We’re more than two-thirds of the way through the Q2 Earnings Season for the Silver Miners Index (SIL), and one of the most recent names to report is First Majestic Silver (AG). The company had a rough Q2 performance with quarterly silver-equivalent ounce (SEO) production down 43% year over year, and revenue down 58% due to a decision to hold back inventory. While the higher silver price is expected to improve the company’s earnings trend considerably, a high amount of insider selling and relative overvaluation make the stock less attractive than its peers. Therefore, while a rising silver (SLV) price should lift all miners, I see better opportunities elsewhere in the sector.
First Majestic Silver released its Q2 results in early August and reported quarterly production of 3.5 million SEOs, down 43% year over year. This shouldn’t have hurt quarterly revenues too much as the silver price increased substantially year over year ($17.33/oz vs. $14.80/oz), but revenue took a massive hit due to the decision to hold back inventory for sale at a later date. While this decision has worked in the company’s favor as the silver price did rise, I’m not too fond of the move. I would prefer a management team that conducted business as usual and didn’t get into the prediction business when trying to time their product sales. It may work early in a cycle, but it could be a disastrous decision late in a cycle. Given the much lower metals sales and one-time costs related to COVID-19, we saw all-in sustaining costs spike to $18.57/oz, with First Majestic reporting a mine operating loss of $7.7 million in the quarter.
As we can see from the table above, it was a disappointing Q2 for First Majestic shareholders, as revenue plunged by nearly 60% due to COVID-19-related mine closures, which affected the company’s operations. Unfortunately, these closures led to one-time standby costs of $9.17 million (including costs from a labor dispute), which weighed on costs and contributed to a mine operating loss in Q2. While the one-time standby costs were the main culprit for the mine operating loss, we haven’t seen a very impressive trend in mine operating earnings anyways, with the company reporting a loss in three of the past eight quarters. Let’s take a closer look at the operating results below:
Beginning with the company’s flagship San Dimas Mine in Mexico, it was an especially challenging quarter, with the mine entangled with a closure related to COVID-19, and a 13-day labor disruption related to annual bonus negotiations. Given the challenging operating environment, the company saw a significant drop in quarterly production to just 2.4 million SEOs. This translated to a more than 30% drop in output year over year and led to a massive spike in costs to $13.04/oz. The softer operating results were due to significantly lower throughput, with 114,000 tonnes milled in Q2 vs. 200,000 tonnes in the year-ago period. While we did see grades improve for both silver and gold, it wasn’t enough to offset the decreased throughput. The one silver lining was that the High-Intensity Grinding mill arrived and remains on track for commissioning in Q3 2021, which should contribute to lower costs starting in H2 2021.
Moving over to the company’s Santa Elena Mine, it was a challenging quarter here too, with the mine similarly affected by the government-mandated shutdowns in Mexico. Santa Elena produced 595,000 SEOs in Q2, down 59% year over year, and all-in sustaining costs more than tripled to $24.71 ($7.73/oz Q2 2019). During the quarter we saw 89,000 tonnes processed at 109 grams per tonne silver and 1.70 grams per tonne gold, representing much lower silver grades and lower throughput sequentially. Fortunately, the mines should return to normal levels during Q3. The much higher costs in the quarter were due to the construction of temporary work comps in an attempt to limit the spread of COVID-19, as well as sanitation efforts, combined with much lower gold sales from the same period last year. Let’s take a look at how these weaker operating results affected the company’s growth metrics:
As we can see from the chart above, First Majestic has had a dismal earnings trend for years now, with net losses per share in FY2015 through FY2018. Fortunately, the company managed to swing to positive annual earnings per share (EPS) in FY2019, and FY2020 annual EPS is expected to improve considerably, with estimates sitting at $0.10 currently. If we look ahead to FY2021, the growth should continue at a rapid pace, with current forecasts of 200% growth ($0.31 vs. $0.10).
While this is a positive sign, it’s worth noting that even after this significant improvement expected in the earnings trend, annual EPS is still well below FY2013 levels ($0.56) when the silver price was at $23.00~/oz. Given that First Majestic is expected to post lower annual EPS despite a higher silver price, I don’t see a ton to like here. Personally, I am most interested in the companies posting record annual EPS despite the same commodity prices. These are the ones that stand out as being leaders fundamentally.
The reason for the significantly weaker annual EPS estimates despite a higher silver price is the massive increase in the share count we’ve seen since the previous bull market. As shown above, since FY2016, First Majestic’s share count has grown by nearly 70% to 210~ million shares, while Pan American Silver (PAAS) has seen only a 34% increase in its share count in the same period. This explains why Pan American Silver has one of the most impressive earnings trends in the sector, while First Majestic has an uninspiring earnings trend that’s made no progress in nearly a decade.
If we take a look at the valuation above, there’s not much to like about First Majestic either, as Pan American is currently trading at 20.4x forward earnings, while First Majestic is trading at 37.5x times. This means that investors can buy an industry leader like Pan American at a more than 40% discount to First Majestic, and they can get a small dividend as well. While this doesn’t mean that First Majestic can’t go higher or that the stock has topped, it does suggest that there is better value out there in the sector. This is especially true when we consider that Pan American has slightly higher gross margins on a trailing-twelve-month basis (39% vs. 38%).
Finally, while the earnings trend and estimates for a multi-year high in quarterly revenue for Q3 is a large step in the right direction, the above insider sales are a bit disconcerting, with over 450,000 shares sold in barely 20 trading days. It’s worth noting that this represents barely 0.25% of the current share float. Still, the one discouraging thing is that many of the insiders selling are significantly winding down their holdings in the company. As the current balance column (far right column) shows, several insiders have reduced their holdings substantially, while three have completed liquidated. I’ve never found insider selling to be an excellent indicator of future returns when in isolation, but when we see blocks of sales like this, it’s undoubtedly a put-off.
First Majestic has had a tough start to FY2020 due to unprecedented headwinds, but, fortunately, margins and earnings should improve substantially in H2 2020. However, while this is good news, the recent insider selling and the withheld inventory in hopes of higher prices (regardless of the outcome) are not ideal for the investment thesis here. As noted earlier, while the delayed sales did pay off this time, I would prefer a company that just sold its inventory, especially if it’s indebted, rather than trying to time the market. While rising metals prices should lift all boats, I believe there are better ways to play the sector, in miners that have been less dilutive to shareholders. Given Pan American’s higher margins, better earnings trend, and more attractive valuation, I see the stock as a better way to play the sector for investors.
Disclosure: I am/we are long PAAS. 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.
Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.