Description

Summary thesis:

1. Top tier Silver/Gold miner now trading at a pro forma FCF yield of 11% and 5x EV/EBITDA (vs. peer group at 5% and 8x EBITDA resp). Street hasn’t updated models due to lack of information and the deal having just closed in 1Q’23. 

2. Yamana shareholding was heavily quant based and those holders were probably forced sellers due to lack of numbers/forecasts once they received PAAS stock. Stock has underperformed materially since deal closure end of March. 

3. Gold Reserve life now extended to 12 years, vs. 5 years prior to acquisition

4. Free option on resolution of Escobal (worth up to $3 per share or 20%+)

5. We think at spot Gold and Silver prices, the stock is worth $30 (+100% upside) using peer multiples

Profile:

PAAS is the second largest silver producer globally with pro forma 28Moz run-rate production. The acquisition of Yamana significantly lowers its portfolio AISC and double FCF generation potential (Yamana EBITDA margins are 2x PAAS). The company now operates four producing silver and seven gold projects in the Americas with combined FY22 pro-forma revenues of US$2.7bn and mine EBITDA of US$1.0bn. In addition, PAAS has a healthy pipeline of organic growth opportunities focused on silver, continues to advance its world-class Escobal silver project through the ILO 169 consultation and now holds a 56.25% stake in the large-scale, brownfield polymetallic MARA project in Argentina

Source of opportunity:

Pan American Silver Corp (“PAAS US”) represents a unique opportunity where the run-rate FCF generation of the new group is not fully understood by the market. Post three years of covid disruptions where PAAS operations were more severely impacted versus peers due to operations being solely located in South America (where covid disruptions were much more onerous. Additionally two geological /  technical issues in important operations that after Q1 that we are now looking past (La Colorado and Dolores), and a complex transformation deal with Yamana doubling the group EBITDA and FCF. Group net debt will be close to zero by the end of 2024. 

Post our conversations with management we are confident that costs are coming down as a combined group (as seen already in Q1). Also our maintenance capex estimate declines post sale of at least one decommissioned mine 

At spot prices ($24/oz Silver, $1,975/oz Gold) – PAAS will generate a run-rate $550+mn of FCF a year in 2025, an 11% FCF yield or near double the space. It has further optionality in its portfolio (extensions and asset sales plus non-producing asset in MARA worth $500mn) all while getting the option of Escobal being allowed to restart– arguably the world’s number 1 Silver asset – for free. 

PAAS current proforma, annualized FCF:

A further confusion to consensus understanding of ’24 numbers, is that ’23 guidance only includes nine months of the Yamana assets not twelve which many have modeled, and ’23 also includes a host of one off’s -- Severance, deal fees care and maintenance for at least one asset that is moving off balance sheet soon-- plus some non-cash items (assumptions of debt / revaluation).

Reserve Life – Much improved pro-forma:

Prior to the deal, PAAS had only 5x years of reserves left of gold, and that figure now increases to 12+ due to the purchase of Jacobina in Brazil – an asset with over 15x years of reserves found already, and the second lowest cost mine in their portfolio. By all accounts given the history of drilling it should increase also. Jacobina, now by far the most important producing asset for the proforma group has over double group average life of reserves and is also their second lowest cost operation.

Escobal Optionality

Escobal, the silver mine in Guatemala owned by Pan American Silver (“PAAS US”), is one of if not the top silver mines in the world. It is both one of the highest graded silver mines ever found, and when in production the 2nd largest producer (21mn oz annually globally). It has been under care and maintenance since 2017 when then owner Tahoe Resources was forced by the Guatemalan supreme court to halt production due to protests from the local Xinca community. Tahoe Resources was subsequentially bought by PAAS – even though the mine was not operational—with a CVR included in the purchase price that paid out on first commercial sale from Escobal if it restarted within ten years. The mine was so strategic and important, PAAS decided to pursue the transaction and take a long-term view. PAAS acquired Tahoe after it was announced a consultation review would take place and a process / soft timeline was given --- which at the time then CEO of Tahoe resources said on their conference call in 2018, “a defined path towards resuming production has been presented.” Just as the process started to accelerate in 2020, covid hit effectively putting it at a standstill for over two years. On the government’s own timetable, we believe a resolution is coming in the next twelve months.

History:

Escobal was originally discovered by Goldcorp in 2007 – so it is a relatively new mine / discovery. The discovery was then sold to Tahoe Resources in 2011 and in April 2013 the mine was granted a 25-year operating license by the Guatemalan government. Escobal reached commercial production in January 2014. A total of $500mn was invested.

In June 2017 Escobal after a little over three years of production was forced to shut down post protests from the local community and a ruling from the Guatemalan Supreme court. At the time it was the second largest silver mine in the world, responsible for 21mn oz or roughly 2% of the 1,000mn oz yearly market.

Quality of Escobal – Tier One Silver Asset:

In 2016, its last full year of production, Escobal was the world’s second largest production silver mine after just three years of production.

2016 top five producing silver mines in the world:

1. Saucito (Mexico) = 21.9 mn/oz

2. Escobal (Guatemala) = 21.2 mn/oz

3. Dukat (Russia) = 19.8 mn/oz

4. Cannington (Australia) = 18.2 mn/oz

5. Uchucchacua (Peru) = 16.2 mn/oz

The Saucito mine in Mexico produced just 12mn oz of silver in 2021 and is set to close by 2024.

Pensequito (Mexico) owned by Newmont is now the world’s largest producing silver mine (31mn oz).

If we look at Escobal – it is a 334g/t resource. It is ultra-high grade. Penesequito, silver is a by-product for Gold – still high grade at 38 g/t – but 1/10th the silver grade as Escobal. All indications are Escobal could drill out and grow its reserves, which are already at 13 years life.

Source: 2022 Resource and reserves report Pan American Silver Corp

Consultation Process—getting Escobal back and running in 2024:

The Guatemalan supreme court referred the mine to an ILO 169 consultation process. This process, a UN sponsored process, refers parties when indigenous peoples are involved to consultation with the objective of achieving agreement or consent, in this case to operate the Escobal mine. The idea behind it is informed consent (the indigenous people should be informed, know their rights, what will happen and what is at stake” and that participation in the process are fundamental rights of natural inhabitants.. in this case the Xinca peoples. The process is required to come to an outcome (so the process won’t drag on forever).

The consultation is supposed to and press has said end in 2023 given their own timeline which should pave the way for supreme court verification and a restart (timeline below). Although there could be further negotiations once the consultation process is over (on royalties paid, local wages etc…) – the legal ability to operate should be known in the next six months.

This is a tried and tested process in Guatemala. The ministry has already concluded a similar consultation process, which saw them lift the suspension of the Fenix nickel mine which was closed three years earlier. This process again followed the ILO 169 rules, in this case for the maya Q’eqchi’ communities.

We believe PAAS would not be investing $25mn a year and in the process if they didn’t think there was a high chance of being able to restart soon. Also, they are new operators, not the original operators which the indigenous people had issues with.

Value of Escobal – Worth conservatively $1,300mn – 22% of the current market cap — and increases FCF for the group by 33%.

Escobal is largely de-risked operationally once allowed to operate. It has already been a producing mine. Additionally, PAAS has been spending $25mn in care and maintenance a year to keep the mine ready to go back into operations – mine is not only in position to restart but restarting it will release an additional 25-50mn headwind to FCF a year from dropping the costly expense to preserve an operational mine that isn’t producing.

https://www.panamericansilver.com/wp-content/uploads/2023/03/Annual-Report-2022_Pan-American-Silver_Final.pdf

In terms of its own FCF generation– at spot levels Escobal should add 165mn a year—including the collapse of care and maintenance – should be at full run rate $190mn a year in FCF post roughly 75-100mn in start up costs and a 12–18-month ramp to name plate.

Catalyst

Escobal resolution

Pro Forma FCF estimates correctly modeled by street