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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