SILV - If You Think Avi Is Correct Buy Fresnillo Plc (Rating Upgrade)

2023-05-26 13:15:25 ET

Summary

• A few days ago, Avi Gilburt published an article titled "Sentiment Speaks - Silver May Explode."
• Following this thesis, in this article, I am trying to find a silver miner to bet on during an incoming bull market in silver (if Avi is correct).
• Most recently, contrary to other authors on Seeking Alpha, I was bearish about Fresnillo plc. Luckily, I was correct.
• However, I have changed my opinion on Fresnillo plc. Below I discuss the main factors behind.

Introduction

A few days ago, Avi Gilburt, an Elliott wave theory expert, published an interesting article titled: "Sentiment Speaks - Silver May Explode." Briefly, according to Avi, silver is setting up for a strong move higher.

Now, I have no idea about the Elliott wave theory but I know one thing - very often Avi was correct about the market. So, if he is once again correct, it could be a nice idea to invest in silver or silver mining companies (or both). In this article I am recommending a well-known silver miner that, after the recent price drop, could become a speculative vehicle to play this incoming (according to Avi) silver bull.

Miners with big exposure to silver prices

Firstly, let me look at a few mining companies with relevant exposure to silver:

Chart 1

Note: Unfortunately, there is no definite standard illustrating in what way a company is exposed to silver prices. As a result, to calculate this measure I had to use a few methods, e.g. production figures, sales figures or revenue. Fortunately, no matter what method is applied, the final figure (i.e. exposure to silver prices) is quite precise.

As you see, the first position belongs to Impact Silver Corp. ( ISVLF ) . Last year as much as 93.0% of total revenue was delivered by silver sold by Impact. However, due to the company's tiny market capitalization ($42M), I do not discuss this miner today.

Further, apart from Impact, there are the following four miners ranked in the top five:

• Endeavour Silver ( EXK ) with exposure of 68.5%
• Silvercorp ( SVM ): 55.7%
• SilverCrest ( SILV ): 52.7%
• Fresnillo plc ( FNLPF ): 42.3%.

Of these four miners, only two are worth, in my opinion, a further discussion: SilverCrest and Fresnillo plc. Why? Because the remaining two plays are too risky:

• Silvercorp is operating in China, a jurisdiction many investors avoid. In addition, I do not like the dividend and buy-back policy implemented by Silvercorp management
• Endeavour Silver - there are too many questions about this miner, e.g., the future of Terronera.

As a result, there are only two miners left (Fresnillo plc and SilverCrest). However, SilverCrest, according to my own calculations, is overvalued today (the detailed analysis is available for subscribers to Unorthodox Mining Investing). Hence, only Fresnillo plc is, in my opinion, worth investing today.

Why did I change my opinion on Fresnillo plc?

Fresnillo plc shares have underperformed GDX - the first premise

Paradoxically, in my latest two articles published on Seeking Alpha I made a recommendation to sell these shares but…since my last article on Fresnillo plc (March 9, 2023), the company's shares have lost 3.2% while over the same period GDX has delivered a nice profit of 13.4%. It means that between March 9 and May 25 Fresnillo plc underperformed GDX by 16.6 percentage points . It is the first premise behind my "BUY" recommendation.

Valuation - the second premise

Now, please, look at this chart:

Chart 2

The chart presents the enterprise value / EBITDA valuation measures calculated for the largest precious metal miners. Note that now Fresnillo plc is the cheapest stock among its peers. It is the second premise behind my "BUY" recommendation.

Fresnillo's exposure to silver prices may be even bigger - the third premise

Another thing, chart 1 shows that last year the silver accounted for 42.1% of total production. However, this year, due to putting online a new mine called Juanicipio, this exposure may jump up to 45.1% - 46.5%, depending on the amount of metals produced:

Table 1

1Q 2023 production results - the fourth premise but…there is also a risk.

Last quarter Fresnillo plc produced 12.3 million ounces of silver (excluding the silver stream) and 173 thousand ounces of gold. Using the silver equivalent as a production measure, the company produced 32.2 million ounces of silver equivalent. Compared to 1Q 22, it means an increase of 13.5%. Interestingly, the main factor behind this growth was the open pit segment (an increase of 17.9%) and particularly Herradura, one of the world's largest gold mines:

Chart 3

For me it is a slight improvement because since 1Q 2022 the company has been steadily increasing production.

In addition, later this year the Juanicipio mine will convert into a full-production mode. That is why the annual production should go up max. 8.3%, compared to 2022.

However, there are also pretty bad news. For example, only two mines (out of seven) improved their performance in 1Q 2023:

• The disseminated ore body at San Julian - here we saw higher silver grades plus higher throughput, compared to 4Q 2022
• The new mine, Juanicipio, processed the highest amount of ore in its history but…the silver grade dropped from 415 g/t in 4Q 22 to 363 g/t in 1Q 23. Well, it is not a common thing when a mine starts its operations…

The remaining five mines either processed less ore or reported lower silver / gold grades or both. A small exception was the Fresnillo mine - it processed more ore but reported a lower silver grade once again.

Juanicipio - a still unresolved risk factor

These days Fresnillo plc, as an operator, finally commissions the Juanicipio processing facility. According to the latest quarterly report published by Mag Silver Corp. ( MAG ) (this miner holds a 44% stake in Juanicipio), the mill name plate capacity should be reached in mid-late 2023. In other words, in 2H 2023 all my doubts about Juanicipio should be resolved (I hope positively). However, the issues I have discussed in my last article on Fresnillo plc and Juanicipio in particular, are still intact .

To remind, in this article I have questioned recovery ratios recorded since 1Q 2022. The updated chart is below:

Chart 4

Note that the recovery ratios are still below expectations (i.e. 95%) though last quarter we saw quite a big improvement (recovery of 86.8%). However, we have to remember that only part of the Juanicipio ore was processed at the Juanicipio mill. According to MAG Silver:

"From August 2020 to March 31, 2023, a total of 1,191,936 tonnes of mineralized material from the Juanicipio Project have been processed, with 64,830 tonnes at the Juanicipio processing plant and 1,127,106 tonnes at the two Fresnillo processing plants"

It means that, although I am still a bit skeptical, there is a chance that the projected recovery of 95% will be reached when all the ore is finally processed at Juanicipio.

Now, most recently MAG Silver has started publishing financial statements for Juanicipio. Well, it is not a common approach so I have to say: "Good idea!". Why? Because we have a rare chance to see how Juanicipio performs as a separate economic entity. For example, let us look at the Juanicipio income statement:

Table 2

As you see, last quarter the operation reported a net income of $14.2M (calculated on a 100% basis). Unfortunately, MAG did not publish the cash flow statement so I cannot say whether Juanicipio delivered free cash flow. At least directly. However, keeping in mind that EBITDA was $22.6M, I guess that Juanicipio was cash flow negative (EBITDA is a good proxy for cash flow from operations). Here is how I arrived at this conclusion:

• Cash flow from operations: $22.6M (i.e., EBITDA)
• CAPEX: $57.2M - assuming that MAG invested $25.1M (as the table below shows) we can roughly say that Fresnillo plc spent $32.1M (56% of total CAPEX):

Table 3

As a result, free cash flow was negative (minus $34.6M). Well, I am not worried - MAG and Fresnillo plc still invest in Juanicipio so the real picture should be available in 2H 2023 or even at the year's end, when the mine is fully operational.

Summary

I have changed my mind and now I am recommending Fresnillo plc shares as a speculative buying opportunity. The main factors behind are:

1. Most recently Fresnillo plc shares have underperformed GDX
2. Valuation - now the company's shares are trading at the lowest enterprise value / EBITDA ratio among big miners
3. This year Fresnillo's exposure to silver prices should increase, compared to 2022
4. Slightly higher production reported in 1Q 2023 (compared to 1Q 2022).

However, the old risks are still intact. For example, the Juanicipio issues are still unresolved.

As a result, keeping in mind that silver can be ahead of a strong move up (Avi says so), I recommend Fresnillo plc as a speculative buying opportunity. Why only "speculative"? Well, until I see the hard facts about Juanicipio (I mean recoveries in particular) I would bet on strong outperformance of Fresnillo plc against its peers (e.g. GDX). In other words, if I am correct, and Fresnillo plc indeed outperforms GDX, at some stage of a bull market in silver, I would sell these shares (i.e., Fresnillo plc).

Finally, contrary to other authors publishing on Seeking Alpha (focused on an entry article and forgetting about the exit one), I will publish an appropriate article when I think it is time to exit Fresnillo plc.

For further details see: