Sell Pan American Silver (NASDAQ:PAAS)
I have generally been bearish on precious metal prices over the long term. Nevertheless, in the short term this sector is starting to show the signs of a major bull rally. That being said, we must acknowledge the fact that all miners are were not created equal.
Pan American Silver is simply bad company, and even as silver prices rise it will remain a clear underperformer to the other options.
Pan American Silver is a company that has been profitable for a small blip of its 30 year existence. The more this company grows, the more money it loses. Even as precious metals rally, PAAS is a long way away from profitability.
A History of Losing Money
Pan American Silver was founded in 1979 as Pan American Energy Corp. By 1995 it started its new life as a Pan American Silver, a silver and metals miner.
PAAS has almost never made money. Before the start of the silver bull market in 2006, the company had a negative net income for every single year except 2004.
After over a generation of losing millions of dollars every single year, Pan American was finally able to turn a profit during the silver bull market starting in 2006 and growing into the silver bubble we saw in 2011 and 12. Since then, the company has returned to its old ways of losing money.
However, things have changed. In the past PAAS was a small company and was only able to lose 5 or 10 million dollars a year on average. Now the company is much bigger. Pan American took advantage of the high prices in the late 2000's to expand, and as a result its losses have gone from bad to horrific. The firm is now regularly posting losses of $100 million, $200 million... even topping half a billion in losses for 2014. This was a time when silver prices ranged from $15 to 17 per ounce.
Why is Pan American Silver so Bad?
It is normal and expected for mining companies to operate at a loss during the early years. The commodities cycle is unpredictable, and we must give companies time to develop an economy of scale advantage that will protect them when prices go down.
As these companies grow and production increases, fixed cost per unit tends to decrease. This minimizes losses when prices are lower and magnifies gains when prices are high. Unfortunately, this has not occurred with PAAS. In fact, as the company grows... its losses become bigger not only in cost, but relative to the gains it had when prices are good. Instead of stabilizing over time, the company is destabilizing. Its assets and book value are deteriorating, while companies like First Majestic (NYSE:AG) are able to keep the value of the company stable.
Pan American Silver
First Majestic Silver
Pan American Silver's costs of production are simply too high
PAAS is not good silver investment (in bull or bear markets) because its costs of production are simply too high compared to the competition. When you look at the company's income statement you see revenue often completely eaten away by cost of revenue - resulting in negative gross profits.
Pan American Silver Gross Profitability:
|Cost of Production||-706,777,000||-743,869,000||-692,985,000|
|Gross Profit (loss)||(32,089,000)||8,073,000||131,519,000|
Pan American was already losing money just by producing in 2015, and it barely broke even in 2014. This is before spending a dime on selling and administrative expenses, non recurring expenses or tax. By the time we get to operating income, PAAS is losing hundreds of millions every year:
It is little wonder PAAS is unable to generate positive net income. It can barely break even on gross income, and is bleeding money by the time we get to operating income.
On the other hand, AG is able to post significant gross profits every year, and manages to keep this number above 0 even when silver prices fell.
The precious metals rally is starting to look substantial, and mining stocks are posting gains that cannot be ignored - even by a bear like me. When it comes to investing in a silver miner, there are clear choices and PAAS is not one of them. The increase in the stock's price is speculation, not reflective of an actual improvement in the state of this company.
Even if silver rallies further, that will not fix this company's profitability situation. What I mean by this is - instead of losing $500 million, PAAS might lose $300 or $200 million instead. Over the long term this will cause the stock to underperform the physical metal and other miners.
Don't believe me? Look at the following graph. This company is a money blender - one of the worst stocks in the entire sector:
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.