2023-04-26 12:08:54 ET
Summary
- MAG Silver has been one of the worst-performing precious metals stocks this year, down 18% year-to-date vs. a 3% decline for the Junior Silver Miners Index.
- I attribute the underperformance to proposed mining law changes in Mexico and recent share dilution which hurt momentum in the stock, partially overshadowing strength in metals prices.
- The good news is that MAG Silver should have much better years in 2023 and 2024, with nameplate capacity expected to be reached in mid-late 2023.
- That said, while MAG Silver is cheaper than most of its peers in the silver space, I don't see enough margin of safety at current levels and continue to see more attractive opportunities elsewhere in the sector.
Just over three months ago, I wrote on MAG Silver ( MAG ), noting that while it was one of the more attractive names in the silver space, there wasn't nearly enough margin of safety to justify paying up for the stock at US$16.80. This was especially true when silver had run directly into resistance near $24.00/oz, which pointed to an increased risk of owning silver producers. Since then, the price of silver suffered a ~16% drawdown and MAG Silver has suffered a ~30% drawdown, with producers having leverage to silver in both directions. In this update, we'll dig into the company's FY2022 results and whether there's finally enough margin of safety to justify going long the stock.
All figures are in United States Dollars unless otherwise noted.
Q4 & FY2022 Results
MAG Silver released its Q4 and FY2022 results last month, reporting that Fresnillo ( FNLPF ) processed ~165,800 tonnes of material from underground development and initial stopes at an average grade of 415 grams per tonne silver at the Juanicipio Mine where it has a minority interest (44% ownership). This translated to attributable production of ~803,300 ounces of silver and ~2,200 ounces of gold for MAG Silver, a significant increase on a year-over-year basis due to increased throughput, but still well below the levels expected when we entered 2022 and a ~24% decline in silver production sequentially. The decline in silver production was related to lower grades (415 grams per tonne of silver vs. 513 grams per tonne of silver), and I would expect a mediocre Q1 performance with the use of low-grade stockpiles during the ramp-up period.
On a full-year basis, ~646,100 tonnes were processed at an average grade of 520 grams per tonne of silver, translating to a throughput rate of ~1,770 tonnes per day, less than half that of the Juanicipio Plant once it reaches nameplate capacity. This translated to the production of ~8.69 million payable ounces of silver, ~20,300 ounces of payable gold, and 4,500 and 6,800 tonnes of lead and zinc, respectively. On an attributable basis, this resulted in production of ~3.82 million ounces of silver and ~8,900 ounces of gold for MAG Silver, or ~$95.0 million in net revenue (net of treatment and processing costs), and attributable gross profit of ~$58.4 million, up from ~$26.4 million in FY2021.
While this represented solid growth year-over-year, it was well below expectations because of the delayed tie-in and commissioning, but this has finally begun as of January with the connection to the national power grid. This means that ore will start being directed to the 4,000 tonne per day Juanicipio Plant rather than the Fresnillo and Saucito plants, where Fresnillo made available room to process material given the significant delay between mining and milling activities with the Federal Electricity Commission approval [CFE] only granted on December 28th. Meanwhile, MAG Silver noted in its prepared remarks that the first lead and zinc concentrate was shipped this month, the plant averaged ~2,500 tonnes per day in March, and recoveries are slightly above budget for this stage of the commissioning process, all positive developments.
As for MAG's financial results, attributable profit was down year-over-year because of weaker average realized metals prices ($22.50/oz silver and $1,848/oz gold) and came in at ~$2.9 million in Q4 2022 due to lower grades. This resulted in a net loss for the period of $0.80 million after accounting for ~$3.8 million in G&A and $0.1 million in exploration/business development, down from quarterly net income of $8.66 million in the year-ago period. However, attributable income was up sharply on a full-year basis to ~$40.8 million and despite higher G&A costs (new Chief Sustainability Officer, new CFO, severance payments, increased travel costs), the company reported net income of ~$17.6 million, a 193% increase year-over-year. This helped MAG Silver to finish the year with $30.0 million in cash, despite an $8.1 million cash call in December.
Assuming there are no further hiccups, we should see Fresnillo report annual production of at least 12.5 million ounces of payable silver related to Juanicipio in FY2023 or ~5.5 million ounces of payable silver that's attributable to MAG Silver. And looking ahead to FY2024, attributable production should increase to at least 8.0 million ounces of payable silver at sub $10.00/oz all-in sustaining costs [AISC], making this one of the most profitable silver mines in North America. This should translate to upwards of $140 million in free cash flow for MAG Silver, leaving MAG Silver trading at a FY2024 free cash flow yield of 9.6%, well above that of its peer group, especially considering that some aren't even generating any free cash flow.
Recent Developments
Moving over to recent developments, one of the most significant developments is the silver price, which is knocking on the door of $25.00/oz after a V-shaped recovery from its March lows. This has resulted in a quarter-to-date average realized silver price of $23.60/oz and a year-to-date average realized silver price of $23.20/oz which should positively impact MAG's FY2023 financial results if metals prices continue to cooperate. Unfortunately, the stock has underperformed with MAG Silver choosing to do a financing earlier this year for ~2.9 million shares at US$14.65 with additional flow-through shares (~0.97 million shares at US$17.67), resulting in roughly 4% share dilution for investors. The level of share dilution is relatively minor, but it did lead to underperformance in the stock during Q1.
Meanwhile, from an exploration standpoint, MAG Silver reported results from a few holes at its Deer Trail Project in Utah, a ~7,300-hectare land package south of the famous Bingham Canyon Mine. The company is exploring for carbonate replacement deposit mineralization and while results from the Deer Trail Mine Corridor weren't overly impressive except decent grades reported in DT-22-07 (2.90 meters at 24 grams per tonne of silver, 0.67% copper, and ~14.1% lead/zinc) and a very narrow intercept in DT-21-05 (0.49 meters at 137 grams per tonne of silver, 0.60 grams per tonne of gold, 0.18% copper, and ~29.5% lead/zinc), the company discovered a new zone: Carissa.
As the image above shows, the Carissa Zone lies one kilometer southwest of the Deer Trail Mine Corridor and, according to the company, drill-hole DT22-09 and DT22-10 intersected "the most widespread mineralization and strongest alteration drilled on the property". The company also noted that the sulfide lacing and skarn zones became more potent at depth and this suggests it may be drilling closer to a porphyry source given the increase in pathfinder elements like tungsten, tin, bismuth, and molybdenum. For now, it's still very early days at the project, but the elevated copper grades in the first two holes drilled into the Carissa Zone are encouraging, with highlight intercepts of 26.62 meters at 0.62% copper and 0.16 grams per tonne of gold (DT22-09) and 24.95 meters at 0.44% copper (DT22-10) before the hole was lost at 1355 meter core length.
Valuation & Technical Picture
Based on ~105 million fully diluted shares and a share price of $12.80, MAG Silver trades at a market cap of ~$1.35 billion. If we compare this figure to an estimated net asset value of $1.19 billion ($100 million assigned to exploration upside at Larder/Deer Trail), MAG Silver is trading at 1.13x P/NAV, a meaningful premium to net asset value despite it being a single-asset silver producer with its 44% owned operations in a Tier-2 ranked jurisdiction. Given that MAG has a minority interest in a world-class mine owned by a top operator in one of the more mining friendly states in Mexico, I believe a premium is justified, and we typically see silver producers trading at a significant premium to gold producers. That said, given the recently proposed mining laws that could impact investment if passed, I think it's harder to justify the significant premiums for single-asset Mexican producers like MAG Silver that have all of their income tied to the country.
Some of the proposed changes to mining laws include:
- Minimum payments with 10% of mining profits going to community.
- New mining concession grants contingent on water availability.
- Increased grounds for the cancellation of mining concessions.
- Mining concessions only providing the right to one mineral vs. any mineral.
- Preferential right to mining activity would no longer be in place regarding third parties overlapping on claims.
- A reduction in the term and the extension of new mining concessions from 50 years to 15 years.
- The potential removal of deposits in protected natural areas/populated where ecosystems could be impacted.
Although these proposed changes have less of an impact on those companies mining precious metals in Mexico with existing operations and are most restrictive to companies looking to start new operations or explore new concessions, the trend in Mexico continues to be negative, and we've seen no shortage of permitting challenges for some companies over the past few years, and what some might argue to be unreasonable disputes, such as with First Majestic Silver ( AG ). So, while I don't think this is a deal-breaker for investing in the country, I believe that an increased margin of safety makes sense given that Mexico is becoming less attractive from an investment standpoint relative to other jurisdictions.
Using what I believe to be a more conservative multiple of 1.40x P/NAV to reflect the less favorable jurisdictional profile relative to a couple of years ago, I see a fair value for MAG Silver of ~$1.63 billion [US$15.50 per share]. This points to a 21% upside from current levels which makes MAG Silver more attractive than some of its peers, which I believe to be closer to fully valued, such as First Majestic Silver ( AG ) and Gatos Silver ( GATO ) which also have all their exposure tied to Mexico. That said, relative value without a margin of safety is not enough to justify owning a stock, and I prefer a minimum 35% discount to fair value for small-cap precious metals stocks. After applying this discount to MAG Silver, the stock would need to decline below US$10.10 to move into an ideal buy zone.
Finally, if we look at the technical picture, MAG Silver now has a new resistance level at US$14.30 after its rally failed in this area earlier this month and no strong support until US$11.00. This doesn't mean that the stock must decline to the US$11.00 area, but after measuring from a current share price of US$12.80, the reward/risk ratio of 0.83 to 1.0 is not that compelling. Obviously, I could be wrong in my assessment here and some might argue that with First Majestic Silver trading at ~2.0x P/NAV with higher operating costs and limited free cash flow generation, MAG Silver can easily command a P/NAV multiple of 1.80 or higher. And while this is a valid point, I think it's a weak argument to suggest a company is undervalued by comparing it to the most expensive name sector-wide.
Summary
MAG Silver continues to be one of the more attractive ways to get exposure to silver, with a minority interest in one of the highest-margin silver assets in North America. That said, unlike some diversified producers such as Pan American Silver ( PAAS ), MAG Silver has all of its exposure tied to Mexico and with two-early stage projects, it will be at least 2029 before we see diversification from a cash flow standpoint unless MAG Silver were to acquire a producing or advanced asset. For now, MAG is reasonably valued, but I don't see enough margin of safety especially considering the recent developments in Mexico. In summary, I continue to focus on names elsewhere in the sector, such as Marathon Gold ( MGDPF ) which I see having far more upside to fair value.
For further details see:
MAG Silver: Leverage To Silver At A Reasonable Price