Pan American Silver Corp (TSX: PAAS) is a Canada-based world’s premier silver mining company, with large silver reserves and a diversified portfolio of producing mines, with nine operations in America. It also produces and sells gold, zinc, lead and copper. Its properties in North and Central America include Timmins, La Colorada, Dolores and Escobal. Its operating properties in South America include Shahuindo, La Arena, Huaron, Morococha, San Vicente and Manantial Espejo. Its exploration and portfolio assets also include La Colorada Skarn and Navidad.  

Investment Rationale

• Rising Silver Demand to Help the Group: If one must learn anything from 2020, it is to expect the unexpected. We believe silver could be the metal with the next big surprise on account of rapidly rising demand for silver in industrial applications, especially those driving the green transformation such as photovoltaic cells used in solar panel production. Also, silver has significantly outperformed the gold over the past 1-Year, with silver surged approximately 44% against a 17.81% movement in the gold prices at the same time.

 

• Decent Q3FY20 Performance: Low operating costs and strong precious metal prices contributed to robust mine operating earnings of USD 124.6 million in the third quarter of 2020 for the group. Further, all operations are running, and projects are proceeding. The company has generated strong operating cash flow year-to-date of approximately USD 292 million. In line with the group’s capital allocation priorities, the company has substantially reduced debt, with only USD 60 million drawn on its Credit Facility. Also, the company is aiming to have no bank debt by the end of the year. The group is also increasing the dividend for the second time this year, raising the quarterly dividend by 40% to USD 0.07 per common share.

Source: Company Presentation

• Negligible Balance Sheet Risk: In the latest production guidance, it was noted that Pan American repaid the remaining USD 275.0 million outstanding on its corporate credit facility and distributed USD 46.2 million in dividends to shareholders, with the quarterly dividend being increased twice during the year. As of December 31, 2020. Pan American had no bank debt, while the cash and short-term investment balances increased to approximately CAD 279.1 million. This suggests that the group is exposed to negligible balance sheet risk.

 

• Bullish 2021 Guidance Set the Company for Upside Bets: The group is expecting a 35% increase in silver production relative to 2020 and record gold production in 2021. The company is also observing a robust free cash flow level. Further, the group’s ability to overcome the extraordinary challenges over the past year while managing nine operations, generating substantial free cash flow, advancing La Colorada skarn project, and repaying all of the bank debt is a testament to the management and the benefit of having a diversified portfolio of quality assets. Further, the company anticipate 2021 being a much stronger year across all of its operations. All of these are likely to keep the group’s shares in the street’s limelight.

 

• Risk Associated with Investment: The group is significantly exposed to the volatility in a varied number of commodities ranging from Silver, Gold, Copper and Zinc. However, the majority of changes in financial performance could come from volatility in silver and gold prices. Also, the second wave of Coronavirus could hamper the group’s production, which would weigh on the group’s financials as well.

Q3FY20: Financial Highlights

Source: Company Presentation

• Revenue in Q3 2020 was USD 300.4 million, 15% lower than Q3 2019, primarily due to decreased quantities of metal sold, partially offset by higher realized precious metal prices. Metals sales were impacted by the replenishment of dore and in-process inventories, COVID-19 related throughput reductions and mine suspensions, and timing of sales.
• Net income of USD 65.3 million (USD 0.31 basic income per share) was recorded for Q3 2020 compared with net income of USD 37.7 million (USD 0.18 basic income per share) in Q3 2019. The USD 27.5 million quarter-over-quarter increase in earnings mainly reflects a USD 60.7 million increase in mine operating earnings, with the decreased revenues being more than offset by lower cost of sales. The increase in earnings was partially offset by a USD 23.1 million decrease in investment income, reflecting lower gains recognized in Q3 2020 on the fair-value measurements of certain equity investments owned by the Company, and a USD 20.8 million increase in care and maintenance costs due to the COVID-19 related suspensions of Huaron and Morococha
• Adjusted earnings stood at USD 72.1 million, (USD 0.34 adjusted earnings per share) in Q3 2020 compared to the Q3 2019 adjusted earnings of USD 71.2 million (USD 0.34 basic adjusted earnings per share). Q3 2020 adjusted earnings exclude the USD 20.5 million of COVID-19 related care and maintenance costs.
• Cash flow from operations in Q3 2020 totaled USD 114.9 million, USD 33.0 million higher than the USD 81.9 million generated in Q3 2019.
• As at September 30, 2020, the Company had cash and short-term investment balances of USD 231.6 million, working capital of USD 465.6 million, and USD 410.0 million available under its USD 500.0 million revolving credit facility.

Source: Company Presentation

• Total debt of USD 129.8 million was related to the USD 90.0 million drawn on the Credit Facility, USD 5.6 million of loans in Peru, and the remainder to lease liabilities. In Q3 2020, the Company repaid USD 110.0 million on the Credit Facility and made an additional repayment of USD 30.0 million in October 2020.
• Consolidated silver production in Q3 2020 was 4.09 million ounces, 39% lower than the 6.67 million ounces produced in Q3 2019, primarily reflecting the COVID-19 related suspensions of Huaron and Morococha, reduced operating capacities at the other mines on account of adopting stringent COVID-19 protocols.

Q3FY20 Production. Source: Company Presentation

• Consolidated gold production in Q3 2020 of 116.9 thousand ounces was 22% lower than the 150.2 thousand ounces produced in Q3 2019, primarily reflecting the replenishment of in-process inventories at the heap leach operations, as expected, following the drawdown of inventories that occurred during the COVID-19 related suspensions earlier in 2020.

Cash Costs per ounce sold: Q3FY20

• Silver Segment Cash Costs were USD 7.14 per silver ounce sold.
• Gold Segment Cash Costs were USD 793 per gold ounce sold.

Source: Company Presentation

All-In Sustaining Costs per ounce sold: Q3FY20

• Silver Segment AISC were USD 6.01 per silver ounce sold.
• Gold Segment AISC were USD 1,057 per gold ounce sold.
• Consolidated AISC per silver ounce sold, including by-product credits from the Gold Segment gold production, were negative USD 8.42 per silver ounce sold.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 26.54% of the total shareholding. Van Eck Associates Corporation and The Vanguard Group, Inc.  holds the maximum interests in the company at 10.66% and 2.86%, respectively.  Further, shareholding pattern reflects that 3 out of top-10 shareholders have increased their stake, with Van Eck Associates Corporation and Mirae Asset Global Investments are among the top investors in the company which have increased their stakes by 0.81 million and 0.73 million, respectively. The institutional ownership in “PAAS” stood at 59.45%, and ownership of the strategic entities stood at 1.60%.

 Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters).

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: The company has issued strong FY20 and FY21 guidance, with an expected 35% increase in silver production relative to 2020 and record gold production in 2021, despite the assumption that COVID-19 will continue to have an impact on operations. The company expect to be generating robust levels of free cash flow and anticipating 2021 being a much stronger year across all of their operations.

Further, the company reported decent third quarter performance, led by lower operating costs and strong precious metal prices contributed to robust mine operating earnings of USD 124.6 million in the third quarter of 2020. Further, all operations are running, and projects are proceeding. The company has virtually zero debt in its balance sheet, which implies negligible balance sheet risk.

More importantly, silver could be the metal with the next big surprise on account of rapidly rising demand for silver in industrial applications, especially those driving the green transformation such as photovoltaic cells used in solar panel production. Consequently, silver prices are likely to remain elevated in the foreseeable future. Also, we expect the gold price to remain higher as global economic outlook remain uncertain. Elevated silver and gold price are likely to help the group in delivering robust performance in the coming quarters.

Therefore, based on the above rationale and valuation, we recommend a “Buy” rating at the closing price of CAD 38.96 on January 21, 2021.

1-Year Price Chart (as on January 21, 2021). Source: Refinitiv (Thomson Reuters) 

*Recommendation is valid at January 22, 2021 price as well.

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