Gold and Silver miners (Jr and Exploration)

[Edge83]

First Majestic Silver: Heading To 30 Million Oz Of Silver EQ Production

'Jan. 17, 2018 2:47 PM ET| About: First Majestic Silver Corp. (AG)
Don Durrett

Summary
Moderate to high risk because of high all-in costs.

$2 billion in potential free cash flow at $100 silver.

Highly leveraged to higher silver prices. Significant upside potential.

Excellent management team. Growth oriented. Shareholder focused.

One of the few pure silver players left.

If you are looking for undervalued silver producers, then First Majestic Silver (NYSE:AG) is worth a look. They meet most of the criteria (discussed below) that I look for when analyzing a silver mining stock for large returns. There are several key criteria that I look at, although it usually comes down to risk/reward and upside potential. I especially focus on future cash flow potential versus their current market cap.

First Majestic (FM) has been somewhat out of favor with investors, with its share price trending down from $18 in 2016 to $6.79 today. However, if you look at the chart below, you will notice that it is trading significantly higher than its 2016 low, when silver prices were much lower. This tells me that it will likely trend higher with higher silver prices. In fact, the First Majestic share price could jump back to $18 quickly if silver makes a move to $20, like it did in 2016 (see chart below).

First Majestic Silver

I normally focus on silver mining stocks with much lower market caps than First Majestic's $1.3 billion. I prefer to buy them with FD market caps somewhere between $50 million and $150 million. I will sometimes go up to $300 million, but not much higher. The reason I like to buy at lower valuations is upside potential. I am always looking for long-term 5+ baggers. Buying large caps stocks makes it more difficult to find the alpha I'm after.

First Majestic made a smart acquisition last week of Primero Mining for $320 million. Their production target is now 30 million oz of silver equivalent and they should reach 25 million oz of silver equivalent in the near term. The deal got my attention because it will increase their potential free cash flow to $2 billion at $100 silver. I chase cash flow, and when I did the math, their potential valuation hit my magic number of 500%. In fact, if they get valued at a free cash flow multiplier of 10x, they have 5+ bagger potential.

Investors are focusing on the near-term and can't see the forest for the trees. They think that because FM lost money last quarter and has high all-in costs (free cash flow) around $16, it is a high-risk stock. And because they damaged their balance sheet by assuming $100 million in debt in the Primero deal, investors think this stock now has no value.

Sure, FM has risk because of their cost structure. However, if you are a silver bull who expects $50, $75, or $100 silver, then this is exactly the type of stock you want to hold because of its leverage to the silver price. How many silver producers have potential free cash flow of $2 billion? Very few.

Now is a good time to look for undervalued silver producers with growth potential. If we are at the beginning of another gold bull run that will see new highs above the 2011 level of $1,935 (see historical prices), then it would be wise to buy the potential winners now.

My investing style is to focus on potential future cash flow in conjunction with higher silver prices. For instance, what is the future value of XYZ silver stock if it develops a 50 million oz project and produces 2 million oz annually at $100 silver? If you do a quick and dirty analysis using potential future cash flow, you get the following:

2 million oz x $75 (estimated free cash flow per oz using all-in costs of $25 per oz) = $150 million in annual free cash flow.

If you multiply that by 10, you get a $1.5 billion estimated valuation.

Note that some companies were valued at 30x cash flow during the last mania in stocks in 1980 and a 10x cash flow valuation is quite common today for strong mining companies. A conservative method is to use 5x free cash flow to value a company. However, my expectation is that we should see 10x cash flow valuations as silver prices rise and companies obtain much healthier balance sheets.

It's amazing how valuable a silver mining company could become at higher silver prices when it owns and produces large profitable projects. There are many development stocks today with solid projects that are valued unbelievably cheap. Not all of them will be successful in building their mines, so it is a crapshoot picking the winners early. The smart play is to watch these stocks and see which ones are going to get financing. Of course, the longer you wait, the higher your entry price will be, and many will no longer be available at low valuations.

The most ideal risk/reward stock is an undervalued producer, or near-term producer that is both permitted and financed to build its first project. First Majestic is one of those ideal undervalued producers because it has a very good risk/reward profile. Yes, it has risk if silver prices drop, but it also has a high reward if silver prices rise.

The only way you can understand the risk of a stock is to do your own due diligence. Below, I will go step by step and show you what to look for when analyzing a mining stock. However, even with this data in hand, you should do your own due diligence to confirm what I have written.

Even if you think you know a stock intimately, the data will change. If there is one constant in the story of a stock, it is change. And stocks with high risk, it seems like the data changes more frequently. Whereas a major or a strong mid-tier producer can survive a data change without much impact, a junior can drop in value a significant percentage on small changes. The volatility can be stunning, and sometimes juniors do not survive these changes.

Here are my two most important rules to limit your risk exposure:

1) Only invest in a company that has the goods. Make sure that your company has at least one very good project. In other words, do not chase drill results (and if you do, then do it rarely). Exploration should be the icing on the cake, and not the cake.

2) Do not invest more than 1% of your portfolio's cost-basis into a single high-risk stock. Thus, if your total invested dollars is $100,000, then your max is $1,000 for a high-risk stock. You can break this 1% rule, but do it rarely.

This 1% rule may seem too low, but you have to stay humble and acknowledge the high risk with mining stocks. If you think the stock has moderate risk, such as First Majestic, then you could do 2%. And for low-risk stocks, you could triple this total to a maximum of 3%.

For any single stock, except ETFs, I would not exceed 3%. Remember, this rule only applies to your costs basis. If a stock that you own increases in value, that does not apply to this rule.

You may be thinking that you could end up with 50 or more stocks. Perhaps, but this won't happen if you buy bullion and/or ETFs as a foundation. With bullion, mutual funds, and ETFs, you can go significantly over the 3% limit.

The following analysis is based on data from my website (www.goldstockdata.com).

First Majestic Silver. (Analysis on 1/14/2018).

First Majestic Silver is a large silver producer in Mexico. They recently acquired Primero Mining for $320 million. I am assuming this deal will close. Their resources, production, shares, and debt reflect this deal closing. Their production will increase from around 17 million silver eq oz in 2018 to around 25 million silver eq oz (their share). They have to give Wheaton Precious Metals 25% of the gold equivalent production at San Dimas at $600 per oz. Hopefully, their cash costs will be near the $600 number.

Investors didn't like the deal because First Majestic lost money last quarter with all-in costs (free cash flow) around $16 per oz. Without positive free cash flow, investors didn't like FM using up their cash to make this deal. They had to assume around $100 million in debt. Thus, FM no longer has a pristine balance sheet with no debt. However, for those who are forward-thinking, the cash flow potential of FM just jumped significantly. They now have the potential to create over $2 billion in free cash flow at $100 silver prices. At a 5x free cash flow valuation, FM should be worth at least $10 billion at $100 silver. My expectation is $12 billion as long as Mexico doesn't increase taxes and royalties, and FM hits their production and cost targets.

They will now have 7 producing mines in Mexico with 168 million oz of silver eq reserves and about 400 million oz of resources. There is some risk with this stock because of their high all-in costs, but they have one of the best management teams in the business. Once silver reaches $18, they are going to be producing a lot of cash flow and investors will run to this stock. It has huge leverage to silver prices. They are one the few pure silver miners, with about 75% of revenue from silver.

The 3 Ps

Properties

Do they have a flagship project? Several.

Do they have a pipeline of projects for growth? Yes, growth oriented.

Do they have the exploration potential to expand resources? Yes.

Is the grade and recovery rate satisfactory? Yes, grade is around 150 gpt.

Is the location satisfactory? All mines are in Mexico, which has risk of increased taxation and royalties.

Do they own it? Yes, 100%.

People

Do you consider it a strong management team? Yes. The CEO is one of the best in the business.

Is it an exploration or production team? Both.

Do they have experience? Yes. Substantial.

Do they have a track record for building mines? Yes. Excellent executors.

Are they investor friendly and not always diluting? Yes, they have done a good job containing share dilution.

Is the team large enough to build a mine? Yes.

Have you listened to a CEO interview? Yes, many times.

Are they cash-focused? Historically, yes. They recently assumed some debt, which I expect them to pay back quickly.

How much stock does management own? The CEO owns 3.3%.

Do the website and company presentation provide adequate guidance and details? Yes.

Projects

What are the resources? About 400 million oz of silver equivalent at 150 gpt.

Long life mine? Yes.

What are the current/estimated cash costs and all-in costs per oz? Cash costs are moderate at around $7.50 per oz for silver equivalent. All-in costs (free cash flow) is high at around $16 per oz.

What documentation has been released for first mine (Preliminary Economic Assessment, Pre-feasibility Study, Feasibility Study)? N/A.

What is the capex for its first mine? N/A.

What is the after-tax IRR for first mine? N/A.

Can its first mine be financed? N/A.

How will its first mine be financed (debt, equity, streaming)?

N/A.

Risk Issues

They have two significant risk issues:

The first is their cost structure. If silver prices crash to $15 or lower, they will be bleeding through cash and potentially could sell or close down a mine.

The second is their focus in Mexico, which could raise taxes and royalties to offset their decline in oil production.

I have the stock rated as moderate risk, but you could make an argument that it has high risk.

Share Structure

Is it highly diluted? No, it has 202 million fully-diluted shares.

Timeline Risk (time frame until production)

N/A.

Market Cap Size

$1.3 billion. Normally this is too high for large returns.

Stock Chart

Is this a good entry point? Yes, likely 5+ bagger.

Balance Sheet

What is its cash/debt situation? $120 million in cash and $100 million in debt. (Assumes the Primero deal will close).

Valuation (Assumes the Primero deal will close).

What is its potential future market cap growth rate at $100 silver? 550% at 25 million oz silver equivalent (see below). I could have used 30 million oz based on their future production target, but decided to be conservative.

What is its potential future free cash flow at $100 silver? $1.8 billion annually at 25 million oz (25 x $75). (This assumes all-in costs are $25 per oz).

What are its future reserves valued at today? $3.42 per oz at 400 million oz ($1370 million/400 million oz).

Future market cap growth calculation

Current Market Cap: $1.3 Billion.

Potential Future Market Cap: 25 million oz x $75 = $1.8 billion annual cash flow x 5 = $9 billion

Compare the two values and you get a 550% increase. Note that I usually use a 10x multiplier, but decided to be conservative.

Is First Majestic highly undervalued? Yes, with a potential increase of 550% and future reserves valued at $3.42, it is highly undervalued.

This valuation assumes they will reach 25 million oz of annual production, all-in costs will be $25, and future silver prices will reach $100. Plus, it assumes Mexico will not raise their mining tax or royalty rates.

Note: You can check the data included in this analysis at First Majestic Silver's website and www.firstmajestic.com.

Disclosure: I am/we are long AG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

https://seekingalpha.com/article/4138142-first-majestic-silver-heading-30-million-oz-silver-eq-production