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Michael Luddy

PAAS AT A GLANCE

P/E ► 3K HIGH EV/EBITDA ► 28.9 AVG ROA ► 0.3% LOW ROE ► 0.1% AVG Debt to Equity ► 0.223 LOW Current Ratio ► 4.67 VERY HIGH Interest Coverage Ratio ► 3.42 AVG

 

 

 

 

 

 

Pan American Silver (NASDAQ:PAAS) is the world’s largest silver miner with over 17M oz of silver produced and with 228M oz of proven or probable silver reserves in 2007. ^[1] Pan American has seven mines in Mexico, Peru, and Bolivia where the company also mines zinc, copper, lead, and gold. An eighth mine, a silver mine in Argentina, is scheduled to become operational by the end of 2008. ^[2]

Pan American’s silver production increased 31.4% in 2007, primarily due to the opening of its Alamo Dorado silver mine in Mexico which produced 3.8M oz of silver. ^[3] Pan American is also expanding its San Vincente mine in Bolivia by increasing the company’s ownership in the mine to 95%. Pan American expects the expansion to raise silver production to 2.8M oz of silver a year for the first five years. The addition of the Manantial Espejo mine in Argentina in mid to late 2008 will add another 4.1M oz of silver and 60,000 oz of gold annually as well. ^[4]

The price of silver has risen nearly 175% from 2003 to 2007 - averaging $4.88 per oz of silver in 2003 and $13.38 per oz of silver in 2007. Demand for silver has risen dramatically due to the increasing demand from industrial applications (cell phones, computers, appliances), but also because of its use as an inflation hedge against the rising inflation in the US. However, about 51.5% of the company's revenue comes from base metal byproduct production^[5] - silver is separated from other base metals like copper, zinc, and lead. Therefore Pan American is more susceptible to changes in prices of these base metals than simply just silver prices. Byproduct production has lower costs than silver mining, but in both cases if prices fall there is little Pan American can do to change existing costs. The Alamo Dorado mine and the new mine in Argentina are more focused on silver mining and should take away some of the reliance on base metal production in the future.

Company Overview

Pan American is the world's largest primary silver producer with silver reserves of 228M by the end of 2007. In 2007, Pan American was able to increase its reserves (+35.3M oz) more than the amount of silver it was able to mine (20.8M oz). Reserves increased 28% in 2007.

Pan American had 7 mines operational in 2007 and will be adding another mine in 2008:

^[7]

Trends and Forces

^[8]

Silver Prices Have Risen 175% Since 2003

The historical price of silver has most often hovered around $5 per ounce of silver, however as of 2007 that price has risen to $13.38. Pan American is sensitive to the pricing of all the metals it mines (silver, copper, lead, zinc and gold), but silver makes up the majority of the company’s sales is therefore the most influential. A rise in silver prices is generally a very good thing for Pan American because it usually means an increase in the company’s margins. In 2007, Pan American’s cash cost per silver ounce was $3.42^[9] while the price of silver averaged at $13.38 per ounce. Silver demand has been rising due to increased usage from industrial applications like computers, TVs, cell phones, and many others. This demand has been augmented by the increasing inflation in the US because both silver and gold are used as inflation hedges. Demand for silver has been outpacing the annual production of silver since 1990. ^[10]

Continuing Volume Growth

Pan American’s annual silver production increased to 18.7 million ounces in 2008, its 13th consecutive year of growth. The company predicts silver production will increase by 15% to 21.5 million ounces in 2009. ^[11]

Base Metal Byproduct Production Makes Up About Half of Revenues

About 51.5% of the company's revenue comes from base metal byproduct production^[12] - silver is separated from other base metals like copper, zinc, and lead. Therefore Pan American is more susceptible to changes in prices of these base metals than simply just silver prices. As you can see from the table in the Company Overview section, the mines with the most base metal production also have the lowest cash costs per ounce. Base metal production has helped Pan American keep costs lower, but if base metal prices fall too far than Pan American can do little to reduce their existing mining costs. The Alamo Dorado mine and the new mine in Argentina are more focused on the silver mining and should take away some of the reliance on base metal production in the future. However, finding silver mines is becoming increasingly difficult and about 80% of the world's silver is coming from byproduct production.^[13]

Political Risks Could Create Problems

While 41% of Pan American’s net asset value comes from its mines in the relatively stable Mexican mining economy, the other 59% comes from Peru, Bolivia, and Argentina. ^[14] The main risks associated with these countries are labor strikes and local mining opposition, as well as potential changes to the royalty and tax systems. There is also a possible risk of the nationalization of mining operations by the Bolivian government. Peru, Argentina, and Bolivia make up about 18%, 26%, and 15% of Pan American’s net asset value. ^[15]

Foreign Exchange Rates Affect Sales and Demand

Pan American is based in Canada while all of its mines are based in Latin America, this poses a foreign exchange rate risk. Still, Pan American’s gain or loss of exchange rates has been below $1M in the last 3 years. However, foreign exchange rates also affect the demand for not only silver but the other metals as well. When the US dollar falls, the cost for importing the metals rises and then demand falls.

Competition

Pan American is the world's largest silver producer. It competes with other mining companies, primarily silver mining companies, and also competes with companies such as SILVER WHEATON CORP (SLW) which does not mine but rather buys silver from mining companies to sell to a third party.

References

1. ↑ PAAS 2007 Annual Report, pg.1,3,4
2. ↑ PAAS 2007 Annual Report, pg.5
3. ↑ PAAS 2007 Annual Report, pg.1
4. ↑ PAAS 2007 Annual Report, pg.11
5. ↑ Scotia Capital, Silver Mining Sector, "The Silver Lining" pg.45
6. ↑ PAAS 2007 Annual Report, pg.12
7. ↑ Google Finance, PAAS Income Statement
8. ↑ Silver Supply Index
9. ↑ PAAS 2007 Annual Report, pg.1
10. ↑ Silver Prices
11. ↑ Company Press Release
12. ↑ Scotia Capital, Silver Mining Sector, "The Silver Lining" pg.45
13. ↑ Commodities Corner Silvers More Sparkle
14. ↑ Newcrest Initiating Coverage, Bigger is Better, pg.79
15. ↑ Newcrest Initiating Coverage, Bigger is Better, pg.79
16. ↑ Newcrest Initiating Coverage, Bigger is Better, pg.23