Key Points From Pan American Silver's Q2, From A Confident Shareholder

Aug.16.07 | About: Pan American (PAAS)

Before discussing Pan American Silver Corp.'s (NASDAQ:PAAS) second quarter conference call held on 14 August 2007, I want to refer to my prior comments on its first quarter conference call. The prior article will serve as a good background, and I will be following the same general format.

In addition to a transcript of the company's conference call (see Seeking Alpha for a transcript), I have used the company's press release and financial statements.

The company began its conference call with its production and earnings. Pan American produced 4.2 million ounces of silver at a consolidated cash cost of $2.61 per ounce. The production level was 27% higher than the second quarter one year ago. In fact, the second quarter production is a record for Pan American. The cash costs were $1.17 in the second quarter one year ago. As an aside, for those not familiar with mines, mines usually use the sale of byproducts to reduce the cash cost. In addition to silver, the company also produced 9,931 tonnes of zinc; 4,015 tonnes of lead; 1,280 tonnes of copper; and 6,938 ounces of gold.

The company did not earn as much as it had hoped because it shipped only 83% of the concentrate it produced during the first six months. This topic consumed more discussion than warranted during the conference call. The company stated that it will, over the remaining months this year, ship the remainder of the concentrate. That will add another $7.5 million to net income. While recognizing net income sooner rather than later is always a good thing, in the case of mining where shipments are made intermittently, slippage from one quarter to the next is of little longer term consequence.

The specific timing of the concentrate sales is not a top 10 driver of the long term value of Pan American Silver. While it is important for day to day cash management, it is completely unimportant to the valuation of the company. What is important is that the company sells all the concentrate that it produces on a rolling 12 months basis. In other words, it does not accumulate and stockpile concentrate for an overly long period.

I have provided below a series of key points expressed during the conference call.

General Comments

  • Company expressed that it has a solid quarter in that it performed as it had expected;
  • Record quarterly silver production, up 27% over the same quarter one year ago;
  • Net income was $18.5 million ($0.24 per share), up from $15.0 ($0.21 per share a year ago);
  • Sales up 26% over Q2 2006 to $79.2 million;
  • Alamo Dorado began commercial production 1 April 2007;
  • San Vicente mine (Bolivia) ownership increased to 95% and mine expansion project initiated; and
  • Construction at Manantial Espejo mine over 33% complete.

Alamo Dorado, Mexico

  • Produced 233,000 ounces of silver in April; 275,000 ounces in May; and 348,000 ounces in June;
  • Expect mine to operate at design capacity within weeks; and
  • Cash costs were $4.21 as production ramps up.

La Colorada, Mexico

  • Company's second largest silver producer;
  • Produced 1,035,974 ounces of silver, a new record and an increase of 13% over same quarter last year and 21% over the first quarter; and
  • Cash costs were $7.20 per ounce, which reflects a one-time $500,000 distribution as profit sharing to employees.

Morococha, Peru

  • Silver production was higher than forecast at 674,000 ounces;
  • Cash costs were a negative $5.23 per ounce;
    • Fifth consecutive quarter of decreased cash costs, a benefit from high zinc byproduct production and prices; and
  • Mine is on track to deliver 2.7 million ounces of silver for 2007.

Huaron, Peru

  • Largest silver producer;
  • Produced 949, 500 during Q2 with cash costs of $1.90 per ounce produced;
  • Because of decline in silver headgrades, the company increased mine throughput with a new monthly record in July of 67,000 tonnes; and
  • On target to achieve 3.8 million ounces in 2007.

Quiruvilca, Peru

  • Silver production was 407,000 ounces at a cash cost $1.30 per ounce;
  • Previously announced project is three to four months behind schedule because of contractor availability;
  • Likely to see improvement in the fourth quarter as a result of access to higher grade ore.

San Vicente, Bolivia

  • Purchased an additional 40% interest for $9 million, resulting in a 95% interest in the mine;
  • Silver production for Q2 was 173,634 ounces of silver at a cash cost of $3.74 per ounce;
  • This mine has high grade silver and zinc ore;
  • The prize will be expanding the mining and milling capacity;
  • Company has announced plans for mine expansion;
    • Construction of a new 750 tonnes per day processing plant and expansion to existing mine;
    • Economic returns provide an internal rate of return (NYSE:IRR) of 26% and a payback period of only 2.5 years;
    • Using today's prices, IRR is even higher and payback is only one year;
    • For an investment of $40.5 million, the company will add 2 million ounces of silver production per year at a cash cost of less than $2 per ounce; and
    • While political risk is always a concern, the returns more than offset the political risk.

Manantial Espejo, Argentina

  • At the end of March, the project is 33% complete; and
  • The company is making excellent progress on its new mine development.

Notable Nuggets From Question And Answer Session

  • Although costs at La Colorado were higher than usual because of a one time employee profit sharing payout, for the remainder of the year costs should return to $6.50 – $6.60 range.
  • Alamo Dorado will raise the average cash cost but, even more importantly, will raise the profitability of Pan American Silver.
  • Costs in general have risen across the board about 6% – 8% and appear to have stabilized—that is just the reality of the commodities industries in general;
  • Company expects cash costs for the remainder of the year to be in the $2.30 – $2.35 range;
  • San Vicente's expansion should start in December of 2008 and be at full capacity by mid 2009;
  • Quiruvilca mine is enjoying a longer life with higher silver prices; at lower silver prices of about $9 – $$10, the mine has about five or six years; at today's prices, the mine has another ten plus years of life;
  • Company hinted at strong and positive progress (exceptional results) from its exploration program at Morococha, which will be released at year end;
  • I was surprised by the bluntness of the Bolivia assessment in that it is a harsh political climate. While true, companies typically soften their message in a public forum such as conference calls. In my view, the management of Pan American is exceptionally straightforward. The company stated that, although Bolivia does have a high political risk, the company has factored that risk into its evaluation and has factored in the proposed higher taxation levels of 37.5%. Even with the higher taxation, the company will earn a robust return on this very attractive project; The company is partnered with the state mining company Comibol;
  • There was more discussion on the timing of concentrate sales, which, as I have indicated, is a complete non-issue. Mr. Burns responds to Mark's question as follows:

    Mark, just to end, I’m just not concerned. It’s not a concerning factor, as I said, over the balance of the year. We are going to ship all that concentrate. It is just a timing issue that’s hit us in the first and second quarter and it is going to reverse. It is going to reverse. That is a normal cycle for our business.

    This timing issue is simply a nonissue. It will have a negligible effect on the overall valuation of the company.

Overall General Impressions

I remain steadfastly bullish on silver and Pan American Silver. The company's management is unusually straightforward, competent, and focused.

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 $12 dollar level instead of in the mid $13 level from last quarter, the stock has come off somewhat. I suspect that with the increased volatility in the markets, some commodities and their related stocks are being aggressively hit. Silver and Pan American Silver are examples. While painful in the short term, I hope silver and Pan American continue to go down so that I can increase my position. As stated, I remain bullish on both the commodity and the company. Tuesday, the day of the second quarter earning's release, the company closed at $26.78, down $0.95 from $27.73 for a loss of 3.4%. Wednesday the stock fell a further $1.66 to $25.12 for a loss of 6.12%. Wednesday the market closed 1.39% (S&P 500) lower. Again, I think some commodities are being aggressively hit.

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 prosper well into the future.

Disclosure: I am long Pan American Silver shares.