The Q4 Earnings Season for the Silver Miners Index (SIL) is set to begin in a couple of weeks, and one of the first companies to report its preliminary results is Pan American Silver (PAAS). Despite a decent finish to the year, Pan American’s silver production came up short vs. its revised guidance mid-point and missed its initial guidance by a mile. Fortunately, 2022 should be a much better year, with mining rates steadily improving at La Colorada. In an industry where it’s difficult to find attractive valuations among most silver producers, PAAS trades at ~8x FY2022 cash flow and ~1.2x P/NAV, suggesting any further weakness should present a buying opportunity.
Last week, Pan American Silver released its preliminary Q4 and FY2021 results, reporting quarterly production of ~5.28 million ounces of silver and ~156,700 ounces of gold. This was an improvement on a sequential and year-over-year basis (Q4 2020: ~4.87 million ounces) but wasn’t enough to meet the revised guidance midpoint for silver (~19.5 million ounces). Making matters worse, Pan American appears to be experiencing workforce deployment levels related to COVID-19, with the latest wave affecting the company. This has deferred the announcement of FY2022 guidance, suggesting that this could be a weaker year than where the company’s expectations were pre-Omicron. Let’s take a closer look below:
As shown in the chart below, Q4 was a much better quarter for Pan American, with silver production increasing to ~5.28 million ounces, up more than 8% year-over-year and 9% on a sequential basis. This was helped by a steady improvement in production at La Colorada following the issues in early to mid-2021 (ventilation constraints). Meanwhile, gold production also improved materially, hitting a new 18-month with another strong quarter out of Dolores, which is benefiting from higher gold grades related to mine sequencing. However, while this was a significant improvement from FY2020 levels, production is still well below FY2019 levels, when Pan American reported production of ~6.6 million ounces of silver and ~174,000 ounces of gold.
The culprit for the lower silver production has been lower silver grades at Dolores related to mine sequencing, lower than planned grades at San Vicente, lower production at Colorada, and less than ideal workforce deployment across the board due to COVID-19 headwinds. Initially, I was expecting these headwinds to be mostly in the rear-view mirror by FY2022, with a year of much better productivity in FY2022. However, it appears that Omicron may have stunted what should have been a smoother recovery this year. This is based on the company’s recent comments that it will not be providing FY2022 production guidance yet, with the latest wave of COVID-19 infections leading to reduced workforce levels.
If we look at annual production statistics, the sharp decline relative to FY2019 is even more clear, with gold production up only due to the increased gold grades from Dolores and this asset moving into the gold segment. Meanwhile, silver production is down more than 20% (partially affected by Dolores), but mostly due to a weaker year from the company’s largest contributor: La Colorada. As noted previously, La Colorada should see a steady improvement in mining rates this year which will help to increase production. However, based on my preliminary estimates, I would still expect silver production to remain well below FY2019 levels, while gold production should hit a new high above 600,000 ounces.
The one silver lining for revenue and earnings in FY2022 is that lead and zinc prices continue to trend higher, and silver seems to be finally waking up from its slumber to begin the new year. On a 10-day basis and excluding the pullback in early January, silver’s average realized price is sitting closer to $23.40/oz, up from $23.15/oz in Q4 2021. This isn’t a huge improvement, but it is a step in the right direction. Once we get past the tough comps in H1 2021 (~$25.50/oz average realized price), Pan American should have much easier comps in H2 2022 and should be able to post strong revenue growth and EPS growth in the back half of this year.
Based on current estimates, annual EPS is expected to increase more than 80% from FY2019 levels ($1.46 vs. $0.78) and make a new high vs. FY2020 levels. However, meeting or beating these estimates will be contingent on metals prices cooperating, and the COVID-19 situation not worsening globally. As noted above, Pan American has not provided guidance yet for FY2022 metals production, suggesting that it could be a slightly weaker year than hoped for before the emergence of Omicron in December. Still, with the company benefiting from a much higher contribution from La Colorada, and improved operating costs (relative to FY2021 levels), this should be a much better year for the company from an earnings standpoint.
Valuation & Technical Picture
Moving over to Pan American’s valuation, we can see that the stock has historically traded at ~13x operating cash flow over the past decade and closer to ~14x cash flow since it acquired Tahoe in 2018. Based on FY2021 operating cash flow estimates, the stock is trading at ~11.4x operating cash flow, only a slight discount to this historical multiple. However, operating cash flow is expected to increase to $2.90 or higher in FY2022 based on current estimates, leaving the stock trading at ~8x forward operating cash flow. This is a similar valuation to where the stock briefly traded in Q1 2020.
Even if we use a more conservative multiple of 10x operating cash flow, a 20% discount to its historical multiple, and estimates of $2.09, this would translate to a fair value of $29.00 per share. I have purposely applied this discounted multiple due to the fluid COVID-19 situation, which continues to impact the company’s productivity, and the potential for inflationary pressures to worsen, with cash costs up across the board for nearly all producers. However, even in this more conservative assumption, Pan American has more than 23% upside to fair value and pays an attractive ~1.70% dividend yield, which is well above its peer group in the silver space. For comparison, most silver miners are not paying dividends, and if they are, they’re below 1.00% annualized.
So, is the stock a Buy?
Looking at Pan American’s technical picture, we now have two strong resistance levels overhead, with lower resistance coming in at $29.60. This could impede future rallies to the $29.50 and provide a sticking point, given that there is likely a significant amount of supply overhead from buyers in 2021 that might be anxious to get out of the stock at break-even. However, with the stock down 40% from its highs, PAAS is now sitting just above a major support zone at $21.55. Based on $6.10 in upside to resistance and $1.95 in downside to support, the reward/risk ratio for the stock has improved considerably.
Generally, I prefer at least a 4 to 1 reward/risk ratio to justify starting new positions, especially when there is a looming uncertainty, which in Pan American’s case is the possibility of lower productivity due to COVID-19 headwinds. So, while Pan American’s risk/reward ratio has improved, the ideal buy zone comes in at $23.15 or lower. At this level, Pan American would have $6.45 in upside to potential resistance and $1.55 in downside to support. In summary, I believe Pan American should be at the top of one’s watchlist for those anxious to add some silver exposure to their portfolio.
It isn’t easy to find much value among most of the silver producers, with many trading at significant premiums to net asset value, with First Majestic (AG) being one clear example at ~3.0x P/NAV. However, Pan American trades at a much more reasonable valuation of ~1.20x P/NAV, making it one of the few ways to get silver exposure with a margin of safety baked into the stock. Based on what should be a much better year ahead for Pan American and easier year-over-year comps following a year of consolidation for gold prices, I would view pullbacks below $23.15 as low-risk buying opportunities.
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Disclosure: I/we have a beneficial long position in the shares of GLD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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