Silvercorp (SVM) is a Canada-based company, operating two silver mines in China. Since its first listing on the Toronto Stock Exchange, the company has been underperforming its peers:
In my opinion, this underperformance is not supported by Silvercorp's fundamentals. The company controls an excellent asset, its Ying silver-lead-zinc-gold property, which, since 2011, has been providing very decent financial results. In this article I would like to list a few major factors supporting my thesis that the current underperformance has nothing to do with the company's fundamentals; what is more - it is based mainly on emotions and the lack of understanding, presented by the majority of investors. Last but not least - I believe that Silvercorp's management is also partly "responsible' for the poor performance of the company's stocks.
Currently the company operates two mines, both located in China. The first and the most important one is the Ying mine, delivering two main metals: silver and lead. The second mine is the so-called GC Project, located in Guangdong Province in China. It is mainly a base metals mine delivering lead and zinc; apart from these base metals the mine also delivers silver.
In addition to these two assets, Silvercorp holds the BYP mine, a gold-lead-zinc property, currently suspended.
In 2015 fiscal year (fiscal year ends in March) Silvercorp sold 5,121 thousand ounces of silver (32.6% up, in comparison to 2014). The company also sold 51,470 thousand pounds of lead (up 38.5%) and 15,940 thousand pounds of zinc (up 88.7%). Despite lower prices of precious and base metals (except for zinc), in 2015 Silvercorp was able to report sales of $128,465 thousand (an increase of 18.5%, compared to 2014).
Above I have mentioned that the Ying mine is an excellent asset. Let me dig a little bit deeper into it.
First of all, the Ying deposit holds large mineral reserves. According to the last Technical Report, there are 12.64 million tons of ore classified as reserves, comprising 82.52 million ounces of silver (grading 203 grams per ton, on average), 380.4 thousand tons of lead and 127.2 thousand tons of zinc. The company estimates that the mine should operate for another 15 years (until 2030).
The Ying property consists of 5 separate mines (SGX, HZG, HPG, TLP and LM), of which the SGX is the largest one (holding 38.4% of total Ying tonnage). Silvercorp is still exploring this property so it cannot be ruled out that mine life will be extended beyond 2030.
Now, let me look at the mine's economics. The company regularly reports costs of mining and milling so it is quite easy to assess how profitable the Ying mine is. In the fourth quarter of 2015 the company reported that the Ying mining costs were $78.91 per ton of ore mined and milling costs were $14.15 per ton of ore milled. Additionally, the company was paying $3.99 per ton in shipping costs (to transport concentrates produced). It means that total operating costs were $97.1 per ton of ore milled. Knowing the average prices, at which the payable metal was sold, plus grades and recovery rates reported at the mine I have calculated that each ton milled at the Ying mill and then sold in the form of concentrate was delivering $167.1 in sales. It means that Silvercorp was making $70 per ton of ore milled.
Apart from that, the company was generating cash of $95.8 per ton of ore milled. In my opinion, these figures confirm that the Ying mine is an excellent asset. Even at today's quite low silver prices this property is able to deliver positive financial results and, what is even more important, generate a lot of cash.
As I have mentioned above, in 2013 Silvercorp presented the last Technical Report on the Ying mine. According to that report (page 230), assuming the long-term silver price of $16 per ounce, net present value of cash flows, generated during mine life, is estimated at $477.8 million (using quite a conservative after-tax discount rate of 8%). Because Silvercorp holds practically no debt but a lot of cash, I may state that taking into account only the Ying mine the intrinsic value of the company is standing at $535.0 million (the Ying's value plus cash minus debt). This figure is around 500% higher than the current market capitalization (assuming that the company's shares are trading at $0.53 a share). I believe that these two figures show quite well the extent to which Silvercorp's shares are undervalued.
GC Project is the second operating mine. In my opinion, this asset is much worse than the Ying property. In the fiscal year 2015 this mine sold 501 thousand ounces of silver, 9,379 thousand pounds of zinc and 4,795 thousand pounds of lead. To be honest, it was the first year of operations at GC but the mine's results do not look too impressive. Using the same methodology as in the case of the Ying mine, each ton of ore milled at GC contained metals worth $67.1. To extract and process this ore, the company had to spend $63.8 per ton in mining and milling costs. It means that each ton of ore milled at GC delivered only $3.3, which is a fraction of what the Ying mine delivered ($70.0). Adding to that much smaller GC capacity (compared to Ying), the current financial impact of this mine on the company's operations is meaningless (or even negative, assuming some additional costs related to the GC operations).
It seems there are a few factors, which may have a negative impact on the GC performance in the long-term.
Firstly, although the company does not deliver any information about it, the ore extracted at GC is probably quite highly polluted.
Below is an excerpt from the Technical Report on the GC Project (page 130):
"As has been mentioned in Section 13, there are some residual concerns / improvement opportunities regarding concentrate quality. Both copper and zinc levels are higher than ideal in the lead concentrates.
With respect to the lead and zinc concentrates, AMC (AMC is an expert company, which prepared the report) has also been advised that the renewed smelter contracts allow up to 1% As (arsenic) before penalties apply which allays AMC's previous concerns about their marketability"
I think the last sentence is particularly important. It seems that the lead and zinc concentrates (which are the main concentrates produced at GC Project) contain quite high amounts of arsenic. Silvercorp has to pay penalties for processing concentrates containing impurities (like arsenic). Although these penalties are not directly reported by the company, looking at the prices, at which Silvercorp sells metals produced at the GC Project, I believe that penalties are relatively high. For example, in the fourth quarter of 2015 the company was paid just $9.58 per ounce of silver smelted and refined (in the case of the Ying property, it was paid $12.14 per ounce), which was a very low price. That is why I think that penalties, paid for smelting and refining metals produced at GC, make this mine much less profitable than the Ying property.
Another problem - since commencing commercial operations the GC mine has been performing worse than it was estimated. For example, in the first full year of operations the mine should have extracted 484,547 tons of ore (Technical Report, page 142). Actually, the mine provided only 271,652 tons of ore. What is more, silver head grades were lower than those estimated in the Technical Report (around 106 grams per ton versus 163 grams per ton). Well, I think Silvercorp will have to put a lot of effort to improve this mine. For the time being it is lagging a lot behind its flagship property.
Share repurchase program
On December 19, 2014 the company announced that between December 2014 and December 2015 it was going to repurchase up to 16.5 million shares. On December 23, 2015 Silvercorp announced it had repurchased 2.05 million shares since December 2014. What is more, the company announced that the repurchase program would last until December 2016 and up to 16.3 million additional shares might be repurchased (18.35 million shares in total).
Well, I think that the company's management is too passive. Currently Silvercorp holds cash of $66.8 million, which is enough to buy 126 million shares, assuming that the company's shares are trading at $0.53 a piece. It means that in theory Silvercorp is able to buy as much as 74.8% of shares outstanding. Taking into account that the company is currently ridiculously undervalued I think that the management should propose much larger repurchase program. In the long-term such a program should decrease the extent of undervaluation. What is more, a larger program is supported by the theory - the best time for buy-backs is when the company's shares are trading much below their intrinsic value. As I discussed in the "Ying property" section, Silvercorp's shares are extremely undervalued today.
Silvercorp bears a few specific risks:
Currency risk - the company operates in China therefore it is exposed to the exchange rates risks. For the time being, the US dollar, which is a reporting currency, is getting stronger against the Chinese renminbi. This trend has a positive impact on Silvercorp's results (lowering costs expressed in US dollars). However, when the trend reverses the situation will change.
Dividends - in August 2015 the company announced the suspension of dividend payments. Following this announcement, share prices went quickly down from $1.19 to $0.77 per share. Such reaction proves that dividends were the main reason many investors were investing in Silvercorp shares. I think this decision was quite strange. Silvercorp, even at today's low silver prices, is able to deliver free cash flow. What is more, the company holds a lot of cash so paying dividends, or even increasing them, should not be a problem for the company. In my opinion, the management's decision was premature and not supported by the fundamentals.
In my opinion, Silvercorp is one of the best silver and base metals miners. Despite low metals prices the company is able to deliver positive operating results (negatively impacted by impairments recorded in 2014 and 2015 fiscal years). What is more, the Ying property (the flagship Silvercorp's mine) is an excellent asset. Assuming the long-term silver price of $16 per ounce, this property drags the company's intrinsic value up to around $535 million ($3.17 per share). It means that currently Silvercorp shares, trading at $0.53 a share, are deeply undervalued.
Disclosure: I am/we are long SVM.
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.