Since I first wrote my reserved article on Hecla Mining (HL) almost two months ago, the stock has fallen by 11.2% while the Dow Jones industrial average rose by 4.9%. At this point, I find that the company may be at its low and is more skewed towards reward than risk.
The company has had strong third quarter results and has improved financial standing, but is now at a noticeable discount to peers. Accordingly, I more optimistic than the Street, which rates the stock a "hold." One silver miner that the Street and I both can agree on, however, is Silver Wheaton (SLW). This undervalued gem has more stability during challenging macro conditions and enjoys tax advantages.
From a multiples perspective, Silver Wheaton is the more expensive of the two due to faster anticipated growth rates. This is striking in light of how Silver Wheaton has a considerably larger sales base to grow off of. It trades at a respective 22.8x and 12.5x past and forward earnings while Hecla trades at a respective 14.1x and 9.7x past and forward earnings. Since Silver Wheaton contracts with other producers, gross margins are also substantially higher at 80.5%. The Street currently rates the company Wheaton near a "strong buy."
Even still, Hecla is proving its own strengths. At the third quarter earnings call, Hecla's CEO, Phil Baker, noted development progress:
A quarter ago, we were not sure how long the rehab would take at the Star mine and the Equity ramp. As it turned out, they are both complete and we are in the final stages of powering them up for drilling. At the Star, we hadn’t identified the two separate studies that we’re now doing. The first, the mineability study is focused on getting the Star back into production in the next few years from the material in the upper country, which has a potential for $25 million ounces. This study will be ready by the end of the first quarter.
The other, the dewatering study provides not only potential production from deeper resources at the Star, but also it generates additional exploration on the Star and the area between the Star and the Lucky Friday and ventilation opportunities for the Lucky Friday and this study will be complete within a year.
At the same time that third quarter earnings were stellar, the company has improved its balance sheet and continues to focus on gaining cash. This liquidity goal is complemented by the unique dividend yield that is tied to silver prices. Furthermore, I believe that analyst reservations are overdone in regards to whether projects in Idaho, Mexico, and Colorado will materialize into mines. Management understands that, at this point especially, it cannot set the bar artificially high and expect to create long-term shareholder value. The fundamentals will prevail, as they did in the third quarter.
On December 14, a rock burst in Lucky Friday and Hecla responded by halting production. The company installed a haulage way to avoid the region, and production should be fine as it resumes. One problem, however, is that management guided for 9MMoz in 2011 and 9.5MMoz in 2012, which was below what some analysts were expecting.
Consensus estimates for Hecla's EPS are that it will grow by 51.6% to $0.47 in 2011 and then by 23.4% and 12.1% more in the following two years. Of the 5 revisions to estimates, all have gone down. Assuming a multiple of 14x and a conservative 2012 EPS of $0.55, the rough intrinsic value of the stock is $7.70, implying 36.3% upside. If the multiple were to decline to 10.5% and 2012 EPS turns out to by 15.5% below the consensus, the stock would fall by 8.8%. Accordingly, I find the "hold" rating on the Street much too bearish.
The situation at Silver Wheaton is, however, appearing brighter. The company is not as vulnerable to input inflation as its competitors are given how the flexibility in contracts. As Goldcorp (GG) expands production and capacity at Penasquito, Silver Wheaton is well positioned to benefit from a recovery. (Note, however, that there Goldcorp faces numerous risks with the ramp-up.) With that said, the Yauliyacu mine had considerably high investment, and sales were lower than anticipated in the third quarter. Management recently reiterated guidance of 25-26 moz worth of silver production in 2011.
Consensus estimates for Silver Wheaton's EPS are that it will grow by 111.7% to $1.72 and then by 46.5% and 2.8% more in the following years. Assuming the multiple drops to 19.5x and 2012 EPS turns out to be $2.46, the intrinsic value of the stock would be $47.97, implying 59.4% upside. Even if the multiple were to plummet to 14x and 2012 EPS turns out to be 6% below consensus, the stock would still appreciate by a fair degree.