Silver And Silver Miners: Should You Invest?

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Includes: AG, BCEKF, EXK, FSM, GPL, HL, PAAS, SVM, USAS
by: Henry Elrod

Summary

Silver mining stocks are speculative.

Three (of the eight reported on) have been profitable recently.

Silver prices are probably more stable than you think.

Beginning

Investments in silver, silver futures, and silver mining stocks are all highly speculative. Most of the silver-related literature in SA centers on discussions of the exploration prospects of the various silver mining companies, and prospects for a spike in the market price of silver. For a look at some of these articles, look here: Hamilton, here: Digressions, or here: SA articles about silver. If the links do not work, open this article in MS Word, then right click and copy the hyperlinks to paste into your browser. The premise of this article follows on the assertion in the Digressions article, that an efficiently run silver miner should be able to make money without a bull market in silver prices.

Data for this report was gathered from SVU's (SEDAR) filings (SEDAR is the Canadian equivalent of the SEC's EDGAR database), and SVU's annual report archive on their web page, and from both Yahoo and Morningstar (access to Morningstar is proprietary).

Comparisons

Data from a range of silver miners were compared. Statistics used included measures of size (sales revenue and shareholders' equity), measures of profitability (5-year averages for gross profit percentage, and percentage return on sales), a measure of management effectiveness in management of assets (asset turnover), and two measures of overall management effectiveness combining the other measures, return on investment and return on equity, also five-year averages (ROI & ROE). One more measure shown is free cash flow, defined as Morningstar does as cash from operating activities less capital expenditures. Finally, a second look at more recent earnings is used to compare recent performance, as the earnings of these firms are so erratic that the averages may mask important short-term earnings trends.

The firms compared were all Canadian domiciled, but for Nola Mining, which is a US company. They are Americas Silver Corp. (USAS), Endeavor Silver (EXK), First Majestic (AG), Fortuna Silver (FSM), Great Panther (GPL), Hecla Mining (HL), Pan American Silver (PAAS), and Silvercorp Metals (SVM). Bear Creek Mining (BCEKF) was originally selected but thrown out because of its development stage enterprise status. Geographically, all have mining interests in Mexico except for SVM, which mines three locations in China. USAS and HL mine in the US, and both HL and GPL also have interests in Canada. The remainder have interests scattered across South America, including Chile, Peru, and Argentina.

Size

By size, of the eight, PAAS and HL are large, with owners' equity of $1.51 and $1.48 billion, respectively. AG and FSM are middle-sized, with equity of $853 million and $564 million, respectively. The others are small, with equity less than $265 million. See the comparison in the size by equity chart:

In terms of sales revenue, none are over a billion dollars, and only two, PAAS and HL, are over $500 million in annual sales revenue. Relative sizes are shown in the chart of size by sales revenue.

Profitability

The comparisons of profitability reveal a picture slightly different from that of size and vary by the time periods selected as well. On average, over the last five years, only AG and FSM posted positive returns on sales percentages. The two-year averages for return on sales show a different picture:

Five year averages

Two year averages

Gross profit percent

Return on sales percent

Return on sales percent

USAS

17.2

(21.8)

USAS

(7.7)

EXK

15.1

(21.4)

EXK

4.4

AG

45.1

20.9

AG

(8.4)

FSM

36.7

12.0

FSM

17.6

GPL

34.4

(5.1)

GPL

(2.3)

HL

22.1

(3.4)

HL

3.8

PAAS

13.2

(12.1)

PAAS

14.2

SVM

45.7

(11.3)

SVM

24.1

Among the eight firms, FSM is fourth is size by equity, third in size by sales revenue, and is the only firm to report profits over both the last two years and the last five years, with returns on sales of 17.6% for the last two years, and 12.0% return on sales over the last five years.

Cash flow

Given the large capital investment in equipment and developed properties, which generate non-cash deductions to net income, free cash flow (Yahoo numbers; follow the link and substitute the ticker symbol for the company you want to see for the SVM in this link), defined as the excess of net cash flow from operating activities, over cash consumed by capital expenditures) may be a more useful number than GAAP net income. Among the eight firms reviewed, three (USAS, EXK, and GPL) reported negative free cash flows over the last three years and have been eliminated from the table.

AG

FSM

HL

PAAS

SVM

Free cash flow (3 years)

(Yahoo Finance, $ millions, except percentages)

From operating

226.6

177.7

447.7

528.1

166.5

From investing

(171.2)

(157.0)

(432.7)

(370.1)

(135.0)

Free cash flow (3 years)

55.4

20.7

15.0

157.9

31.5

Average

18.0

7.0

5.0

53.0

11.0

Free cash percent of sales

7.4

3.3

0.9

7.0

7.9

AG, PAAS, and SVM show significantly higher rates of production of free cash flow than either HL or FSM.

Silver prices

Geologically, there is no shortage in paying quantities of recoverable silver. (For details about the content of this paragraph, see Butterman, W., and Hilliard, H. (2005). Silver. Reston, Virginia, U.S. Geological Survey, available here) World consumption grows at about one percent per year, and the volume of silver produced is constrained by the number of producing mine operations. About one fourth of the world's annual production of silver comes from recycling, chiefly of materials used in photography and the manufacture of photographic products. Major spikes in silver prices, notably in the mid-1970s and in 2011 are thought to be related to (a) the Hunt brothers' attempt to corner the US silver futures market, and (b) the rise of silver commodity-based exchange-traded funds. Otherwise, silver prices appear to follow the general trend of world-wide inflation.

Industrial manufacturers that use silver as key components in their products or manufacturing processes may use silver futures contracts to hedge supplies at known prices and to insure timely provision of desired quantities. Investors interested in profits based on volatility in the market price of silver may gamble with futures, but predicting commodity price fluctuations within fixed and relatively short time periods can be difficult.

Stock prices

Beta (β), the measure of systematic risk or volatility of an individual stock compared to the market as a whole, is not an important component of the prices of the stocks reviewed in this article, with two exceptions. USAS has a β of 2.4. β for SVM is close to that, at 2.38. The mean β for the other six firms is 0.67, and the mean β for the group of eight as a whole is 1.10. If the Betas are normally distributed, the two higher βs are not outliers, as they are within two standard deviations of the mean of the overall group. The point is that other than for the two with high betas, it appears the general rise or fall of the market has little effect on the prices of silver mining stocks.

None of the historic stock prices of the companies measured correlate well with silver prices. The coefficients of correlation of four are negative. Here are the coefficients and r2s, over ten years of data, using the year-end stock price and the reported average annual spot (London fix) silver price:

Company

Coefficient of correlation

Coefficient of determination

USAS

0.139

0.019

EXK

0.289

0.084

AG

0.508

0.258

FSM

0.134

0.018

GPL

(0.005)

-

HL

(0.167)

0.028

PAAS

(0.418)

0.175

SVM

(0.028)

0.001

A cautious investor should also note that most of these stocks are thinly traded. Additionally, given their cash flows (discussed below), these securities are subject to dilution from secondary offerings, private placements, convertible debt agreements, and so on. With erratic earnings and cash flows, means of raising cash are limited to new debt and equity issues.

Issues

Important risks to consider in evaluating silver mines as investments include political risk, i.e., the possibility of government seizure or other interference in the ownership and/or operation of business assets. Land ownership in Mexico by non-Mexican nationals is fraught with the possibility of land seizure because of Mexico's history of land reform. Both Peru and Chile share similar histories and have enacted land reform seizures as late as the 1990s. SVM, in China, does not own the mines they work, but rather, owns controlling interests in Chinese joint ventures that hold mining rights granted by the government.

The media from which silver ores are extracted are taken using both tunneling and strip mining strategies. Processes used to extract the silver include use of large quantities of water, high-temperature smelting, and electrolysis, all of which can leave soil and water contaminated with slag and harsh chemical residue. Unwanted hazardous environmental waste can leach or seep from the mines themselves or from tailings. Undisclosed and unrecorded environmental remediation costs may not be fully recognized in the financial reporting of these companies. For more information on environmental remediation cost estimates, see EPA. Additionally, mines are subject to damage from natural disaster events such as earthquakes and flooding, which may entail significant refurbishing and rebuilding costs, and mine revenue may be lost or curtailed for years at a time.

The advent of ETFs also complicates the picture for investing in silver mining stocks (for information about silver ETS look here: ETF. Although the effects of large equity position in the hands of ETF and other fund/institutional managers are not clearly understood, it is interesting to note that a large portion of the controlling interests in the world's silver resources is not held by these types of firms.

Conclusions and alternatives

Investing in silver mining companies is speculative, and involves risks not found in the average mutual fund, or even in simply picking a stock from the Dow 30 Industrials by casting lots. Given the breadth and depth and variety of silver reserves, production, and world consumption, there appears to be little economic pressure that might create major price increases in the underlying commodity. Although the scope of this report is limited to eight firms, the general sense is that (a) investments based on the prospect of significant price appreciation in the underlying commodity are speculative, especially as silver mining stock prices do not appear to be strongly correlated to silver prices and (b) that among the firms compared, based on recent profitability and free cash flow, the favorite has to be either Pan American Silver (NASDAQ:PAAS) or Fortuna Silver (NYSE:FSM), with Silvercorp Metals (NYSE:SVM) a close third. Also, it appears that patience in making purchases might be worth the effort, as many of these stocks have traded at significant discounts in recent years. SVM, for instance, traded below fifty cents in 2015 and 2016, versus its current price of $2.74 per share. Additionally, there are many silver miners that were not reviewed in this report, and the report largely ignores investing in the commodity itself either through futures or through silver based ETFs.

Disclosure: I have no positions in silver or silver mining securities.

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. Nothing in this article is intended as investment advice, and nothing herein should be construed as investment advice.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.