FR:CC - First Majestic Silver Finally Stops Digging An Expensive Hole

2023-03-23 07:00:00 ET

Summary

• Mining at Jerritt Canyon has been suspended. At long last.
• First Majestic Silver has not generated free cash flow in 2022. Far from it.
• The threat of throwing good money after bad lingers.
• We consider AG stock a SELL unless it finds a greater fool and offloads the Jerritt Canyon mine.

There was a time when First Majestic Silver's ( AG ) marketing revolved around painting the company as one of the last listed silver pure-plays, based on the company's portfolio consisting of a handful of small-to-mid-sized primary silver mines. Unfortunately, most of these silver mines had suffered from under-investment and were in dire need of capital investment following the last silver price downturn. And instead of breathing new life into these assets, the company decided to change course, sell some of its run-down Mexican silver mines, and buy a run-down gold mine in Nevada instead.

This mine in Nevada didn't take long to develop into a veritable albatross around the company's neck, straining the company's balance sheet, and diluting the registry via the company's ATM facility. The music finally stopped on March 20 when First Majestic Silver announced the suspension of mining activities at Jerritt Canyon.

We would like to have a closer look at the damage in the following.

The Jerritt Canyon Mine

Gold mineralization at Jerritt Canyon was discovered in 1972, and open-pit mining started in 1980. Operations moved underground in 1993 while the open pits wound down in 1999. Gold mining continued, but became less and less profitable as the years went by until operations ceased in 2008, only to restart again on a smaller scale a year later.

Almost 10M ounces of gold were mined on the property in total, and annual production topped 350Koz during the heydays of the late 80s and early 90s. Majors like Freeport-McMoRan ( FCX ) and AngloGold Ashanti ( AU ) owned stakes in this mine at one point or another, but as production declined at the start of this century Jerritt Canyon was handed down to smaller and arguably more obscure operators, changing hands several times. To put it kindly, profitability seemed questionable at best when the ubiquitous mining investor Mr Eric Sprott purchased the mine out of bankruptcy in 2016, and found a willing buyer in the form of First Majestic Silver five years later. The acquisition was paid for in First Majestic Silver shares worth $470M at the time.

Jerritt Canyon is not a simple operation in terms of mining as well as processing. The remaining resources require rather costly underground mining techniques, a large portion of the resources are located below the water table and dewatering is an issue. However, perhaps most importantly, the sulfide ore at Jerritt Canyon is complex and requires a roaster to process. This operation includes one of only three operating roasters in Nevada, the other two are owned by i-80 Gold ( IAUX ) and Nevada Gold Mines, the JV between Barrick Gold ( GOLD ) and Newmont ( NEM ).

Managing such a processing facility takes experience, and almost as importantly, a suitable blend of ore with sufficient sulfur content to keep the process going without the need to add additional energy. This is one aspect where previous owners have struggled, and apparently First Majestic Silver has as well. Fixed costs are high for such an operation, and in order to run profitably, it has to be operated at nameplate capacity to spread the fixed cost around the maximum output. High-grade ore also helps in this context. First Majestic Silver seems to have fallen short on all these fronts so far.

When First Majestic Silver acquired the mine in 2021 the CEO Mr Keith Neumeyer had the following to say (emphasis added):

We look at three primary tests when we look at M&A transactions.

Life of mine is very important, you don't want to be buying a mine that you're going to have to shut down in a couple of years . You'd want a good lengthy life of mine and also you want to be able to have a chance or at least an exploration plan or a view that you can increase the life of mine substantially over time.

The second test is production increase. Can you actually produce more metal? And in some mines, you can, obviously, in others you can't. It just depends on the uniqueness of that particular potential target.

The third test that we look at is cost reductions and we analyze that quite deeply. We get pretty deep into the weeds on that and then we come up with our own conclusions on what kind of things we could do.

Hindsight is always 20/20, but these introductory statements to the conference call following the Jerritt Canyon acquisition sound like the antithesis to the actual performance of the mine since then.

• Test 1- fail. The reserve-based mine life was short to start with (the end of the year 2025), and it has not been extended so far.
• Test 2 - fail. Production has lingered well below expectations.
• Test 3 - fail. Costs have stubbornly remained well above the gold price.

And as a result, the company had to shut down the mine after (less than) a couple of years. And to add insult to injury, the suspension announcement came less than a month after the company had reaffirmed its 2023 production guidance for the mine.

And it does not end there. Tailings disposal is another pressing issue. There are two existing tailings storage facilities at the Jerritt Canyon mine site. TSF1 is in the process of being reclaimed and revegetated, and TSF2 has been raised to accommodate a limited amount of additional tailings. The technical report states that this expanded TSF2 will be filled to capacity by the end of 2023, and the construction of a new TSF3 will be necessary to accommodate tailings starting in 2024. To this end, the company had been planning to convert the existing water storage reservoir into a tailings storage facility, a capital project that has not been mentioned in recent company communications.

Taking into account the acquisition price of $470M, accumulated mine operating losses of $130, and capital spending of $270M the total cost to First Majestic Silver so far amounts to $870M (Rude Otto crunches the numbers in more detail here ).

Summary & Investment Thesis

The Jerritt Canyon acquisition was a major misstep for First Majestic Silver, and has cost the company dearly. The balance sheet is strained, and the ATM facility has been keeping the company afloat as the other operating mines have not generated sufficient cash flow to prop up Jerritt Canyon. The strategy of selling shares into the market only to throw the cash into the money pit in Northern Nevada has apparently come to an end; except management has already threatened a grand plan to bring Jerritt Canyon back into production without specifying funding for this plan, and without addressing tailings storage in any detail.

First Majestic Silver has generated a whopping $140M of negative free cash flow in 2022, and has increased the share count by 25% since the Jerritt Canyon acquisition. Thankfully, the company still has the Santa Elena mine to lean on; and it has a portfolio of suspended mines to sell, along with the newly created royalties on these assets to plug the holes torn by the Jerritt Canyon operations. We submit that First Majestic Silver needs to hunker down, minimize expenditures at Jerritt Canyon, and find a greater fool to try its luck with this mine. And meanwhile, stop paying dividends that are clearly not covered by operations, and repair the balance sheet with cash flow from Santa Elena. And perhaps it would also help if management spends less time fantasizing about the silver price shooting into the triple-digits and Tesla ( TSLA ) buying out silver miners.

In its current state, and without clear intentions to exit the Jerritt Canyon disaster First Majestic Silver remains a clear SELL in our view. Judging from the market reaction so far we are not alone in this assessment-

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