First Majestic Silver Is Hedging Lead Production
While they were strong in that the company increased first-quarter silver production year over year, the company lost one of its advantages over its silver mining peers: Namely, its increased silver production came with an even greater increase in lead and zinc production. Silver production rose about 15 percent, but silver-equivalent production (i.e., silver plus lead and zinc converted into silver) rose 33 percent.
Now, rising production isn’t a bad thing. The problem is that First Majestic had been priding itself on the fact that it got the vast majority of its revenue from silver. Those who are familiar with the silver mining industry know that this is very difficult. So-called “silver miners” often get a lot of their sales from secondary metals such as copper, lead, zinc, and gold.
For instance, Pan American Silver (NASDAQ:PAAS) — one of the industry’s largest silver miners — gets just 70 percent of its revenues from silver. SilverCrest Mines (NYSEMKT:SVLC), a small company that looks like a silver miner given its name, actually gets most of its revenues from gold, and its large undeveloped silver project in reality will get just half of its revenues from silver. By comparison, First Majestic had been getting over 90 percent of its revenues from silver, and for silver investors, this made the stock extremely appealing.
However, when production commenced at the company’s Del Toro mine, First Majestic lost some of this advantage. Silver revenues dropped to 83 percent of total revenues. That’s still a great ratio for the industry, but it meant that the company was more exposed to base metals such as lead and zinc. Furthermore, it meant that investors looking for “pure” silver plays had another option in Tahoe Resources (NYSE:TAHO), which gets about 85 percent of its revenue from silver.
First Majestic addressed my concern directly with a press release that came out Tuesday. The company agreed to sell forward about $30 million worth of lead at 94.5 cents per pound over the next four years. In the press release, management claims that it did this in order to raise capital so it could fund its other development projects. But I think another reason is that management wanted to increase its leverage to silver by hedging its base metal exposure.
Not only did the company reestablish — to some extent — its silver purity, but I think it did so the right way, by hedging lead production and not zinc production. There are two reasons for this. The first is that First Majestic is more exposed to lead than zinc. The second is that zinc has stronger long-term supply-demand fundamentals than lead. Zinc production is going to be exceeded by demand starting next year, and there are very few zinc deposits that are nearing production. This is going to create an extremely bullish scenario for one of the world’s most commonly used metals.
Going forward, First Majestic still has a fair amount of exposure to base metals — more than it did a couple of years ago, before production at Del Toro began. The forward sales that were announced only hedges about 35 percent of the company’s total lead production. Nevertheless, the forward sales do hedge some of the company’s base metal exposure. Furthermore, they exemplify management’s commitment to creating a pure silver miner.
Going forward, the company’s development projects are going to increase the company’s exposure to silver with respect to lead and zinc, and investors can be confident that maximizing relative silver production remains one of First Majestic’s management’s primary goals. Therefore, investors who are bullish on the silver price should consider taking a position while the stock price is depressed, at just $9.50 per share.
Disclosure: Ben Kramer-Miller is long shares of First Majestic Silver.