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Fresnillo: Why This Silver Stock Could Reward Investors

Fresnillo: Why This Silver Stock Could Reward Investors
(Piotr Trojanowski/Dreamstime)

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Wednesday, 11 September 2019 03:16 PM Current | Bio | Archive

After several years of dormancy, precious metals are showing signs of life. Gold and silver prices have seen recent gains, fueled in part by the Federal Reserve’s decision to lower interest rates for the first time since 2008.

For investors, there are many silver stocks that could be highly rewarding if the recent rally in precious metals prices turns into a long-term trend. We believe Fresnillo plc (FNLPF) is one of the most attractive silver stocks today, due to a combination of strong assets, disciplined capital allocation, and a healthy balance sheet.

Business Overview

As the world’s largest silver miner, Fresnillo deserves a look from any bullish silver investor. The company also owns the distinction of being Mexico’s largest gold producer. It operates seven mines, two development projects, and three exploration projects. It derives 52% of its revenue from gold, 34% from silver, 9% from zinc, and 4% from lead. The company’s primary strengths are that it owns high quality assets, exercises strict discipline in allocating capital, has low cost operations, and has a sound balance sheet. These make it a solid choice for long term exposure to the silver and gold mining sector.

The company’s assets include 2.2 billion ounces of silver and 39.1 million ounces of gold. In addition to this vast store of wealth in reserve, the company also owns high grade ore at 200-300 grams per ton of silver and 0.5-0.8 grams per ton of gold.

Disciplined Capital Allocation

The company has a history of prudently allocating capital with a long-term perspective as evidenced by the fact it has recorded no impairment charges since 2008. Its peers, in stark contrast, had enormous problems during that time period as the precious metals bear market forced them to make enormous impairments on their heavy investments in new mines during the precious metals bull market. Barrick Gold experienced enormous losses, investing $32.7 billion over the past decade of which $21.1 billion was impaired. Fresnillo, meanwhile, invested $4.3 billion and only impaired $20 million.

Its high-grade ore and disciplined capital allocation result in efficient operations and high profitability. They are able to produce an ounce of silver at a cash cost of $7.88 (well below global industry averages), while also generating EBITDA margins and returns on equity that vastly outpace industry averages. This has enabled the company to mine at a lower direct cost of production over the past decade than large cap competitors Goldcorp, Newmont, and Barrick. Fresnillo also leads these large miners in operating costs. As a result, they have also generated the highest return on invest capital during that time span.

Finally, the company’s strong balance sheet enables them to deploy capital when needed to maximize returns without putting the business as a whole at risk. The company has a net debt to equity ratio of just 0.15 and a net debt to EBITDA ratio of just 0.6x.

Potential Risk Factors

Despite these strengths, the stock has greatly underperformed the broader mining sector in recent months due to cutting production guidance. This stemmed from lower than expected ore grades and throughput at Fresnillo and construction delays at Herradura. This led the company to cut its dividend by 76%, signaling pessimism to investors.

Furthermore, the company has several other drawbacks, including high tax rates in Mexico (average effective tax rate over the past seven years is 40%) and its significant geopolitical and currency related risks due to its international focus.

Still, the stock appears to provide a compelling value to investors with higher risk tolerance looking to enter the mining space. This is because the stock has declined in recent months, even as the broader mining sector has surged.

Shares of the company trade for a 2019 P/E ratio of 17. We believe a 2024 target P/E ratio of 25 is reasonable given the target valuations of other companies in this sector. If Fresnillo’s stock were to reach this target, valuation would add approximately 7.5% to annual returns through 2024.

We believe that Fresnillo will return 13% per year through 2024, consisting of 3% annual EPS growth, the 2.5% dividend yield and the 7.5% annual gain from multiple expansion.

Final Thoughts

Fresnillo management has one of the strongest track records in the industry for delivering shareholder value over the long term. Furthermore, the balance sheet is strong and the assets remain attractive. Therefore, the current pullback in share price should be viewed as a great opportunity for long term precious metals bulls.

Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.

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BenReynolds
After several years of dormancy, precious metals are showing signs of life. Gold and silver prices have seen recent gains, fueled in part by the Federal Reserve’s decision to lower interest rates for the first time since 2008.
fresnillo why this silver stock could reward investors
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2019-16-11
Wednesday, 11 September 2019 03:16 PM
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