3 Reasons to Buy Pan American Silver

Shares of Pan American Silver have outperformed the price of silver. Here are three reasons to consider buying the company.

Jul 12, 2014 at 9:39AM

The silver market is heating up again as the price of silver added 8.5% to its value during the year (up to date). Because of this recovery, Pan American Silver (NASDAQ:PAAS), a silver producer, has benefited from this rally, and the company's stock jumped by more than 32%, year to date. As a result, many analysts covering this stock have given it a hold rating. Why is this company an interesting investment for investors seeking to increase their exposure to precious metals?

1. Silver's recovery
The rally of gold and silver prices kept silver undervalued compared to gold. The chart below shows the ratio of gold to silver prices during 2013-2014. 

Gold To Silver Ratio

Source of Data: CME.

This ratio shows that gold has outperformed silver during the past year and a half as the ratio grew from the low 50s to the mid-60s. This ratio may suggest silver has more room to grow than gold has. In times when precious metals thrive, silver tends to pick up the pace and outperform gold (as was the case during 2009-2011). But in times when precious metals fall (as in the past few years), silver tends to underperform gold. Thus, if precious metals keep recovering, this could bring down the ratio of gold to silver, which means silver may outperform gold in the near term. In such a case, silver companies such as Pan American Silver would perform better in the stock market than gold producers. 

Most of the growth in the company's revenue is likely to come from the potential recovery in the price of silver since the company doesn't plan to increase its silver production this year: Its full-year forecast ranges between 25.75 million silver ounces and 26.75 million silver ounces, or an average of 26.25 million silver ounces. In comparison, back in 2013, total silver production was 26 million ounces -- a 1% gain, year over year.

Silver Wheaton (NYSE:SLW), a silver and gold streaming company, also estimates its 2014 silver sales to remain close to its silver equivalent sales in 2013. 

2. Debt
One of the main advantages Pan American Silver has over its peers is the low level of debt it holds. As of the last day of March 2014, the company's debt-to-equity ratio was only 0.275. Other gold and silver producers such as Hecla Mining (NYSE:HL) hold higher debt on their balance sheets -- Hecla's debt-to-equity ratio is 0.38. This low level of debt allows Pan American Silver to take on more debt to expand its operations if needed and maintain low financial risk. 

3. Valuation
Despite the importance of the factors listed above, it all boils down to the company's valuation. Is Pan American Silver's stock overvalued? 

Comparing the company to other gold producers won't account for the difference in metals; comparing it to Silver Wheaton is also misleading because Pan American Silver produces silver, and Silver Wheaton is a steaming company with a much higher market cap. Therefore, we will need to consider other small market cap precious metals producers such as Hecla Mining and First Majestic Silver (NYSE:AG). Looking at these companies' enterprise value to EBITDA ratios, Hecla Mining has a ratio of 14.5. The enterprise value to EBITDA ratio of First Majestic Silver is 13.72. On the other hand, Pan American Silver's ratio is only 9.68. This means the current valuation of Pan American Silver is low and the company has more room to grow, especially if the silver market continues to recover. 

Pan American Silver is a silver producer with low debt that isn't valued highly compared to its peers. This makes Pan American Silver an asset worth considering for investors who want precious metals exposure in their portfolio. 

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Lior Cohen has no position in any stocks mentioned. The Motley Fool owns shares of Silver Wheaton. (USA). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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