” Emphasis mine.
Nevertheless, the inferred resources are 226 million ounces which would give a value of around $300 million, not discounted.
In total, the company has about 450 million of silver equivalent ounces as resources and reserves. If they mine 20 million per year (without Primero), we get about 6 years of proven and probable reserves, another 6 years of measured and indicated, and 8 years of the highly speculative inferred resources.
Given the minimum 10% discount rate, I would only use the probable and proven reserves as actual value where we get to a value of around $150 million if silver prices stay where they are now. Each $1 increase in silver prices would add $120 million to AG’s value. So, if silver prices hit $26, AG would be fairly valued. But let’s now see if there are any liabilities.
Liabilities are actually a good point here as there is practically no long term debt (2017), with the exception of the $75 million loan that will be received with the Primero acquisition.
AG bought Primero in a $320 million all-share agreement where Wheaton Precious Metals got a $151 million stake in AG just to restructure the gold stream which means more dilution. Primero shareholders got just 3% as the company was almost bankrupt.
Now, management says AISC at San Dimas will be $10 from going forward thanks to the new streaming agreement, but there have been strikes and operating such a big mine isn’t easy. I sure hope AG’s management is capable of turning it around, which would lower AISC to about $13 and increase the value of AG.
San Dimas has about 41 million ounces of proven and probable reserves which would be valued at $246 million at current silver prices, and AISC of $10. However, Primero was almost bankrupt and who knows whether AG will be able to make its mine shine again.
Adding Primero, we get to a value of around $375 million at current silver prices. The easiest way to calculate the value of AG is to use AISCs, proven and probable reserves, and multiply that by the difference between the price of silver and the mining costs.
With a total of 160 million proven and probable reserves and average expected AISCs at $13, the fair value of AG in a positive scenario and stable silver prices is 160 (million ounces) * ($16-$13) = $480 million. Minus $75 million in debt = $405 million.
However, if silver prices increase to $25, we would have a value of $160 * ($25-$13) = $1.9 billion, which is double the current market cap. If silver prices go to $100 as AG’s CEO likes to say they will, we get to a value of $160 * ($100-$13 (AISC would increase with higher taxes etc.)) = $14 billion.
On the risk side, given that the company doesn’t have much debt, I don’t think it will go bankrupt. However, if silver prices don’t go higher, I see that it might be more likely to see AG at the current silver price as a fair value. Nevertheless, the $14 billion in value is certainly exciting and always a possibility, even if remote.
Silver Miners Look Like Pump & Dump Schemes
One major issue that I have found with some silver miners is the high promotional nature they have. This is because their survival depends on the value of their shares to get the much needed cash to grow and pay the bills, especially if you have high AISCs like AG has.
So AG’s CEO is constantly promoting silver everywhere, and I’ve been seeing Google ads from Silvercorp recently.
I firmly believe in businesses that promote themselves with quality earnings and shareholder friendliness in the form of dividends and no dilution. The more I look at the silver mining environment, the more I find things like hundreds of interviews with talking heads saying silver will go to $100, and silver-related Google ads everywhere. What kind of company needs to promote its stock on Google?
The reasoning is that most shareholders are retail investors, probably silver bugs that keep the whole environment alive as the industrial demand would keep silver prices around $10 and, consequently, many companies with higher AISCs would be in trouble.
So, be very aware that investing in AG is a pure bet on silver prices going higher which could happen, but also might not.
Therefore, the key is to understand the risk reward. If silver prices drop to $13, or even $10, you can expect a 90% drop in AG. If silver prices start increasing, you can expect an immediate positive reaction in AG’s stock price.
So, perhaps those who want more safety but still be exposed to silver might want to hold physical silver, and those who love trading will love AG, both on the way down and on the way up.
As for general corporate governance, AG has a history of burning cash, shareholder dilution, and a lot of impairments on shiny promises like the San Dimas acquisition and other exploration targets. Be aware of that.
If silver prices go to $100, you can expect a value of around $14 billion but then again, it would better to own silver because the actual metal would increase 7 times while you can expect much more dilution before silver hits $100, if it hits it.