As sovereign debt issues become increasingly prevalent, mining investments will continue to be skewed more toward reward than risk. In this article, I will run through my DCF model on Hecla (HL) and then triangulate the results with an exit multiple calculation and a review of the fundamentals compared to Silver Wheaton (SLW) and Freeport McMoRan (FCX). I find that Hecla has decent upside.
Let's begin with an assumption about the top line. Hecla finished FY2011 with $477 million in revenue, which represented a 13.8% gain off of the preceding year: deceleration. I model per annum growth around 5% over the next half decade or so.
Moving on to the cost side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 48% of revenue vs. 8.5% for SG&A, and 6% for R&D. Capex is estimated to hover between 18% and 15%. Taxes are estimated at 30% of adjusted EBIT (i.e., excluding non-cash depreciation charges to keep this a pure operating model).
We then need to subtract out net increases in working capital. I model this hovering around -1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $4.92, implying 17.2% upside. The market seems to be factoring in a WACC of 11.5%, which is overly high for a stock that has solid fundamentals.
All of this falls within the context of strong operating results:
Now for the year-end fourth quarter results, please see slide four. First financially, it was an excellent year and the fourth quarter had very solid financial results. We had record 2011 sales and gross profits with $478 million and $265 million, respectively. While silver production was less than 2010, the 9.5 million ounces was in line with guidance, despite the challenges faced at the Lucky Friday mine over the last year.
From a multiples perspective, Hecla also showcases upside. It trades at a respective 8.2 times and 6.9 times past and forward earnings vs. 20.1 times and 12.8 times, respectively, for Silver Wheaton and 7.7 times and 6.9 times, respectively, for Freeport. Assuming a multiple of 7.5 times and a conservative 2013 EPS of $0.54, the stock would hit $4.05 -- roughly in line with my DCF result.
Consensus estimates for Silver Wheaton's EPS forecast that it will grow by 29% to $2 in 2012, grow by 27% in 2013, and then fall by 7.5% in 2014. If the company merits a multiple of 11 times and produces EPS of $2.48, the stock would fall by 12.5%. This multiple is still at a meaningful premium to its peers. In light of this premium, I would steer away from an investment for now.
Consensus estimates for Freeport's EPS forecast that it will decline by 14.5% to $4.14 in 2012, grow by 29.5% in 2013, and then fall by 0.9%. Assuming a multiple of just 9 times and a conservative 2013 EPS of $5.31, the stock would hit $47.79. This corresponds to 29.4% upside. According to NASDAQ, the stock is rated near a "strong buy" -- a sentiment that I share. Ultimately, I am most attracted to Freeport due to its strong brand name, analyst support, low multiples, and lucrative projects.
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