Will MAG Silver Continue to Soar?

Silver, precious metals

So far this year, investors have bid up the price of gold and silver mining shares substantially. Given the horrendous performance of most of these stocks last year, this performance is justified in many circumstances. However, it has also created some selling opportunities. One such opportunity is in MAG Silver (NYSEMKT:MVG).

In 2014, shares of MAG Silver have risen over 60 percent. MAG Silver owns 44 percent of the Juanicipio silver mine in the Fresnillo mining district in Mexico. Fresnillo (OTCMKTS:FNLPF) owns the remaining 56 percent. The Juanicipio silver deposit is one of the largest undeveloped silver deposits in Mexico, containing 200 million ounces (88 million attributable to MAG Silver) of high grade silver.

Furthermore, it is going to be a relatively inexpensive mine to develop and to operate. Initial development costs are expected to be just a hair over $300 million, with MAG Silver’s share at just $132 million. Given the company’s $494 million valuation, it should have no trouble raising this capital, especially since it already has a $28 million cash position.  With gold, lead, and zinc offsets, the mine is expected to have negative cash-costs. This makes the Juanicipio project especially appealing given that many silver projects cannot turn a profit at $21.50/ounce silver. Once production begins in 2017, Juanicipio should produce 10.3 million ounces of silver per year (4.5 million attributable to MAG Silver.) As a result, at the current silver price, the mine should generate about $60 million in post-tax cash flow for 15 years — and potentially longer.

From this, there is a lot to like about MAG Silver. First, it has one of the best partners — Fresnillo — in the silver mining industry. Fresnillo is the largest primary silver producer in the world and its engineers and geologists have a lot of experience in the Fresnillo mining district. Given that MAG Silver has Fresnillo as a partner, there is a heightened probability that the mine is going to be built. Second, the mine will be cash flow positive even in a weak silver market environment, and furthermore, the mine is low risk given that it is located in Mexico, which is typically a mining-friendly country.

Nevertheless, I think a lot of investors see that Juanicipio is a high quality project, and as a result, they have bid the shares up to a point where the risk/reward isn’t especially appealing. Therefore, after the stock has risen 60 percent this year, I think that investors need to consider taking profits. While the stock isn’t extremely overvalued, I think that investors are showing a lot of confidence in MAG Silver and they are consequently ignoring the risks to a large degree.

First, while $60 million in annual cash flow is a lot for a company valued at $494 million, this cash flow is worth less given that investors won’t see it for three years. Furthermore, mines often take a while to reach their target levels of production and efficiency, and so this $60 million in cash flow might be 4 or 5 years away.

Second, while Mexico is generally a low risk place to mine, investors need to keep in mind that the government recently passed a 7.5 percent mining royalty tax that has risen the overall tax liability to roughly 35 percent of profits. While several Mexican mining companies’ share prices have corrected to reflect this, I don’t think that MAG Silver shares have priced this in.

Therefore, while I like MAG Silver as a company, I think the stock should be avoided at the current valuation. Investors who agree that this is a solid company with a relatively high probability of success should wait for a better entry point.

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