First Majestic Silver (NYSE:AG) is a stock that reminds me of the Warren Buffett quote about how it is better to pay a fair price for a great company than to pay a great price for a fair company. First Majestic Silver is not a cheap stock, trading at more than 20 times earnings. However, compared with other silver miners, it is arguably the best managed and the most disciplined in its history of putting forth a clear strategy and executing it.
First Majestic Silver is in the business of buying late-stage mines or the companies that own them. In order to make First Majestic’s buy list, a mine must meet three criteria.
First, the mine must be located in Mexico. This condition is pretty straightforward, and the company has a perfect track record in executing it — the company owns seven properties, and all seven are in Mexico. The reason that the company likes to own mines in Mexico is that it has historically been a mining-friendly jurisdiction. The Mexican government has rarely, if ever, stood in the way of a mining venture. Furthermore, the Mexican people tend to support mining companies, as they infuse capital into the economy and provide workers with relatively high-paying jobs.
I should note that recently, the appeal of mining in Mexico has been dampened somewhat, as the government has levied a 7.5 percent royalty on mining. This has hit the shares of companies that mine in Mexico, and First Majestic is no exception. However, this should be a onetime event and it shouldn’t deter investors from taking positions at this point. Nevertheless investors should watch the Mexican legislature closely, and if there is any further punitive action against mining companies, then they should reevaluate their investment theses.
Second, the mine must generate nearly all of its revenues from silver. This is a far more difficult condition to meet because more often than not, silver is mined as a byproduct of copper, zinc, lead, or gold. Finding a mine that is nearly all silver is pretty rare. In focusing on only these mines, the company hopes to attract investors who are particularly bullish on the price of silver.
As one such investor, I empathize with this strategy and appreciate that the company has generated nearly 90 percent of its revenues from silver over the past few years, while many of its silver mining peers have earned just 60-80 percent of their revenues from silver. Ultimately, going forward, 80-85 percent of the company’s revenues will come from silver, as opposed to the 90 percent it has previously achieved. This is largely the result of a lower silver price for the time being versus much firmer pricing in the lead and zinc markets (these are the company’s two primary byproducts).
Third, the mine must have relatively low production costs. “Low” is a relative term, as it means something different when the price of silver is $50 per ounce as opposed to when it is $20 per ounce. From an investment standpoint I would consider “success” in this endeavor as the ability to remain profitable despite a weak silver market. Given the recent weak silver price environment, First Majestic has done an admirable job in achieving this. Even in the second quarter of 2013, in which the price of silver traded from $18-$20 per ounce, the company was able to turn a slight profit while its peers lost money.
Not only did the company’s peers lose money, but they lost some of their silver reserves, which require a higher silver price, and they consequently took substantial write-downs on their balance sheets. First Majestic Silver took no such write-downs.
Ultimately, First Majestic Silver is a little more expensive than its peers, given the size of its reserve base and given its production figures and its expected earnings. However, given the company’s disciplined strategy along with its strong financial position and history of growing reserves, production, and profits, I think this premium is worth paying.
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