Pan American Silver Corp (TSX: PAAS) is a Canada-based silver mining company, with large silver reserves and a diversified portfolio of producing mines. 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. The group’s portfolio assets also include La Colorada Skarn and Navidad.

Investment Rationale

Strong Financial Position: As on June 30, 2020, the company had cash and short-term investment balances of US$261.6 million, working capital of US$471.6 million, and US$300.0 million available under its US$500.0 million revolving credit facility. The company’s liquidity is sufficient to satisfy their anticipated 2020 working capital requirements, planned capital expenditures, and to discharge liabilities as they come due. To provide additional flexibility and liquidity, Pan American has deferred certain capital expenditures and exploration spending.

Rising Silver and Gold Prices would drive the margin: Silver tested a seven-year high in August 2020 as concerns about a weak dollar and declining bond prices thrust investors to safe-haven assets as uncertainty about the economy remained high. Silver is trading at about US$27.62 an ounce, reflecting more than 50% increase on a YoY basis and more than 70% rise from five years ago. The recent spike in the silver prices is expected to benefit Pan American Silver in terms of margin expansion, higher profitability, and expansion in earnings. Further, the groups’ margin profile is also expected to expand given the ~9% increase in the gold prices since June quarter to date as it derives a certain portion of its revenue from gold sales. We believe that average gold realized prices and silver prices are going to expand in the third quarter, which would improve the company’s financial position.

PAAS Shares Are Hovering in a Long-run Bullish Zone: 200-day Simple Moving Average is typically considered as a long term support level for any underlying, as it reflects a support base in a stock created over 200-days of trading sessions. The Price/ 200-day SMA ratio of the stock stood at 1.35x, which implies that shares of PAAS trading approximately 35% above the 200-day long-term support level, which indicates a long-term bullish trend in the stock given the stock is trading far above its psychological support level. Also, the long-term moving average is inching up, which is another bullish trend in the stock. At the last closing price of CAD 44.64 (as on August 27, 2020), its shares traded above the crucial short-term support level of 50-day SMA, another positive trend.

Risk Associated to Investment: The group is significantly exposed to the volatility in the price 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.

2QFY20 Highlights:

Source: Company Presentation

The group’s reported a revenue decline of 27% in the second quarter of FY20 against the year-over reported revenue, primarily because of the impact of the COVID-19 related suspensions at their Latin American operations. Reported revenue during the quarter stood at US$249.5 million. Strong precious metal prices, with gold and silver averaging US$1,708 per ounce and US$16.58 per ounce, respectively, helped offset the impact of the COVID-19 pandemic.

Q2FY20 Production Details:

Source: Company Presentation.

Consolidated silver production for the three months ended June 30, 2020, of 2.79 million ounces was 57% lower than the 6.47 million ounces produced in the three months ended June 30, 2019, primarily reflecting the suspensions related to COVID-19. While consolidated gold production for Q2 2020 of 96.6 thousand ounces was 38% lower than the 154.6 thousand ounces produced in Q2 2019, primarily reflecting the suspensions related to COVID-19. Zinc production in Q2 2020 was 4.3 thousand tonnes, 75% less than Q2 2019 production. Lead production of 1.7 thousand tonnes was 75% less than Q2 2019 production. Copper production of 0.3 thousand tonnes was 86% less than Q2 2019 production, reflecting the COVID-19 related suspensions.

Silver Segment Cash Costs and All-in Sustaining Costs (AISC) were US$6.23 and US$12.54 per silver ounce sold, respectively. Due to the continuation of leaching activities, Dolores made up a significant portion of production in the quarter and materially benefited Silver segment Cash Costs. Silver Segment AISC reflects the investment in critical projects and cost-increasing net realizable value (NRV) inventory adjustments at Dolores, offset by cost-reducing NRV adjustments at Manantial Espejo.

Gold Segment Cash Costs and AISC were US$905 and US$1,015 per gold ounce sold, respectively. Gold Segment Cash Costs were negatively impacted by mine sequencing at the La Arena operation, resulting in less ore tonnes at lower grades, and mining lower grade extensions to reserves at Timmins.

Net cash generated from operations was US$62.8 million, which included US$46.5 million of COVID-19 related mine care and maintenance costs. Working capital changes resulted in a US$31.3 million source of cash, mainly driven by the draw-down in inventories from continued leaching at the Company's three heap leach operations during the COVID-19 related suspensions.

Source: Company Presentation

The Board of Directors has approved a cash dividend of US$0.05 per common share, or approximately US$10.5 million in aggregate cash dividends, payable on or after August 27, 2020, to holders of record of Pan American’s common shares as of the close on August 17, 2020.

Source: Company Presentation

During Q2 2020, Pan American placed its operations in Mexico, Peru, Argentina and Bolivia in care and maintenance for various durations, depending on the government restrictions imposed in those regions in response to COVID-19. However, By the end of Q2 2020, all of Pan American's suspended operations had resumed production; however, its Huaron and Morococha operations in Peru were returned to care and maintenance on July 20, 2020 after several workers at the mines tested positive for the COVID-19 virus.

Stock Performance

PAAS shares traded 2.32% lower and settled at CAD 44.64 (on August 26^, after the market close). Over the past 52 Weeks, its shares have tested a peak of CAD 53.30 (on August 06, 2020) and recorded a 52W Low of CAD 14.22 (on March 16^th, 2020). At the last closing price, PAAS shares traded approximately 16.25% below its 52W High price point and up around 213.92% against the 52W Low price level.

1-year Price Chart (as on August 27, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

In a year-over, PAAS shares have increased approximately 77.57% and approximately 45% on a YTD basis. Further, the shares have generated a return of approximately 24.14% in the last three months. Moreover, its shares have outperformed the benchmark index and the sector competitors in all the periods mentioned above.

Especially, on a YoY basis, its shares have outperformed the benchmark TSX Composite Index by 71.75%, which depicts a significantly higher relative strength in the stock.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 28.33% of the total shareholding. Van Eck Associates Corporation and The Vanguard Group, Inc.  holds the maximum interests in the company at 10.27% and 2.89%, respectively.  Further, shareholding pattern reflects that 3 out of top-10 shareholders have increased their stake in the company over the last three months, with Arrowstreet Capital Limited Partnership and RBC Global Asset Management Inc. are among the top investors in the company which have increased their stakes by 2.65 million and 0.75 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 relative valuation metrics

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

Stock Recommendation: Despite challenging second quarter because of COVID-19 led disruptions, the group is well-positioned to benefit in future from an upsurge in the commodity prices it deals in. Further, the group’s liquidity remains strong to pass through current challenging times. The company’s liquidity is sufficient to satisfy their anticipated 2020 working capital requirements, planned capital expenditures, and to discharge liabilities as they come due.

Moreover, the company has a strong balance sheet with Net Cash positive at the end of June 30. Also, the debt contribution in the company’s balance sheet is quite low, with Debt/Equity ratio stood at 0.13 lower than the industry average median of 0.24 and long-term debt as a proportion to total capital stood at 10.6% better than industry median of 15%. More importantly, the group’s Net Debt/EBITDA ratio stood at 0.58, which is substantially better than the industry median of 4.83 and also indicates the strong financial health of the business.

Further, the shares have recorded strong relative strength on the stock exchange against the benchmark index and significantly outperformed the benchmark on a year-over-year basis and YTD basis. Also, The Price/ 200-day SMA ratio of PAAS’  shares stood at 1.35x, which implies that shares of PAAS trading approximately 35% above its 200-day or long-term support level, which indicates a long-term bullish trend in the stock given the stock is trading far above its psychological support level.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 44.64 (as on August 26, 2020, after the market close), with lower double digit upside potential, based on the NTM Peer’s Average EV/Sales multiple of 6.01x, on the FY20E Sales.

*Recommendation is valid at August 28, 2020 price as well.

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