Is There a Silver Lining for This Mining Company?

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Pan American Silver (NASDAQ: PAAS) began its operations in 1994. During the last nearly-20 years, it has gained in reputation and currently stands as the second- largest silver mining company in the world.

It is noteworthy that silver is regarded as more useful than gold for industrial purposes, as it has a 60% annual off-take relative to less than 15% for gold.  Silver is a key component to many new technologies, such as RFID tags, biocides in hospital linen, and preservative treatments for timber. Furthermore, it is a crucial component of photo-voltaic cells, which are primarily used for converting solar energy into electricity.

In spite of continuous volatility in the prices of precious metals, 2012 was an extremely successful year for the company. It reported revenue of $930 million underpinned by record production of gold and silver. It is rather ironic to see that in spite of posting robust revenue and earnings, the company’s share price dropped more than 20% during its fiscal year 2012. I believe this was primarily due to the fact that investors, owing to a global economic crisis, avoided the precious-metals market.

The first quarter of 2013 witnessed a 60% fall in the company’s earnings due to general economic weakness in North America and Europe, which consequently led to low average prices for all metals. A recently published report by Thomson Reuters projects a bright picture for the industry, as demand for silver is estimated to escalate sharply and reach a record 500 million ounces during 2014.The growing demand is mainly underpinned by an expected rebound in the construction, housing and auto industries.

Pan American has been making all the right moves to secure robust growth in its top-line and a consistent increase in earnings. This is further validated through the strategic acquisition of Minefinders for $1.5 billion, which enables Pan American direct access to its mining reserves in Mexico. This will facilitate the company in achieving its goal of becoming the largest and lowest-cost primary producer of silver in the world.

As Latin American countries of Peru, Bolivia and Mexico are the largest reservoirs of silver, Pan American has succeeded in establishing itself as one of the largest miners in the region.

The mining industry has been lately affected by protests with concerns related to environmental degradation and the impact on the general health of the public in nearby areas. Moreover, political risks threaten the future of such high-value investments.

Industry scenario 

A comprehensive analysis of the metals and mining industry by global advisory firm Ernst and Young, identified several crucial challenges, which could impact the industry in the long term.

At present, the primary risk faced by the industry is resource nationalism, as most countries are seeking to retain ownership of their natural assets. Such changes in ownership laws have a significant impact on the potential reward miners expect from the risk taken for paying 100% for their investments and receiving only a small percentage of future investment return.

A decline in demand of solar panels has led to a noticeable drop in demand for silver, making the near-term outlook for the industry relatively weak. However, as growth picks up on the back of robust demand through the APAC region, particularly China, resurgence in the demand for silver is in the cards.

Competitive landscape

Pan American faces intense competition from some of the largest mining companies in the world. Its primary competitor and the largest company in the mining sector is BHP Billiton (ADR) (NYSE: BHP). The company is headquartered in Melbourne. It is one of the biggest names in the mining industry with a diverse range of revenue streams such as silver and gold mining, petroleum, diamond and iron ore.

The company experienced a 35% decline in its earnings during fiscal year 2012, predominantly due to forced write-downs on account of falling prices of shale-gas and nickel assets.  A highly challenging global economic outlook and weaker growth in key emerging markets made matters worse.

However, once the macroeconomic environment improves and growth picks up, BHP has placed itself in an ideal position to reap benefits. The company made several strategic acquisitions in U.S. to extract shale gas and oil from the Texas region. This is  potentially  a game changer not just for BHP but for the entire U.S. industry. At present, the U.S. is making considerable efforts to bolster its production levels in order to meet the domestic demand and turn its status to the global net exporter of crude oil.

While Pan American is only  interested in gold, silver and copper production, BHP, with its diversified portfolio, large resource pool and global presence, is a far more complete company. As global growth picks up, this is one stock that is certain to outperform its peers.

Companhia de Minas Buenaventura (ADR) (NYSE: BVN) is another competitor to Pan American, and the largest mining company in Peru. The first quarter of 2013 was extremely disappointing for the company with 51% year-over-year fall in earnings. The slump was primarily due to a decline in global demand coupled with lower contributions from its equity stakes in Newmont Mining and Freeport Mc-MoRan. The lower contribution from its equity stakes is attributed to low prices of gold and silver.

Additionally, considering the constantly rising demand for special economic benefits for workers in its Uchucchacua mine, the company is facing increasing trouble with labor strikes.

Foolish assessment

With a global economic recovery in sight and demand from China and other emerging economies set to rise, I believe the industry will fare well in the long run.

However, factors such as constantly rising protests on the account of environmental degradation and countries preferring to keep ownership of their natural assets could marginally hinder expected growth. I believe Pan American will  report even better numbers post 2014, therefore, I suggest investors hold onto its stock and have a long-term horizon.

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Kiran Gulati has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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