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Why Is Pan American Silver Being Cautious With This Expansion?

Silver miners are experiencing difficulty growing their production in the current price environment. Low prices are pressuring cash flows and earnings. Surely, starting a new project in such an environment is a difficult decision for management. However, the market rewards miners that manage to grow despite headwinds. Pan American Silver (NASDAQ: PAAS  ) and Endeavour Silver (NYSE: EXK  ) are vivid examples of this thesis. Both companies expect production growth this year, and their shares are up healthily.

Pan American Silver recently published the preliminary economic assessment of its Mexican Dolores mine expansion. The project is estimated to increase the mine's annual silver production by 1.39 million ounces, while increasing average annual gold production by 37,000 ounces. The company evaluated the results of the study as positive, but decided to defer making a construction decision for the next 9-12 months. Why is Pan American Silver being so cautious?

Silver prices disappoint
Pan American Silver stated that the project is poised to generate excellent returns at prices of $22 per ounce of silver and $1,300 per ounce of gold. The company also believes that the expansion project economics remain robust at $19 per ounce of silver and $1,200 per ounce of gold. Silver prices have recently spent a lot of time under $20, worrying investors and pressuring higher-cost producers like Coeur d'Alene Mines (NYSE: CDE  ) . The recent rally in silver prices was especially beneficial for Coeur d'Alene Mines, as lower prices have caused negative operating cash flow in the first quarter.

The decision to defer investment could mean that Pan American Silver is not that bullish on silver prices and wants to see how the situation develops. Pan American Silver estimated that the project would need $105 million of capital investment. The company finished the first quarter with $394.4 million of cash and short-term investments, so it has the necessary liquidity to fund the expansion. Thus, liquidity constraints don't seem to be the reason for waiting.

Is Pan American Silver saving for other projects?
This year, the Mexican mining industry was hit with a new tax, which reduced the attractiveness of mining investment in the country. However, this hasn't prevented Endeavour Silver shares from rising despite the fact that all of the company's producing mines and most development projects are situated in Mexico. In turn, Pan American Silver is present in Argentina, where it could develop several growth projects if the government lifts the open pit mining ban.

The company expressed optimism regarding this possibility. Argentina, which could be in a pre-default situation according to Standard & Poor's, desperately needs foreign investment. Thus, it looks rational for the Argentinian government to lift the open pit mining ban. Also, the country has suffered serious inflation, which is positive for the project's costs.

It looks plausible that Pan American Silver wants not only to monitor silver prices, but to watch developments in Argentina as well. If the country lifts the open pit mining ban, the company could restart its Navidad project. In this case, Navidad will compete for the company's money with the Dolores mine expansion. Given the fact that Pan American Silver has to ensure its attractive dividend, it is not likely to proceed with both projects simultaneously in the current price environment.

Bottom line
Pan American Silver's management is taking a cautious approach in allocating the company's dollars, and that's good for shareholders. Solid production, good liquidity, and an attractive dividend yield make it a safe bet on a silver rebound. 

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  • Report this Comment On July 01, 2015, at 5:55 AM, drift123 wrote:

    I always wondered why PAAS put all that money

    into Argentina. PAAS had to know that after

    getting circumventing (legally) the open pit rule and the mine is in production that Argentina would come up with some phony violation to Nationalize the mine.

    Except for French Guiana I can't think of a

    country in South America that I would trust

    to keep their word.

    What many people don't know is that in the mid to late 1800's many Billions of dollars (in todays value) was invested in South America mostly by wealthy Europeans. They had their chance to be a profitable continent.

    It is not a racial thing but a concept of trade/business and making the most of what your country has.

    Hong Kong, and Singapore (both British Colonies had/have little natural resources but they had some leaders that adopted the European way of doing business while maintain local customs

    Just like Democracy is not for all countries, the European/American way of business is not for all countries either.

    Anyway, South America had a chance to have its place in the Sun but the stars aligned in the wrong way and the money was squandered, stolen or misspent.

    I do know that Argentina is in a much better place financially than it was even 5 years ago. They might of finally realized that Nationalizing everything has short term benefits but long term consequences since no country wants to invest money in projects just to have it stolen.

    Maybe all those German Genes from World War Two War Criminals are finally taking hold in Argentina. (and yes I was joking)

    It's really the genes of Belgium, Netherlands, Denmark, Poland, , Luxemburg, Norway, Czechoslovakia, Lithuania, Latvia, Estonia Austria and (Liechtenstein?) Nazi Collaborators that had no choice but to make their way to South America or face the hangman.

    If some war criminal could make their way from Estonia to South America I would be mightily impressed but they would still have be held accountable.

    Oh, yea. About PAAS, I have some shares that I will hold on even if silver goes down to $5.00. If the mines that count on silver (or silver as a by product) quit mining it is not such an easy thing to get a mine up and going.

    What is the expression, "Nothing takes care of low prices like low prices." If numerous silver mines stop producing the ones that can weather the storm should be in a nice position to capitalize on the significant reduction in silver coming to market.

    They should be able to benefit from low production rates for least for 8 months to two years. (I made up those numbers) but they are probably? close.

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Vladimir Zernov
Zernov

Vladimir Zernov believes that fundamental analysis works best with energy and materials stocks and covers them on Motley Fool.

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7/1/2015 4:03 PM
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