This is part 6 of a Ten Pack of Metal Miners article series. You can find articles for Great Basin Gold (GBG), Entree Gold (EGI), Jaguar Mining (JAG), Seabridge Gold (SA), and AuRico (AUQ) also here at Seeking Alpha.
Silvercorp Metals is a Canadian-based miner headquartered in Vancouver with operations in Canada and China. They primarily mine silver, but also have significant quantities of gold, lead, and zinc. Silvercorp is the largest silver miner in China.
The company reports 139 million ounces of silver, measured & indicated. In addition, the company holds 257,000 M&I ounces of gold, which is $411 million of inventory at present prices. Silvercorp has M&I 715,000 tons of lead and 717,000 tons of zinc.
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Total resources are spread amongst 4 locations, 2 each in China and Canada, with one producing mine. According to the company, one additional mine will begin producing in each of the next 3 years, 2012 to 2014, which will double overall production of silver equivalent ounces (silver + [gold x 50] ) by 2014 as production is fully ramped up.
Silvercorp currently has no long term debt, a current ratio of 7.33, $115 million in cashflow, and $230.47 million in cash. Tangible book value is $2.44. Silvercorp has returned 28.2% on equity and 19.57% on assets. The company profit margin is 65.36% with a profit margin of $40.12, all per Yahoo finance.
These are impressive numbers for a company that already has an operating mine and has several more coming online. There do not appear to be any major financial obstacles facing the company stemming from current or future operations.
As per the financials, Silvercorp is a very solid metals miner. Perhaps the most interesting part of the financial equation is the cost per ounce of silver, reported as a negative $6.12 per ounce. This number is calculated by factoring in the other metals as byproducts, where Silvercorp thereby uses those revenues to discount the cost of the silver. In other words, Silvercorp gets paid to mine the silver once the revenues from the other metals are factored in.
That puts Silvercorp at an accounting advantage compared to other primary silver miners. In reality, it means that Silvercorp is a diversified miner that can count on a number of different products to generate revenues. I have always felt that miners who produce more than one valuable product are internally hedged against different economic variables such as recession, business cycle, and sovereign debt and currency crisis.
In the case of the lead and zinc products, I don't see a lot of weakness in future demand sans a global slowdown as these are very common, in-demand minerals. If we do have a recession (which I believe we do) which may worsen, most likely sovereign debt crisis and currency wars will be strong factors. In this case, the silver and gold prices should logically be expected to rise, increasing profitability of those products. I always look at secondary industrial metals as a nice bonus to the miners' ongoing profit margin expectations.
Scandal or Scam?
I would be remiss not to mention the recent scandal surrounding Silvercorp's mining operations. Silvercorp has come under fire for supposedly over-reporting resource numbers and revenues, lack of tax payment proof, and a questionable auction sale, among other things. These are serious accusations, circulated in a report, made by a prominent market short seller. You can find a copy of the report here (.pdf).
There has understandably been quite a bit of buzz about this in the investor community and the shares of Silvercorp have fallen to $7.88 as of this writing, about half off of the previous high this year in April. (Part of the selloff should also be attributed to recent overall stock market weakness.)
In addition to the company rebuttal, Metal Augmentor has posted a rebuttal called Charlatan Exposed: Silvercorp's Shorts. The analysis address several of the points made in the original report distributed by the short seller.
Silvercorp recently hosted an investor tour at its mine, from which Jeff Clark of Casey Research had some preliminary comments and observations. Lastly, the Corporate Secretary publicly answered the allegations in an interview with James Puplava at Financial Sense.
Silvercorp is now suing those short sellers who participated in the negative report.
My opinion of the situation is that investors should not be too worried about the company or the stock. To wit:
1) The mine resources are backed up by a NI 43-101 compliant technical report (.pdf). These are the most detailed and rigorous of the assessments you will see on a mine and are typically accepted by industry personnel as reliable.
Some of the negative comments about resource grades that I have seen by the short sellers lacked understanding of cutoff grades and equivalency calculations. By my research, there is no reason to questions the NI 43-101 numbers.
2) Silvercorp posted supporting documentation, far in excess of what is typically made public, on its website to support its revenues as well as production numbers. In addition, Silvercorp is subject to Sarbanes Oxley legislation and has hired a Big 4 public accounting firm, Ernst & Young, LLP, to audit the company.
Being a former auditor with substantial Big 4 experience, it would shock me to see that the auditors did not properly audit revenues and associated taxes where substantive to company operations, which Silvercorp's mining revenue would be. Clearly, these numbers would be within the scope of SOX regulations and therefore the audit procedures.
3) One of the major points in the short seller report noted that the size of the trucks and number of trips could not add up to the amount of ore Silvercorp says it processes. This point has two issues. First, in the Financial Sense interview posted above, the point was made that the trucks hold more than was estimated by the short sellers, which when multiplied by the number of truck shipments, would actually closely match Silvercorp's numbers. Secondly, some of the ore is shipped directly to a smelter for processing and is not trucked out.
In addition, the Metal Augmentor report points out that the rock samples used in the short seller report were picked up off the side of the road and may not have been directly from the mines. From an auditor's perspective, I would criticize this sampling approach as sloppy at best. No self-respecting Big 4 quality auditor would pick up a random rock sample and extrapolate ore readings to an entire mine population. A better approach would be to take random samples from the trucks as they exited the mine in sufficient quantities and frequencies to reflect the population of ore, as a whole. Or better, rely on the NI 43-101 report.
4) The short sellers' report seems to be relying on fear of corruption in Chinese production and taxation practices. Silvercorp is based in Canada, is subject to strict accounting regulation, and has supported its numbers with both documentation and real world revenues and dividends. The proof is in the pudding, as they say. Corruption in China is not a communicable disease affecting every company that does business in the country and investors should be careful in allowing their fears to cloud sound technical analysis.
5) Silvercorp, including management, is buying back its own shares. You would have to be a really stupid criminal to perpetrate a fraud and then buy into it yourself. This point alone should serve as a serious indicator the short sellers' report may be overblown.
This does not mean that all questions have been answered at Silvercorp. Some investors are calling for another independent resource evaluation and perhaps another third party accounting review. Silvercorp, in my eyes, has adequately answered the questions presented to it. However, going the extra mile in addressing the allegations would be money well spent in getting this situation behind the company to concentrate on what it does best, which is mining.
Because the price has been cut in half and because Silvercorp anticipates doubling production in the next 3 years, I see this stock as a potential 3-4 bagger by 2014. While undoubtedly some future expectations were priced in at $15 per share, those expectations should have been fully priced out at current levels. I look for $20 per share once they get all mines running.
I just bought 258 shares of the stock, which is all the free cash I had left in my brokerage account.
Disclosure: I am long SVM.