Mexico buoys Pan American in stormy seas

Thanks to its acquisition earlier this year of the Dolores silver mine in northern Mexico, Pan American Silver (PAA-T, PAAS-X) set a new quarterly record for gold production and posted the second-highest silver production in its history.

The addition of the low-cost mine 250 km west of Chihuahua city also ensured that the company’s operating earnings remained healthy in the second quarter, despite a 23% year-on-year decline in realized silver prices, while at the same time bringing the company greater geographical diversity at a time when its projects in Argentina face significant political risk.

Draft legislation recently gave Pan American the green light to develop its Navidad silver project as an open-pit mine in Argentina’s Chubut province. But the same legislation also introduced a series of new regulations that would hike royalties and state participation to the point that Navidad would be rendered uneconomic. As a result the company has suspended all work on the project including a feasibility study while the draft legislation remains stalled within sub-committees.

In the meantime Pan American’s management says it is looking increasingly to its mines and exploration projects in Mexico as a way to “organically grow” production “aggressively.” Among other things Pan American is looking at optimizing the Dolores mine and focusing on its mill potential, as well as expanding the resource at its La Colorada underground mine in Zacatecas State.

“Once again Pan American’s geographically diverse portfolio has proved effective in offsetting challenges,” chief operating officer Steve Busby told analysts and investors on a conference call about the company’s second quarter results. “The strategic acquisition of Minefinders has substantially bolstered our production from the geopolitcally secure country of Mexico.”

Pan American produced 6.4 million oz. silver in the second quarter, 14% more than in the second quarter of 2011, and 16% greater than in the first quarter, and that was due to the addition of 0.9 million oz. produced at the Dolores mine. Cash costs at Dolores were well below the company’s guidance at US$2.06 per oz., and had a positive impact on the company’s cost profile.

Elsewhere in Mexico Pan American’s high-grade underground La Colorada mine and its open-pit Alamo Dourado mine in Sonora, 322 km from Hermosillo, produced 1.1 million oz. silver and 1.3 million oz. silver, respectively.

La Colorado’s silver production was in line with the level it achieved in the second quarter of 2011, but Alamo Dorado was slightly lower year-on-year due to declining throughput rates, which were expected, and the mining and processing of harder ores.

“La Colorada continued its steady reliable performance,” Busby noted on the conference all. “We are extremely excited about expansion opportunities at La Colorada given its incredible exploration success.”

About 88% of current production at La Colorada comes from two structures —   HW and NC2 — that together have a strike length of more than 1,500 metres and are producing nearly 960 tonnes per day of oxide and sulphide ore.

Over the last three years underground drilling has expanded the resource down-dip with the deepest hole intersecting the NC2 vein at the 1,008 level, more than 1 km below surface. That drill hole, U-12-12, returned 0.6 metre of 378 grams silver per tonne and 0.63 gram gold per tonne. The current probable reserve only includes mineralization down to the 600 level.

This year Pan American is concentrating on the Amolillo vein, about 500 metres northwest of the HW/NC2 structures. Currently Amolillo is producing 125 tonnes per day of oxide ore from the 245 and 275 levels, along a 400-metre strike length. So far 23 holes (9,600 metres) have been drilled, 16 from surface and seven from underground. In the first phase of the drilling, holes intersected the vein down to the 520 level, 245 metres below the deepest mining level, the company says, and expanded the lateral extension to the east and west by 500 metres for a total of 900 metres of strike length.

Some highlights from drilling Amolillo included sulphide intersections of 2.41 metres at 1,750 grams silver per tonne, 0.63 gram gold, 3.01% lead and 6.70% zinc in hole 04-12, and 2.62 metres of 1,096 grams silver, 1.38 grams gold, 2.76% lead and 4.17% zinc in hole 20-12.

Oxide intercepts included 2.41 metres of 840 grams silver and 1.15 grams gold in hole 48-12 and 465 grams silver and 0.38 gram gold over 3.43 metres in hole 55-12.

Looking ahead Pan American said on the Aug. 15 conference call that it expects to achieve output of 24.25 million to 25.5 million oz. silver in 2012 at a consolidated cash cost of between US$11.50 and US$12.50 per oz. of silver, net of byproduct credits.

Andrew Kaip of BMO Capital Markets forecast in a note ahead of the conference call that Pan American’s 2012 saleable production will be in the order of 30.9 million oz. silver equivalent (including 115,000 oz. gold) at co-product cash costs of US$14.94 per oz. silver. He pointed out that the company trades at 0.1 times the 10% nominal net present value at spot metal prices, compared to peers that trade at about 1.6 times, and said that reflects “investor concerns over the integration of Dolores and challenging operating conditions” at its South American operations.

While management admitted that its second-quarter financial results were not as good as it had anticipated for a variety of reasons including falling metal prices, downward adjustment in sales, depreciation and industry wide cost escalation among other factors, president and chief executive Geoff Burns said the company should see its financial results catch up to its solid operating results over the balance of this year.

Second-quarter revenues came in at US$200.6 million, down 13% from the year-earlier quarter, while net earnings reached US$44 million, or US29¢ per share, 61% lower than the year-earlier quarter. Adjusted earnings were US$17.1 million, or US11¢ per share, a sharp drop from the year-earlier quarter’s US$75.44 million, or US70¢ per share. Mine operating earnings tallied US$56.3 million, or 53% less than in the same period of 2011.

The company increased silver production by 14% over the second quarter of 2011 and 16% over the first quarter of 2012, while also posting record gold production. In the three months ended June 30, Pan American produced 6.4 million oz. silver and 32,244 oz. gold (up a year-on-year 47% thanks to contribution of 15,000 oz. from the Dolores mine and a slight increase from Alamo Dourado on higher gold grades) at consolidated cash costs of US$11.85 per oz. silver, net of by-product credits.

During the second quarter Pan American repurchased 1.3 million of the company’s shares at a cost of US$23.5 million. It ended the quarter with cash and short-term investments of US$519.8 million and working capital of US$768.8 million. It also sold its high-cost Quiruvilca mine on June 1 for a gain of US$11.2 million.

On the topic of possible future acquisitions and whether it would make more sense for the company to acquire an undeveloped project or one that is already up and running, Burns said his priority would be to look at development-stage assets. With Navidad effectively sidelined, he explained, “the one thing we’re now lacking is the next development project.”

As far as jurisdiction is concerned, he added, it would have to be one that is essentially risk-free. “Jurisdictionally we’re going to be very careful where we go for some obvious reasons we don’t need to repeat,” he confirmed. “We’re looking for something that when in pro
duction could potentially move us lower on the cost curve, fighting against some of the cost escalation we’ve seen in Argentina and Peru in particular.”

At presstime in New York, Pan American was trading at US$15.35 per share within a 52-week range of US$13.49 and US$34.49.

Kaip of BMO Capital Markets has an “outperform” rating on the stock with a price target of US$27.50 per share.

Adam Graf of Dahlman Rose & Co. in New York has a price target of US$21.71 per share and a “buy” rating on the stock.