The
silver miners’ stocks have had a roller-coaster ride of a year so
far. They surged, plunged, and then started surging again last week
on a less-hawkish-than-expected Fed. Such big volatility has
spawned similar outsized swings in sentiment, distorting investors’
perceptions of major silver miners. But their recently-reported
fourth-quarter operating and financial results reveal the true
underlying fundamental realities.
Four
times a year publicly-traded companies release treasure troves of
valuable information in the form of quarterly reports. Required by
securities regulators, these quarterly results are exceedingly
important for investors and speculators. They offer a clear
snapshot of what’s really going on fundamentally, in individual
silver miners and this small sector as a whole. There’s no
silver-stock data I look forward to more.
Normally quarterlies are due 45 calendar days after quarter-ends, in
the form of 10-Qs required by the SEC for American companies. But
after the final quarter of fiscal years, which are calendar years
for most silver miners, that deadline extends out up to 90 days
depending on company size. The 10-K annual reports required once a
year are bigger, more complex, and require fully-audited numbers
unlike 10-Qs.
So
it takes companies more time to prepare full-year financials and
then get them audited by CPAs right in the heart of their busy
season. As a silver-stock trader this additional Q4 delay is
irritating, since the data is getting stale by Q1’s end. But as a
CPA and former Big Six auditor of mining companies, I have some
understanding of just how much work goes into an SEC-mandated 10-K
annual report. It’s enormous!
This
extended Q4-reporting window naturally delays the analysis of Q4
results. While I can start digging into the first three quarters’
results 5 or 6 weeks after those interim quarter-ends, I have to
wait longer for the fiscal-year quarter-ends. Thankfully the
majority of silver miners have reported by 9 or 10 weeks, so we
don’t quite have to wait until early Q2 to analyze Q4 results. The
silver miners’ Q4’16 proved fairly strong!
Silver mining is a tough business both geologically and
economically. Primary silver deposits, those with enough silver to
generate over half their revenues when mined, are quite
rare. Most of the world’s silver ore formed alongside base metals
or gold, and their value usually well outweighs silver’s. Thus
around 2/3rds of all the silver mined worldwide is actually a
byproduct of base-metals and gold mining.
As
scarce as silver-heavy deposits supporting primary silver mines are,
primary silver miners are even rarer. Since silver is so
much less valuable than gold, most silver miners need multiple mines
in order to generate sufficient cash flows. These often include
non-primary-silver ones, usually gold. More and more traditional
elite silver miners are aggressively bolstering their gold
production, often at silver’s expense.
So
the universe of major silver miners is pretty small, and
their purity is shrinking. The definitive list of these companies
to analyze comes from the most-popular silver-stock investment
vehicle, the SIL Global X Silver Miners ETF. This week its net
assets are running 5.4x greater than its next-largest competitor’s,
so SIL really dominates this space. With ETF investing now the
norm, SIL is a boon for its component miners.
While there aren’t many silver miners to pick from, major-ETF
inclusion shows silver stocks have been vetted by elite analysts.
Due to fund flows into top sector ETFs, being included in SIL is one
of the important considerations for
picking great
silver stocks. When the vast pools of fund capital seek
silver-stock exposure, their SIL inflows force it to buy shares in
its underlying companies bidding their prices higher.
This
week as the major silver miners finish reporting their Q4’16
results, SIL includes 24 “silver miners”. This term is used rather
loosely, as SIL includes plenty of companies which simply can’t be
described as primary silver miners. Most generate well under
half their revenues from silver, which greatly limits their
stock prices’ leverage to silver rallies. Nevertheless, SIL is the
leading silver-stock ETF and benchmark we have.
The
higher the percentage of sales any miner derives from silver,
naturally the greater its exposure to silver-price moves. If a
company only earns 20%, 30%, or even 40% of its revenues from
silver, it’s not a primary silver miner and its stock price won’t be
very responsive to silver itself. But as silver miners are
increasingly actively diversifying into gold, there aren’t
enough big primary silver miners left to build an ETF alone.
Every quarter I dig into the latest results from the major silver
miners of SIL to get a better understanding of how they and this
industry are faring fundamentally. I feed a bunch of data into a
spreadsheet, some of which made it into the table below. It
includes key data for the top 17 SIL component companies, an
arbitrary number that fits in this table. That is a commanding
sample at 95.6% of SIL’s total weighting.
While most of these top 17 SIL components have reported on Q4’16,
not all have. Some of these major silver miners trade in Mexico and
the UK, and only report half-year results. And plenty of companies
lump their Q4 results into full-year-2016 numbers. If not
explicitly broken out, most of the fourth-quarter results can’t
simply be inferred. So if a field is left blank in this table, that
data wasn’t available this week if ever.
The
first couple columns show each SIL component’s symbol and weighting
as of Wednesday. A bare majority of these silver stocks trade in
the US, with the others in Mexico, the UK, and Canada. So if you
can’t find a symbol here, it’s a listing from a company’s primary
foreign stock exchange. That’s followed by each company’s Q4’16
silver production in ounces, along with its absolute percentage
change from Q3’16.
Quarter-on-quarter changes offer a more-granular read on companies’
ongoing operating and financial performance trends than
year-over-year comparisons. QoQ changes are also included for the
key data in this table’s right half of cash costs per ounce of
silver mined, all-in sustaining costs per ounce, and operating cash
flows generated. Together costs and cash flows reveal the financial
health of silver miners.
The
Q4’16 silver production is followed by that same quarter’s gold
production. Almost every major silver miner in SIL also produces
significant-if-not-large amounts of gold! While gold stabilizes and
augments the silver miners’ cash flows, it also retards their
stocks’ sensitivity to silver itself. Naturally investors and
speculators buy silver stocks and their ETFs because they want
leveraged exposure to silver’s price, not gold’s.
So a
final column reveals how pure the elite SIL silver miners
are. This is mostly calculated by taking a company’s Q4 silver
production, multiplying it by the average silver price in Q4, and
dividing that by the company’s total quarterly sales. If miners
didn’t report Q4 revenues, I approximated them by adding the silver
sales to gold sales based on their quarterly production and the
metals’ average fourth-quarter prices.
This
exercise of examining the quarterly results of the elite silver
miners as represented by SIL’s top 17 holdings is always
illuminating. It offers many important fundamental insights into
the individual stocks and this sector as a whole. These Q4’16
results collectively prove the major silver miners were in no
fundamental peril last quarter, despite silver and SIL plunging
16.9% and 27.8% in that post-election Trumphoria.
While unfortunately the silver miners as a whole are kind of lazy in
breaking out their Q4 results from full-year or half-year ones, they
do report quarterly production. Together these elite miners
produced 76.3m ounces of silver last quarter, almost dead flat from
Q3’16’s 76.2m. But on average most of these top SIL components saw
shrinking silver production, which was collectively offset by
big growth in a handful.
The
reasons for lower silver production vary by company of course,
ranging all the way from temporary lower ore grades to depleting
mines. But this wasn’t a symptom of a slower mining tempo in
general, as these same top silver miners’ Q4 gold production
rocketed 11.4% higher absolutely from Q3’s levels! That bests the
10.9% QoQ production gains in
GDXJ’s elite
junior gold miners, which are in the gold business.
The
silver miners are collectively deciding to diversify into gold due
to its superior economics compared to silver. No silver-stock
investor likes to hear this, but it’s the hard reality today.
Consider hypothetical mid-sized silver and gold miners, which might
produce 10m ounces and 300k ounces annually. What would those cash
flows actually look like at last quarter’s average silver and gold
prices of $17.12 and $1218?
This
silver miner would generate $171m in yearly sales, but the gold
miner’s $365m more than doubles that. Silver mining is often
as capital-intensive as gold mining, requiring similar expenses for
planning, permitting, and building mines and mills to process the
ore. Similar heavy machinery is necessary to dig and haul the ore,
along with similar staffing levels. So silver’s lower cash flows
make silver mining harder.
Silver-mining profits do skyrocket when silver soars occasionally in
one of its massive bull markets. But during silver’s long
intervening drifts at relatively-low price levels, the silver miners
often can’t generate sufficient cash flows to finance expansions.
So the top silver miners are increasingly looking to gold, a trend
that isn’t likely to reverse given the relative economics of silver
and gold. Primary silver miners are getting rarer.
The
silver-streaming giant Silver Wheaton, SIL’s third-largest component
this week, has long been the pure-silver powerhouse of this sector.
A year ago in
Q4’15, it derived 75.9% of its revenues from silver which was
the best by far in SIL. By Q4’16, this had dropped to a mere
50.4%. Mighty SLW is actually on the verge of becoming a
primary-gold play! This is intentional as SLW itself declared
in its Q4 results this week…
“Since 2013, our company has seen a marked increase in gold
production, and in the second half of 2016, revenue was evenly split
between silver and gold. In order to better align our corporate
identity with underlying operations while maintaining a link to our
past and the innovation that the ‘Wheaton’ name has become
synonymous with, we have recommended changing our name to Wheaton
Precious Metals.”
Technically a company isn’t a primary silver miner unless it derives
over half its revenues from silver. In Q4’16, the average sales
percentage from silver of these top SIL components was just 40.6%.
That is right on trend over the past year, with
Q4’15,
Q1’16,
Q2’16, and
Q3’16
weighing in at 47.5%, 44.9%, 45.3%, and 42.8%. At this pace and
40.6% today, the top silver miners are soon heading
well under 40%!
While I understand this, as a long-time silver-stock investor it
saddens me primary silver miners have apparently become a dying
breed. When silver starts powering higher in one of its massive
uplegs and well outperforms gold again, this industry’s silver
percentage will rise. But unless silver not only shoots way ahead
but stays there while gold lags, it’s hard to see
major-silver-mining purity significantly reverse.
In
Q4’16, only 5 of the top 17 SIL components qualified as the primary
silver miners that SIL investors are undoubtedly looking to own when
buying this “Silver Miners ETF”. In today’s current Q1’17 it will
likely slip to 4 as the soon-to-be-renamed SLW slides below 50% of
its sales derived from silver. I’ve been critical of SIL’s managers
in the past on silver-mining purity, but they can’t fight the
rising-gold trend.
Moving on, once again SIL plunged a brutal 27.8% last quarter on
silver’s own sharp 16.9% plunge. This serious silver weakness was
driven by the post-election Trumphoria stock-market rally
slaughtering any interest in prudent portfolio diversification with
gold. That led to a
sharp mass exodus
from gold, and silver
mirrored and
amplified gold’s moves as always. Silver’s average price fell
12.4% QoQ in Q4.
That
scared silver-stock investors, leading to sustained selling fueling
extremely-bearish sentiment by late December. As always during a
major selloff they assumed the silver miners’ plunge was righteous
and fundamentally-justified, instead of purely sentimental and thus
irrational. But it really was the latter as the top 17 SIL silver
miners’ recently-reported Q4 results proved. They were never in
fundamental danger.
There are two major ways to measure silver-mining costs, classic
cash costs per ounce and the superior all-in sustaining costs per
ounce. Both are useful. Cash costs are the acid test of
silver-miner survivability in lower-price environments, showing the
worst-case silver levels necessary to keep the mines running.
All-in sustaining costs reveal where silver needs to trade to
maintain current operations indefinitely.
Cash
costs naturally encompass all cash expenses necessary to
produce each silver ounce, including all direct production costs,
mine-level administration, smelting, refining, transport,
regulatory, royalty, and tax expenses. In Q4’16, these top
SIL-component silver miners that reported cash costs averaged just
$5.28 per ounce. That’s a major 6.2% sequential improvement from
Q3, and less than a third of current silver levels!
But
cash costs are understated due to an outlying anomaly. This week
Silvercorp Metals is the 17th-largest SIL component, making it into
this table. A quarter ago it was 18th, and thus not included. SVM
mines base-metals-heavy silver deposits with huge lead and zinc
byproducts. These are sold and credited to silver-mining costs,
lowering the cash costs to negative $5.48 per ounce! That
really distorts the overall picture.
Ex-SVM,
these silver miners’ cash costs soared 21.1% QoQ from $5.63 in Q3 to
$6.82 in Q4. While that remains far below prevailing silver prices
proving these elite silver miners were in no fundamental peril, it
illustrates the economic challenges of silver mining. With most of
the major silver miners producing less silver in Q4, their high
fixed costs of mining were spread across fewer ounces driving up
per-ounce costs.
Way
more important than cash costs are the far-superior all-in
sustaining costs. They were introduced by the World Gold Council in
June 2013 to give investors a much-better understanding of what it
really costs to maintain a silver mine as an ongoing concern. AISC
include all direct cash costs, but then add on everything else that
is necessary to maintain and replenish operations at current
silver-production levels.
These additional expenses include exploration for new silver to mine
to replace depleting deposits, mine-development and construction
expenses, remediation, and mine reclamation. They also include the
corporate-level administration expenses necessary to oversee silver
mines. All-in sustaining costs are the most-important silver-mining
cost metric by far for investors, revealing miners’ true
operating profitability.
In
Q4’16 the top SIL components reported average AISC of $10.56 per
ounce, up 4.3% QoQ
from Q3’s levels.
But again this is heavily skewed by SVM edging into SIL’s top 17
components. Its anomalous $1.87-per-ounce AISC from its freak
silver deposits really dragged down the average. Ex-SVM again,
these silver miners’ average AISC surged 18.6% QoQ to $12.01. Lower
quarterly production was the key cause.
SIL’s top two components are giant Mexican mining conglomerates that
produce vast amounts of silver but don’t report all-in sustaining
costs quarterly. Together the quarterly silver production of
Industrias Penoles and Fresnillo soared 11.5% or 3.0m ounces QoQ.
Meanwhile the next 15 biggest SIL stocks saw silver production
plunge 5.7% or 2.9m ounces QoQ! That really forced their per-ounce
costs higher.
Nevertheless, silver mining is still quite profitable even at Q4’s
lackluster silver prices averaging $17.12. At that $10.56 average
AISC, that implies hefty profit margins of $6.56 per ounce or 38%!
CEOs in most industries would sell their souls for margins like
that. Even at those adjusted $12.01 AISC, silver-mining profit
margins of $5.11 are still excellent. The sharp silver-stock
selloff in Q4 wasn’t fundamentally justified.
These AISC levels suggest the top silver miners’ profits will remain
rock-solid in the current almost-over Q1’17. Silver has averaged
$17.37 so far this quarter, 1.5% better than Q4. So if AISC remain
stable, Q1’s silver-mining profit margins are likely to be a little
better than Q4’s. The silver miners have forecast stable AISC for
full-year 2017, with 8 of SIL’s top 17 averaging $11.07. Ex-SVM,
that rises to an adjusted $11.87.
The
top silver miners’ operating cash flows fared reasonably well in Q4
considering silver’s sharp drop. They were boosted by gold
performing better relatively. Its average price only fell 8.8% QoQ
compared to silver’s 12.4% drop. This combined with higher gold and
lower silver production led to $537m in OCF generation by the top
SIL miners reporting them for Q4. Compared to Q3’s $1577m, that
seems miserable.
But
it’s misleading due to Q4-reporting limitations. Our sample size in
Q4’16 was 9 of SIL’s top 17 stocks compared to 14 of 17 in Q3. And
SIL’s top component Industrias Penoles reported $899m of operating
cash flows in Q3 but didn’t break out Q4 from full-year results. If
the same other 8 silver miners reporting in Q4 are compared with
their own Q3 operating cash flows, Q4’s $509m was only down 14.3%
from Q3’s $594m!
So
all things considered, the silver miners fared really well
operationally considering silver’s big plunge last quarter. Though
their mining costs jumped due to lower silver production, they
remained relatively low even compared to low prevailing silver
prices. And higher gold production fed stronger operating cash
flows than the sharply-lower silver prices alone implied were
coming. The elite silver miners are doing fine!
But
they remain really undervalued after their extreme Q4
selloff. Silver’s mean reversion higher out of that crazy
post-election Trumphoria anomaly is already well underway. Back in
Q3’16 before that, silver averaged $19.55 which was 14% higher than
Q4’s levels. If silver merely returns to there, silver-mining
profits will surge 37% higher. The battered silver stocks are very
attractive with their big upside leverage to silver.
Once
undervalued
silver starts seriously powering higher with gold again, capital
will flood back into the silver stocks catapulting their prices far
higher. The silver miners’ operating profitability greatly improves
during silver bulls, so their huge silver-stock upside is totally
justified fundamentally. The anomalous post-election
silver-stock plunge and its aftermath is a fantastic buy-low
opportunity on irrational bearish psychology.
While investors
and speculators alike can certainly play the silver miners’ ongoing
mean-reversion bull with this leading SIL ETF, individual silver
stocks with superior fundamentals will enjoy the best gains by far.
Their upside will trounce the ETFs’, which are burdened by companies
that don’t generate much of their sales from silver. A handpicked
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The bottom line is
the major silver miners fared just fine operationally in Q4’16.
Despite all the emotional silver-stock dumping on sharply-lower
silver prices, this industry’s underlying fundamentals stayed quite
strong. Costs remained way under prevailing silver prices even at
lows, feeding big profit margins. And the silver miners growing
their gold production mitigated the hit to operating cash flows from
falling silver.
With silver-stock
sentiment remaining so excessively bearish, this sector is primed to
soar as silver itself continues mean reverting higher out of its
post-election anomaly. The silver miners’ profits leverage to
rising silver prices remains excellent. And after fleeing silver
stocks last quarter, investors and speculators will have to do big
buying to reestablish silver-mining positions. These capital
inflows will fuel big gains. |