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. The La Colorada consists of approximately 60 claims.

Investment Rationale

• A Leading Silver Miner in the World: Pan America has been a leader in the silver mining sector for a number of years. The good news for shareholders is that the company remains undervalued, especially if precious metals pricing turns higher in 2021. It owns a diversified mine list with long-term reserves, little debt is on the balance sheet, and expanding production rates in 2021-22 are likely scenarios. If one believes that rising inflation issues around the world would encourage investors to bid up for silver/gold assets, Pan American should be under the radar.

• Creating Value for Shareholders: The group is the industry leader with high margins and low-cost production. It generated ~USD 1.5B in free cash flow since 2010. Moreover, in FY20, the group generated a record operating cash flow of USD 462.3 million, which was USD 180.3 million or 63% higher than the USD 282.0 million generated in 2019. Further, the group's free cash flow has soared up by 85% to USD 323 million against USD 175 million reported a year over the period, driven by a strong rally in the metal prices in 2020. This solid jump in the operating cash flow and free cash flow has enabled the group to fully repay all bank debt, double the quarterly dividend to shareholders, and grow the cash balance at year-end.

• Future Catalyst to Drive Growth: Three large catalysts, which would grow shareholder value are; 1) Escobal, Guatemala – large, already-built silver mine with 264.5 million ounces of silver in reserves, 2) La Colorada, Mexico – a new discovery with estimated 100.4 million tonnes of inferred mineral resource; and 3)Navidad, Argentina – large undeveloped silver deposit with 632.3 million ounces of silver in measured and indicated resources.

• Piled Up Inventory Expected to Clear in Forthcoming Quarters: In the Q1FY21, a large inventory build impacted revenue, cash flows, and Silver Segment Cash Costs and All-in Sustaining Costs ("AISC"). The inventory primarily related to a three-month build-up of concentrate production at La Colorada due to extended negotiations with a transport supplier and changes to smelting contracts. That inventory is expected to be sold and recognized in revenue over Q2 2021 and Q3 2021

• 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, and the company is expecting a robust free cash flow level. Further, the ability to overcome the extraordinary challenges over the past year while managing the nine operations, generating substantial free cash flow, advancing the La Colorada skarn project, and repaying all the company's bank debt is a testament to the team and the benefit of having a diversified portfolio of quality assets. Further, the company anticipates 2021 being a much stronger year across all of its operations.

• Huron and Morococha Operations Performed Well in Q1FY21: At Huron, Silver production was 15% higher, primarily from higher throughput rates relative to Q1 2020, which had been impacted by the COVID-19 related mine suspension in the second half of March 2020. Production of zinc, lead and copper were 33%, 18% and 14% higher, respectively, reflecting the same factors affecting silver production. Zinc production also benefited from improved grades due to mine sequencing. At Morococha, Silver production was 14% higher, primarily from higher throughput rates relative to Q1 2020, which had been impacted by the COVID-19 related mine suspension in the second half of March 2020.

• Promising Silver Future Demand: Demand for silver would be in the limelight led by a wide range of reasons; a) Silver has the highest electrical and thermal conductivity of all metals, making it an important metal in the transition to a low carbon economy; b) ~10% of silver supply used for photovoltaics (construction of solar panels; c) ~30% of silver supply used in electrical applications. Shift to a low carbon economy involves an increase in electrical componentry, including electric vehicles; d) Silver is an important component in the buildout of 5G networks, the next major evolution in communication technology; e) Silver has medical and sanitary applications because of its anti-bacterial properties.

• Risk Associated to Investment: Shares of PAAS is signifying 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 third wave of COVID-19 could hamper the group's production, which would weigh on the group's financials as well.

Financial Highlights: Q1FY21

• Revenue for Q1 2021 was USD 9.7 million higher than the revenue recorded in Q1 2020, as a result of higher realized prices, lower treatment and refining charges, and positive concentrate settlement adjustments, partially offset by decreased quantities of metal sold.
• Production and royalty costs in Q1 2021 were USD 27.2 million lower than in Q1 2020. The decrease was driven by a USD 31.1 million, or 14% decline in production costs, partially offset by a USD 4.0 million increase in royalty costs.
• Depreciation and amortization expense was USD 3.1 million lower than in Q1 2020, reflecting lower sales and production volumes, as described previously.
• Cash flow from operations in Q1 2021 totaled USD 29.9 million, USD 84.2 million less than USD 114.1 million generated in Q1 2020. The decrease was mainly attributable to a USD 85.5 million decreases from changes in non-cash operating working capital and a USD 24.8 million increase in tax payments, which offset the increase in cash from mine operating earnings.
• The Company's liquidity and capital position at March 31, 2021, was comprised of cash and short-term investment balances of USD 206.4 million, an equity investment in Maverix Metals Inc. with a market value of USD 134.3 million, working capital of USD 513.0 million, and USD 500.0 million available on its revolving credit facility (the "Credit Facility"). Total debt of USD 30.8 million was related to lease liabilities.
• Capital expenditures totaled USD 51.0 million, comprised of USD 45.2 million of sustaining capital and USD 5.7 million of non-sustaining capital, the majority of which was directed to project capital for exploration drilling activities at the La Colorada skarn project and the Wetmore project at Timmins.
• The Board of Directors has approved a cash dividend of USD 0.07 per common share or approximately USD 14.7 million in aggregate cash dividends.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 25.91% of the total shareholding. Van Eck Associates Corporation and The Vanguard Group, Inc. holds the maximum interests in the company at 10.63% and 2.94%, respectively.  The institutional ownership in “PAAS” stood at 33.92%, and ownership of the strategic entities stood at 0.87%.

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

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The group is a leader in the silver mining sector for a number of years.  The company has 30 years of silver production and ten years of gold production in the ground (at 2020's extraction rate on proven/probable reserves) all over Central, South and North America. A total of 9 mines are in operation, with three more under development or awaiting government approval.

In the Q1FY21, a large inventory builds impacted revenue, cash flows, and Silver Segment Cash Costs and All-in Sustaining Costs ("AISC"). The inventory primarily related to a three-month build-up of concentrate production at La Colorada due to extended negotiations with a transport supplier and changes to smelting contracts. That inventory is expected to be sold and recognized in revenue over Q2 2021 and Q3 2021.

The group is expecting a record gold production and a significant increase in silver production during 2021, with the production profile tilted towards the second half of the year. Elevated metal price along with higher production would help the group in delivering improved financial performance in the near to medium term. Based on technical analysis, the stock has support at CAD 30.4 level.        

Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 34.57 on July 08, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached or if the price closes below the support level.

Technical Price Chart (as on July 08, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid at July 9, 2021 price as well.

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