Analysts cautious on Pan American Silver

Vancouver-based Pan American Silver (PAA-T) is best known for being one of the purest exposures to silver for investors, and also for having Microsoft’s Bill Gates as a shareholder in the form of a 13.7% stake held by his privately owned Cascade Investment.

The best part of the Pan American story is undoubtedly its excellent growth profile: in the recent third quarter, the company boosted its silver production by 138% to 2.1 million oz. Several more silver projects lie in the pipeline, pushing the company’s reserve and resource base above 613 million oz.

The company has three operations:

– the centuries-old Quiruvilca silver-zinc-lead-copper mine in Peru, acquired in 1995, which this year will produce 3.1 million oz. silver, 17,500 tonnes zinc, 8,500 tonnes lead and 1,100 tonnes copper;

– the Huaron silver-zinc mine in Peru, acquired in 2000, which is now operating at the commercial rate of 4.3 million oz. silver and 18,000 tonnes zinc per year; and

– the development-stage La Colorada mine in Mexico, acquired in 1998, which will produce about 750,000 oz. silver in 2001 and could hit its full stride of 3.5 million oz. silver per year in 2003.

In addition, Pan American has silver exploration projects elsewhere in Mexico and Peru, as well as in Bolivia and Russia.

For 2001, the company expects to produce more than 7 million oz. silver, mined at a cash cost of (here’s the rub) US$4.27 per oz., even though spot silver at presstime was languishing at US$4.18 per oz. and prospects for significant price increases any time soon are not particularly compelling.

Indeed, despite periodic, short-lived surges of US20-50, silver prices have followed an overall downward trend since a spike above US$6 in early 1998, after Warren Buffet shook up the market with revelations he was selectively investing in silver bullion.

The low silver prices and equally abysmal byproducts credits have pushed Pan American into the red: for the nine months ended Sept. 30, the company lost US$3.7 million (or US10 per share) on revenue of US$26.3 million, compared with a loss of US$39.5 million (US$1.16 per share) on revenue of US$21.3 million in the corresponding period of 2000. (Last year’s loss was mostly due to a US$37.6-million writedown on Pan American’s disastrous Russian adventure, the Dukat project.)

In a Nov. 12 report, CIBC World Markets mining analysts Barry Cooper and Ayesha Hira say Pan American is “expected to continue to post losses for the next year, and consequently we are maintaining our ‘hold’ recommendation and US$3 target price.”

Cooper and Hira expect the company will need further cash infusions next year unless there are significant increases in commodity prices. They comment that “in the past, Bill Gates has supported the company several times, but with silver prices languishing, he may have other investment alternatives.”

In particular, the analysts caution that there are “serious cash deficiencies” at Quiruvilca and that, despite a good operational performance, the mine was losing US$1 for each ounce it produced. In a prolonged period of weak metal prices, Quiruvilca is expected to drain coffers at the rate of US$100,000 per month, though Pan American says it nonetheless makes better financial sense to keep the mine operating than to shut it down.

Cooper and Hira say layoffs and salary cuts at Quiruvilca would reduce the losses, though they remain “concerned that the constant drain on cash reserves will force the company into either repeated financings or other restraints with respect to its financial options.”

The Huaron mine, like Quiruvilca, is producing satisfactorily, having poured 1.1 million oz. silver in the third quarter at a cash cost of US$3.89 per oz.

Meanwhile, La Colorada produced 225,000 oz. silver during the quarter at a cash cost of US$3.86 per oz.

CIBC has forecast Pan American’s 2002 earnings based on prices of US$4.50 per oz. for silver and US45 per lb. for zinc. However, the brokerage house admits that its forecasts “could be too optimistic.”

CIBC’s net asset value for Pan American is about US$1 per share, calculated on the basis of a long-term silver price of US$5 per oz. Therefore, Pan American “seems expensive relative to other investments,” though the analysts add that high multiples are common for comparable silver miners, such as Coeur d’Alene and Hecla Mining.

Canaccord Capital analysts Brian Christie and Brad Humphrey, who wrote a report in late September, during a mini-rally in silver prices, characterized Pan American as being “one of the best-leveraged silver vehicles in the market” and approved of the company’s pipeline of operating mines and development projects, its balance sheet, its strong management team, and the backing of Bill Gates.

“For investors seeking exposure to the silver market, Pan American would be our top pick amongst the producers,” write Christie and Humphrey, with the proviso that “like many gold stocks, [Pan American] shares are trading more on sentiment than on fundamental valuation.”

Pan American has had a 52-week price range of $3.80-5.38 (US$2.41-4.23) and recently traded at $5.38 (US$3.50). Outstanding shares total 37.6 million (41.5 million fully diluted), and ownership is divided among: company insiders (30%), including Cascade; retail investors (40%); and institutions (30%), including the World Bank.

At Sept. 30, Pan American’s total liabilities stood at US$25.6 million, including US$16.5 million in current liabilities. Current assets stood at US$18.4 million, including US$4.9 million in cash and equivalents.

With the two new mines at Huaron and La Colorada now operating at budgeted levels, Pan American says its capital expenditures “will be minimal for the foreseeable future.”