Pan American Silver Third Quarter 2009 Conference Call

I will discuss the Pan American Silver Corp. (PAAS) third quarter conference call held on 11 November 2009 by providing the conference call's major themes in point form. Because I believe the company is well managed by seasoned and competent professionals and because of my concern with potential inflation, Pan American Silver remains one of my core holdings.

In addition to transcripts of the company's conference call (see Seeking Alpha for the transcript), I used the company's press release with financial highlights (PDF, 49 kb). The press release is well worth reading for a quick snapshot.

General Comments

• New quarterly record silver production of 6.4 million ounces, up 31% from same quarter last year and up 10% compared to second quarter 2009.
• New quarterly record gold production of 28,000 ounces, up 12% from same quarter last year. Gold is the most significant byproduct, accounting for almost 20% of total revenues.
• Consolidated cash costs declined 26% to $4.91 per ounce, which is well below the company's full forecasted amount of $6. The company has managed to keep its cost savings that it created earlier this year.
• Cash flow from operations before working capital adjustments was $43 million or $0.50 per share. Pan American had net income of $17.4 million or $0.20 per share, an increase of 172% from third quarter last year and $7.2 million higher than second quarter this year when it was in crisis mode.

Manantial Espejo, Argentina

• Company very happy with its results thus far.
• Over 1 million ounces of silver at a cash cost of negative $3.11 per ounce, which is the result of over 20,000 ounces of gold production that more than covered all operating costs. Remember, byproducts are treated not as revenue but rather as negative costs.
• Pan American solved its mechanical problems (failed grinding mill motor), and the mine processed nearly 170,000 tons of ore.
• Silver mill feed was 214 grams per ton, of which 88% was recovered, just shy of the company's expectations. The shortfall, however, was more than compensated by better than expected gold grade of 3.9 grams per ton and better than expected gold recoveries of 95%.
• Pan American expects slightly improved performance in the fourth quarter at similar cash costs.

Peru

• Produced just above 2 million ounces of silver at a cash cost of $8 per ounce of silver.
• Higher base metal prices helped to offset the Doe Run smelter closure in Peru.
• Company expects that its production will increase by about 10% from the current 910,000 ounces of silver per quarter to close to one million of ounces of silver per quarter with costs decreasing from $10.35 to $7.50 per ounce.
• Pan American is pleased with its Morococha mine where it is producing at nearly 750,000 ounces of silver at a cash of $5.33 per ounce. Company expects similar results for a substantial, but undisclosed, period.
• The Quiruvilca mine is operating at reduced yet profitable conditions. It produced more than 360,000 ounces of silver at a cash cost of $7.69 per ounce. The cash costs include capital expenditures, which are expected to continue into early 2010.

Mexico

• Alamo Dorado mine produced 1.6 million ounces of silver at a cash cost of $4.37 per ounce. Gold production was nearly 5,000 ounces versus expectations of only 3,000 ounces.
• Production rates will decline for Alamo Dorado. Expectations for the fourth quarter are one million ounces of silver. This rate will extend to mid to late 2010. Production should increase again as high grade ore from Phase II pit is used.
• La Colorada mine produced 885,000 ounces of silver at a cash cost of $7.92 per ounce.

Bolivia

• San Vicente produced over 870,000 ounces of silver at a cash cost of $5.81.
• Ramp up continues ahead of expectations with the plant processing just over 600 tons per day against design capacity of 750 tons per day.
• Higher grade ores are being mined.
• Winterization projects have been completed. Mineworkers are gaining confidence in the plant's operation as their familiarity has increased.
• The mine expansion and plant construction has brought economic benefits to the local community of San Vicente.
• Company believes that its success at San Vicente is viewed positively in the country and that it might provide additional incentives for further foreign investment into a region that desperately needs more economic activity.

Exploration

• I did not provide a detailed summary of the exploration portion of the conference. While it is vitally important, it is specialized information. Please consult the transcript for more detail.
• Key comment from the transcript is as follows: "All of this new information will included in general reserve and resource update, which I will share with you in January 2010. I'm confident that once again, we will more than replace all of the resources ounces we've mined in 2009."

Financials

• Pan American reported record sales of $118.6 million, a 49% increase from a year ago. This increase is attributable to record silver and gold production and strong silver and gold prices.
• Mine operating earnings were $34.7 million, more than double last year's value and up 48% from last quarter. Net income was $17.4 million, which translates to $0.20 per share, again more than double last year's value and up 70% from Q2.
• Cash flow from operations before working capital adjustments was $43.3 million. With reduced capital expenditures of $5.8 million, the company banked $28 million.
• The prior results would have been even stronger had the company been able to sell more of its metals. Concentrate shipments and the Doe Run refining schedules resulted in a buildup of inventory.
• The addition of high margin production from Manantial Espejo and San Vicente mines and the continuation in and recovery of strong metal prices helped boost the company's results. The average margin per ton of ore milled has gone from $10 in Q4 2008 to $53 in Q3 2003. Moreover, the total number of tons moved has increased by 50% over that same period.
• Sales increased by $39.1 million from the third quarter 2008. This results almost entirely from increases in the quantities of silver and gold sold, which increased by 30% and 450% respectively.
• Working capital increased by $41.6 million to $258 million. Most of the increase in working capital is higher cash and short term investment balances, which rose $37.1 million to $150 million. The Doe Run concentrated inventory increased during the quarter, which added an additional $10.3 million to working capital.
• Company has no debt.
• With the construction of Manantial Espejo and San Vicente accomplished, the capital expenditure for the third quarter on property, plant and equipment was only $5.8 million.
• The Doe Run of the La Oroya smelter situation has improved. It was closed during the third quarter and remains closed today. Doe Run was a larger buyer of the company's copper concentrate production and only buyer of the stockpile material. The company has been able to sell a couple of concentrates shipments to other buyers during the third quarter 2009. Because other financial terms were inferior, an added $1.35 per ounce of cash costs were incurred at the company's Huaron mines. The company believes that recent developments surrounding Doe Run have been positive. It expects that the smelter will resolve its financing requirements and resume operations in the first half of 2010. Moreover, the company retains a debt provision of $4.4 million in the second quarter related to accounts receivable from Doe Run.

Closing Comments

• Company remains positive: maintaining 2009 production forecast of 25.1 million ounces of silver at or better than $6 per ounce cash costs.
• More than double, nearly triple gold production at 85,000 ounces.
• Company has discovered an exciting new extension at the MCTU zone at the La Colorada mine. Good things should result.
• Progress is being made at Manantial Espejo and the company is targeting a full feasibility study by year-end. There are several new exploration targets.
• Company has a defined silver resource La Preciosa with an excess of 135 million ounces of silver in Mexico. The location is within an hour of its existing infrastructure in Durango. It is well positioned to take advantage of this opportunity.
• The friendly takeover of Aquiline Resources Inc. will create value for shareholders of both companies. It will combine Pan American's financial strength and proven mine development expertise with Aquiline's work class primary silver deposit Navidad. Because of the company's success in working in Argentina, being able to address local and political sensitivities, the company is well positioned to move Navidad forward. With La Preciosa and Navidad, Pan American will possess a strong growth pipeline.

Questions and Answers

Much of the question and answer was related to detailed mining operations information. There was one question related to the company's hedging policies.

The company's philosophy firstly on silver is not to hedge the exposure that we have to silver. So our hedging program is really confined to byproducts particularly base metals and from time-to-time currencies. The moment we have a very small residual zinc program in place, which runs out at the ends of December and the same that goes to our currencies.

We have a small Mexican peso and Peruvian sol position, which also in December. So for 2010, we actually won't have any hedge positions open. However, the subcommittee of the Board of Directors and the Hedge Committee does review those businesses from time-to-time and we maybe adding to them depending on the circumstances.

The company receives spot prices for its gold byproducts.

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My Overall General Impressions

Please note that you can click though each chart above to see full sized images.

One of the hedge fund managers that I follow is Bill Fleckenstein of FleckensteinCapital.com (subscription site). Fleckenstein has been extremely critical of central bankers and in particular Greenspan (see Greenspan's Bubbles: The Age Of Ignorance At The Federal Reserve), who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. Because of the Fed's prior and current policies and actions, Fleckenstein has been and remains bullish on precious metals and some mining companies. Please note that he is a director of Pan American Silver.

As an aside, for all those who wish to listen to a few podcasts featuring Bill Fleckenstein, you can listen to Eric King's interviews.

As I indicated in my prior article (Pan American Silver 2Q 2009 Conference Call), I believe that Pan American is an extremely well managed company. Like Fleckenstein and others, I further believe that with the massive money printing by central bankers, excess liquidity might manifest itself in higher commodity prices, especially in silver and gold prices.

One concern that I have, though, is that the stock price of a mining company sometimes underperforms the price of the commodity being mined. Jim Rogers, who wrote Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market, stressed that it is often better to buy the actual underlying commodity rather than a mining company. His rationale is that when you invest in a company, you then have to worry about such things as management, confiscation through rising royalties and taxes, environmental regulations, increased labor costs, increased energy and other input costs, political disruptions and many other similar factors. These problems sometimes cause a company's share price to underperform the price of actual commodity itself. When compared against Pan American Silver's share price over the past two years, iShares Silver Trust (SLV) shows superior performance. iShares Silver Trust is an ETF that tracks the price of silver.

As an aside, iShares Silver Trust has 293,087,484.400 ounces of silver in trust as of 22 November 2009. On 12 September 2007, slightly more than two years ago, iShares Silver Trust had roughly 139 million ounces in trust.

A cautionary note, however, with the two year comparison chart. Comparisons are often highly dependent upon the start date and duration. Changing either or both will often result in an opposite conclusion.

My impression is that Pan American lost ground to iShares Silver Trust in October through November 2008. Since then both price lines have been highly correlated. I suspect that if silver and gold metal prices were to rise quickly, all other things being equal, then Pan American would benefit more than iShares Silver Trust because other Pan American Silver's input costs would remain reasonably stable. If silver and gold prices were to rise slowly, however, then I am less certain which would benefit more.

Against this two year historical backdrop where the iShares Silver Trust share price outpaced Pan American Silver's share price, however, are the company's plans to add more low cost production, which should favor Pan American Silver's share price. I expect that, after the friendly takeover of Aquiline is complete and during its fourth quarter conference call early in 2010, the company will provide more details on its plans to expand production.

The key point from this discussion is that sometimes investing in an underlying commodity is better than investing in a mining company.

Unless my fundamental outlook changes or Pan American Silver begins disappointing, it will remain a core holding. On Friday, 20 November 2009, Pan American Silver stock price closed at $24.88.

Disclosure: I am long Pan American Silver Corporation shares. As part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

While biking around the Glenmore reservoir in Calgary on 18 July 2009, I saw some people sailing in their boat hi9. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.