Pan American Silver: Overly Hard On Itself

| About: Pan American (PAAS)

Before discussing Pan American Silver Corp.'s (NASDAQ:PAAS) first quarter conference, I want to refer to you to two of my prior posts on Pan American:

Primer For Pan American Silver's Conference Call On 22 February 2007; and Pan American Silver 4Q 2006 Conference Call.

The first article serves as an introduction to the company, and the second article provides my thoughts on the company's last conference call. Armed with that background, let us look at the most recent conference call.

The company began its conference call (see Seeking Alpha for the transcript) with its production and earnings. Pan American produced 3.34 million ounces of silver at a consolidated cash cost of $2.98 per ounce. As an aside, for those not familiar with mines, mines usually use the sale of byproducts to reduce the cash cost.

The production level was slightly higher than the first quarter one year ago. Because cash costs were high at Alamo Dorado during the commissioning process, the company's overall cash costs were higher than expected. Excluding Alamo Dorado, the company's cash costs were $2.29 per ounce. In addition to silver, the company also produced 9,600 tons of zinc, 3,700 tons of lead, and 1,300 tons of copper.

Although the company's net income for Q1 2007 was $20.4 million, significantly better than its loss of $2.8 million for the same period a year ago, the company was disappointed with its results. During the first quarter, the company received $10.25 million in cash from the sale of its Ducat mine in Russia. The company recorded a gain on the sale. The company then went on to provide three reasons why it fell short of achieving better results.

  1. Unsold Concentrate: Pan American produced 33,400 tons of concentrate from its mines in Peru during the first quarter. However, the company only shipped 74% of its concentrate during the first quarter, and thus has 26% remaining to be sold during the second and third quarters. Moreover, many of the remaining concentrates are the high valued silver-lead concentrates. This process is typical—some quarters the company will ship more than it produces, drawing down its stockpiles, and other quarters it will ship less, adding to its stockpiles. Had everything been shipped, the company would have earned an additional $5 million in net income. As far as I am concerned, this is a non-event and barely even worth mentioning—that is the way mines operate.
  2. Zinc Pricing Adjustment For Zinc Production: This is an accounting issue more than anything else. When the company ships its zinc concentrate, it must estimate a price. Three months later, the actual price is determined. Sometimes the price is higher than the original estimate, sometimes lower. This time it was lower. The company had to make an adjustment of about $5 million in reduced gross sales, which obviously affects the bottom line. The good news is that zinc prices have rebounded, and thus the company can expect higher prices again for its zinc. My take on this issue is that Q4 2006 was not as great as it seemed, and Q1 2007 was not as bad as it seemed. Translation: this issue is merely a timing and pricing issue.
  3. Delays In Commissioning Alamo Dorado: The company experienced some problems with its filters at its new mine Alamo Dorado. While regrettable, start-ups are often fraught with hiccups. The key question for start-ups is, Is this problem temporary while everything is at or above expectations or is this problem symptomatic of larger and more challenging issues? In our case, it is the former—a temporary hiccup. So, while not pleased, I am not wildly upset either. These things happen.

The company then gave a quick synopsis of its various operations. I will briefly summarize the key points using point form.

Alamo Dorado, Mexico

  • Produced about 260,000 ounces of silver—short of the company's target of 800,000 ounces—at a cash cost of greater than $10 per ounce;
    • There were problems with the tailings filters that have since been solved;
    • There is more silver in solution reporting to the refinery than the company has been able to consistently plate and extract (not sure what this means exactly), but this issue is more a learning curve issue than a mechanical problem;
  • Because of start-up problems, the company has revised its 2007 production forecast to 3.6 million ounces of silver from 4.25 million for Alamo Dorado; however, the company is maintaining it cash cost estimate of $3.50 per ounce.

La Colorada, Mexico

  • Produced 840,745 ounces of silver during the first quarter, an increase of about 7$ to Q1 2006;
  • Cash costs were about $6.78, a higher figure because of the start-up of sulfide circuit;
  • The mine appears to be functioning well and is on track to produce 3.8 million ounces of silver in 2007.

Morococha, Peru

  • Produced nearly 639,000 ounces of silver at a cash cost of negative $4.20 per ounce (remember, the sale of byproducts reduces the cash costs);
  • High zinc byproducts and high zinc prices helped to reduce cash costs;
  • Silver production was lower than a year ago because the ore contains less silver; however, the silver production was higher than forecasted and 2007 production is forecasted to be 2.67 million ounces;
  • Overall, the mine is performing well.

Huaron, Peru

  • Largest silver producer;
  • Produced 927,000 during Q1 at significantly less costs of only $1.99, down 46% from one year ago;
  • Silver production was lower than a year ago because the ore contains less silver; however, the silver production was higher than forecasted and 2007 production is forecasted to be 2.67 million ounces;
  • On target to achieve 3.8 million ounces in 2007.

Quiruvilca, Peru

  • As expected, lower Q1 production because of lower grade ore;
  • 404,000 ounces at a cash cost $2.33 per ounce;
  • A development project is underway that will lead to higher grade ore bodies;
  • Although a bit behind target now, company expects to be on target by year-end.

San Vicente, Bolivia

  • Company's share of the mine's production was about 136,500 ounces at a cash cost of $3.16 per ounce;
  • This mine has high grade silver and zinc ore;
  • The prize will be expanding the mining and milling capacity;
  • There is potential for significant growth in this mine that has not been captured in long term forecasts.

Manantial Espejo, Argentina

  • At the end of March, the project is 25% complete;
  • Capital costs have increased to $170 million, which includes $21 million in refundable VAT;
  • The mine should start producing next year with an average of 4.2 million ounces per year and cash cost of less than $1 per ounce;
  • Stay tuned.

Exploration Plans

  • The company is engaged in more greenfield exploration at Morococha for a cost of $2.8 million;
  • More activity is taking place at Huaron and La Colorada as well;
  • Greenfield activity is focused on Mexico, Peru, Ecuador and Argentina where the company already has several prospects;
  • Total greenfield exploration costs are expected to be about $6.5 for 2007.

Notable Nuggets From Question And Answer Session

I listened and read the question and answer session, and, for the most part, the questions were not insightful. In my view, there is nothing substantive to glean from the Q & A session.

Company's Q1 2007 Press Release

The company provides a thorough press release covering all the major topics. I skimmed through the 31 pages of text and, after listening and reading the conference call transcripts, I did not discover anything notable that has not been previously discussed.

Overall General Impressions

My impression is that the company was overly hard on itself in its remarks. Unsold concentrate, lower zinc pricing for the first quarter, and a slight delay are all part of operating a mining company. None of the supposed disappointments is a reflection of poor management nor deteriorating fundamentals such as mine geology or lasting mechanical operation problems. Instead, all were transitory in nature and are just part of the game.

The cash costs for the various mines are very low, some even negative, with an overall cash cost of about $3 per ounce. Roughly speaking, for three dollars in increased price of silver, the company earns an additional multiple of net income. The relationship is not completely linear, however. Taxes and profit sharing might not be completely linear. Moreover, Treatment Charges and Refining Charges [TCRC] are not linear. TCRC refers to the costs of the smelters. While there are fixed costs per ton, the contracts also provide for escalators for various metals prices. Thus, increased prices do not lead to a linear relationship in increased profits. That said, with cash costs so low, the company is extremely profitable.

I note in looking at the company stock price chart (Yahoo), that the stock price is off from its recent highs. I suspect that with silver prices [Kitco] now in the low to mid $13 dollar level instead of in the mid $14 level, the stock has come off somewhat. Tuesday, the day of the first quarter earnings release, the company closed at $27.58, down $0.67 from $28.25 for a loss of 2.4%. Wednesday, however, the stock rebounded, along with the rest of the market, up to $28.50.

I am comfortable remaining to be a shareholder. I am still a believer in higher silver prices and I believe the company is well managed and will continue to do well into the future.

Disclosure: I am long Pan American Silver shares.