In an earlier article, I explained why Freeport (FCX) is both substantially undervalued and a safe investment. Improving demand, liquidity, and attractive cash deployment are just some of the reasons why the copper, molybdenum, and gold producer will prevail despite labor problems. I find that Hecla Mining (HL) - which currently has a "hold" rating on the Street - will similarly exceed expectations, but stop short of making a "buy" recommendation at the current moment given how expensive the stock is. Over the last twelve months, the stock has gone down by more than a quarter while competitor Coeur d'Alene Mines (CDE) - which has a "buy" rating on the Street - has gone up by more than a third.
From a multiples perspective, both stocks are expensive. Hecla trades at a respective 23.6x and 9.1x past and forward earnings; Coeur, at a respective 138.5x and 7.5x past and forward earnings. In addition, Coeur and Hecla are volatile stocks that have betas greater than 1.6. At the same time, gold becomes an attractive hedge against the inflationary results of runaway government spending. And, as one contributor noted, sales of Silver Eagle Bullion hit a new high in 2011. While the first point is often debated, exposure to basic materials is becoming an ever-popular cornerstone to many investors portfolio - and this increased weighting will drive demand.
To be more clear, Hecla mines several materials: silver, gold, lead, and zinc. The Greens Creek yields zinc, lead, bulk, silver, while Lucky Friday yields mostly lead and zinc. Coeur, on the hand, is primarily a silver producer, but also mines gold. Mines include Palmarejo, Rochester, Kensington, and San Bartolome.
At the recent third quarter earnings call, Hecla's CEO, Phil Baker, noted operating success and steps that the company is taking to de-risk.
"First financially, it was an excellent quarter with solid financial operating results. Sales were $121 million and net income was a quarterly record. Silver production was as expected at 2.3 million ounces and cost were $0.67 per ounce which remain among the lowest in the world. And realized Silver prices averaged $37 per ounce, so almost all of that was margin. Cash from operating activities was $61 million, increasing our cash position to a record $414 million ...
We announced an innovative dividend policy that tied to pay out to the Silver price. We believe it gives Hecla the highest pay out among Silver companies something over 1% and makes Hecla a more attractive alternative to other Silver companies and also to the ETF."
This policy and commitment to returning free cash flow to shareholders is especially favorable at a time when investors are fearful about a double dip. While the upside is quite favorable, the volatility inherent in the stock precludes many investors from making the initial long position - thus this dividend policy represents a step in the right direction.
As for upside, management has been undergoing expansion of the Lucky Friday mine and reaching even higher grade. It recently completed the mine's #4 shaft, which will expand production by a staggering 60% and keep operations open for decades. An optimization project will also be conducted at Lucky Friday to improve the management of free cash flow. At the same time, Hecla is also opening up mines that were closed due to depressed valuations - an indication to me that management is confident of its current strategy and investments. It is difficult to quantify the effects of increased scale, but some projects have been speculated to yield $15M ounces by 2016.
Perhaps the most impressive metric for Hecla going forward will be gross margins. Costs are being reduced while metal prices are remaining strong. This will enable the firm to maximize free cash flow as it expands. With that said, Coeur has gross margins of 50% versus 46.5% for Hecla.
Consensus estimates for EPS are that it will increase by 61.3% to $0.50 and then by 28% and 6.3% in the following two years. Of the 6 revisions, all have gone down. There exists plenty of potential in the stock, but a better entry point likely awaits in the future, as the current valuation comes at too high of a price to justify the risk.