Though gold prices are currently sitting near a five-month low, they've had an interesting year. Despite being down modestly on a year-to-date basis, spot gold recently had its longest stretch above $1,300 an ounce on an intraday and closing basis (between Dec. 29, 2017 and May 14, 20187) in five years. That's generally a recipe for better-than-expected profits for gold-mining stocks in the short term.
However, all precious-metal miners -- gold and silver stocks -- have done a generally good job of improving their big-picture financial situation since the beginning of the decade. Most mining companies were spoiled by the rapid rise of spot gold and silver in 2010 and 2011, and they frankly overspent on expansion. Over the last seven years, many of these gold and silver mining companies have worked diligently to lower their outstanding debt and focus on only the most promising projects. In many ways, they're better set up to handle a decline in precious-metal prices (should one come to head) than they've been in a long time.
My favorite metric for gold and silver stocks
At this very moment, the two largest holdings in my portfolio are gold and silver stocks. Though this isn't traditionally a value industry, or even one that Wall Street tends to gravitate toward, I see plenty of value. How so, you ask? Look no further than my favorite metric when analyzing gold and silver stocks: cash flow per share (CFPS).
As with any other metric, cash flow presents just one piece of the puzzle when analyzing a publicly traded company. It alone isn't enough to determine whether a stock is worth buying or selling. But when it comes to mining stocks, it's arguably the most important number to investors. The reason being that cash flow from a company's operations determines whether interest payments can be made, if workers can be paid (and thus labor issues avoided), if new exploration can be undertaken, and if the maintenance and expansion of existing mines is possible.
Is cash flow a perfect measurement? Well, no. It doesn't tell me anything about whether or not a company is profitable, it doesn't give me any idea of what sort of debt or solvency issues a company might be facing, and it certainly doesn't tell me anything about future cash flow expectations. These are metrics and findings that I would get by analyzing a full income statement and balance sheet, as well as by listening to commentary from management at least once each quarter. And make no mistake about it, I wouldn't suggest investors overlook or ignore other important metrics when analyzing gold and silver stocks. But when it comes to the most important metric to me with mining stocks, it's cash flow per share.
These gold and silver stocks are cheap, based on cash flow per share
Next, you might be wondering what exactly would be considered "cheap" if analyzing cash flow per share. Though it's going to be up to interpretation, after many years of tracking precious-metal stocks, I'm of the belief that a mining stock valued at 10 times its annual CFPS is considered fairly valued, with a slightly higher multiple for precious-metal royalty and streaming companies. With this in mind, here's why SSR Mining (TSX:SSRM) and First Majestic Silver (NYSE:AG) are currently the top two holdings in my portfolio.
SSR Mining has traditionally been lumped in with silver stocks but now generates around 80% of its total revenue from gold. In 2016, it acquired Canadian-based Claude Resources, adding the lucrative and low-cost Seabee Mine in the process. Within Seabee is the Santoy Gap, a high-grade recovery region of the mine that's been responsible for pushing annual production at Seabee to new heights. Meanwhile, its flagship Marigold mine in Nevada is expected to push to 250,000 ounces of annual gold production by 2022, up from a midpoint estimate of 200,000 ounces of gold in 2018.
In terms of silver production, SSR Mining formed a 75%-25% joint venture with Golden Arrow Resources last year that's seeing the duo develop the Chinchillas Project in Argentina. Commercial production is expected to begin in the second half of 2018, helping to restore silver production for roughly the next decade. The company's previous silver mine, which ceased operations early in 2017, has merely been processing stockpiled material for more than a year.
As hauling capacity is added to Marigold over time, and the Chinchillas Project comes on line later this year, SSR Mining's annual cash flow per share is expected to grow from $1.21 in 2018 to $1.60 in 2020, according to Wall Street estimates. Using my fair value estimate on mining stocks, this implies a $16 share price on SSR Mining, or a 57% increase from its current level. With the company healthfully profitable on an annual basis, and also sitting on $280 million in net cash and marketable securities (roughly 23% of its market cap), it checks off all the boxes I look for in a cheap precious-metal stock.
First Majestic Silver
My second-largest holding is First Majestic Silver, which is expected to generate more of its sales from silver than any other producer. Prior to the recently closed acquisition of Primero Mining and its San Dimas mine in Mexico, First Majestic was expected to generate about 70% of its total sales from silver, with the remainder coming from gold and other byproducts.
The recently acquired San Dimas mine is expected to be quite the game-changer for First Majestic. Primero Mining didn't have the financial capacity to expand its flagship mine, setting up First Majestic for an inexpensive acquisition.
To boot, First Majestic was able to rework the streaming deal Wheaton Precious Metals had in place with Primero Mining at San Dimas. The new streaming deal allows Wheaton Precious Metals to receive "25% of the gold production and 25% of the silver production converted to gold equivalent at a fixed exchange ratio of 70:1 at San Dimas in exchange for ongoing payments equal to the lesser of US$600 (subject to a 1% annual inflation adjustment) and the prevailing market price, for each gold ounce delivered to an off-taker under the agreement." In other words, it'll improve cash flow from the San Dimas mine.
Meanwhile, First Majestic Silver continues to benefit from expansion and production ramp-up at Santa Elena, La Guitarra, and La Encantada. Bringing two additional properties on line in the years to come (Plomosas and La Luz) is expected to push the company's silver production north of 25 million annual ounces and silver equivalent ounces (SEO), which includes gold production, to as high as 30 million SEO by 2022. By comparison, it produced fewer than 11 million silver ounces in 2016.
Though Wall Street is only factoring in $0.89 in CFPS by 2019, this estimate likely doesn't include the recently completed Primero acquisition. In my best estimate, the company will be capable of $1.15-$1.20 in annual CFPS by 2020, implying 65% upside at the midpoint of my estimate.
Long story short, if you have precious-metal stocks on your radar, pay very close attention to cash flow per share as it tends to be a relatively reliable indicator of value when taken into context with other traditional metrics.