Introduction
First Majestic (NYSE:AG) has been a poor performer, and most of its shareholders are disappointed with results. It remains in bad shape, and that’s the reason for the title. However, is this a high-risk stock or a high-upside stock? It depends on how risk averse you are and how you analyze the current situation.
They have high costs, high debt, and Mexico is demanding a tax payment of around $500 million. Ouch, that’s not a pretty situation. However, read to the end to see if this is actually an opportunity.
You do not need to read any further if you’re not bullish that silver prices are heading much higher. The only reason to like First Majestic is if you’re looking for a stock that offers high leverage to higher silver prices.
I’m always looking for stocks that have high potential FCF (free cash flow) vs. their current FD (fully diluted) market cap. Ideally, I like to see future FCF higher than the current FD market cap. With First Majestic, their future FCF is estimated to be higher than their current FD market cap, giving them huge leverage against the silver price.
The only reason they have this huge leverage is because they’re currently experiencing problems. Their FCF is very low at the moment, and they could lose money if silver prices drop. Plus, they have high debt and a Mexico tax liability. It’s not a pretty picture.
As the saying goes, price fixes everything. All they need are higher PM prices, and the FCF will explode.
One of the reasons they’re cheap is because of their problems at their Jerritt Canyon gold mine in Nevada, which they’re currently putting into C&M (care and maintenance). These problems at JC caused the share price to crash, from which it has not recovered.
JC caused many shareholders to sell and have not come back. Moreover, the experience soured many investors on First Majestic, creating a hurdle the company must climb to regain its reputation.
Was JC a sign that First Majestic is a flawed company, or was it simply a mine that required more time to fix, and investors lost their patience? At some point (once gold prices rise), they will restart the JC mine and give it another try. I expect them to succeed the second time.
What I like about First Majestic is that it will participate in a big way if silver runs from $30 to $50. There are not that many silver producers left, and fewer still with the leverage that they have. So, while it has high risk, it also has high upside potential.
First Majestic is clearly a high-risk stock. I always like to point out that investing in PM miners is speculating. We’re gambling since so many things can go wrong. We’re also betting that PM prices will go much higher. If silver prices rise, then First Majestic will be in a strong position. If silver prices languish, then bad things can happen.
|
Stock Name |
Symbol (US) |
Type |
Category |
Share Price (US) |
FD Shares |
FD Mkt Cap (6/21/2023) |
|
First Majestic Silver |
AG |
Silver |
Emerging Major |
$5.35 |
289M |
$1.4B |
Company Overview
First Majestic Silver is a large silver/gold producer in Mexico. Until recently (when they acquired the Jerritt Canyon mine), they were a strong company with a clean balance sheet, moderate costs, and strong FCF. Now they have $192 million in debt, and their costs are no longer moderate, although they do have $235 million in cash. The breakeven costs are around $20 to $22 per oz (silver equivalent). Unfortunately, I don’t see their cost dropping substantially in the next few years.
They will produce about 27 million oz of silver equivalent in 2023 (the revenue comes from about 50% silver and 50% gold). With this much production, they have huge leverage for higher silver and gold prices. They have three producing mines in Mexico, plus their Jerritt Canyon mine in Nevada can be restarted at higher gold prices.
The red flag for this stock is its high all-in costs, but they have one of the best management teams in the business and should survive a downturn. Their other red flag is their reserve total. They only have about 180 million oz (silver equivalent) of reserves. That seems like a lot, but at 27M oz of production, that is only about six years of current reserves.
Maintaining production could be an issue down the road and could hurt the share price. After all, there are not very many large silver mines left to develop, but they do have four development projects plus 26 drilling rigs looking for another large mine. Plus, their total resources are about 500 million oz’s AGEQ.
The good news is that they want to become the world’s largest silver miner (AGEQ). That’s an aggressive goal and will only occur via acquisitions. With that aggressiveness, I would expect this company to do well over the long term.
A couple of additional items of interest. They have a pretty good silver steam deal from the Springpole mine that’s currently under development in Canada by First Mining Gold. They will get 18 million oz over the life of the mine and only have to pay a maximum of $7.50 per oz. Plus, they could sell extra milling capacity at their Jerritt Canyon mine for additional revenue. They also own significant equity positions in Golden Tag and GR Silver.
FM has a large potential tax liability from their Primero acquisition and how the silver stream is taxed (from 2010 until current). On a recent MDA on Sedar.com, they list a potential $185 million tax liability and that it does not include interest and penalties. Ouch. I doubt they will have to pay the entire amount, but the liability appears to be growing because they have not changed their accounting to match what the Mexican tax authority deems appropriate.
Currently, they’re in negotiations with the Mexican tax authority regarding this liability, and it appears that there will soon be a court case to resolve the issue. If they lose, they might have to dilute shares to pay the tax liability.
Company Info
Cash: $235 million
Debt: $192 million
Current Silver Resources: 500 million oz. AGEQ
Estimated Future Silver Resources: 500 million oz. AGEQ
Current Silver Production: 27 million oz. AGEQ
Estimated Future Silver Production: 40 million oz. AGEQ
Current Silver All-in Costs (breakeven): $22 per oz. AGEQ
Estimated Future Silver All-in Costs (breakeven): $25 per oz. AGEQ
Current FCF Multiple: 92
Scorecard (1 to 10)
Properties/Projects: 7.5
Costs/Grade/Economics: 7
People/Management: 8
Cash/Debt: 7
Location Risk: 6.5
Risk-Reward: 7.5
Upside Potential: 9
Production Growth Potential/Exploration: 7
Overall Rating: 7.5
Scorecard Explained
The scorecard is my opinion of these various factors on a scale of 1 to 10, with 10 being the best. Ideally, we want to see a value of 7.5 or higher for each item. A 7 or lower can be considered a red flag.
Strengths/Positives
Significant upside potential
High FCF potential
Quality properties
Strong management
Growth via acquisitions
Large resources
Risks/Red Flags
High costs.
High debt.
Dependence on higher PM prices.
Tax liability.
Location risk in Mexico.
Speculation stock (high risk).
Estimated Future Valuation ($75 silver)
Silver production estimate for the long term: 40 million AGEQ oz.
Silver All-In Costs (break-even): $25 AGEQ per oz.
40M oz. x ($75 – $25) = $2 billion annual FCF (free cash flow).
$2 billion x 10 (FCF multiplier) = $20 billion
Current FD market cap: $1.4 million
Upside potential: 1300%
Future Valuation Explained
This is an estimated return, and will only occur if all assumptions are correct. A more likely outcome will be something less than this amount, although it is not crazy talk to expect silver to exceed $75 or the FCF multiple to exceed 10.
My All-In Costs are the expected costs that will generate FCF (free cash flow).
I used a future FCF multiplier of 10, which I consider to be a conservative expectation. A quality producer today can easily have a multiple of 15.
I used a future PM price of $75 silver because I’m a long-term investor who plans to wait for higher silver prices. I expect to see this level reached within 3-5 years. In fact, I use $100 silver for valuations on my website since that is my expected future price. I tone it down a bit to $75 on Seeking Alpha, which I think is more reasonable.
It is my opinion that gold drives the silver price, and that macroeconomics drives the gold price. The only reason I expect to see $100 silver is because I expect to see at least $3,000 gold. That would be a GSR (gold-silver ratio of 30).
A $75 or $100 silver price may seem like pie-in-the-sky fantasy, but silver traded at $49 in 2011 when gold was at $1,935. If gold rises 50% from its current level, there is a good chance that silver will rise 150%. This is usually what happens as the GSR gets squeezed. Of course, this is an assumption.
Balance Sheet/Share Dilution
They currently have a weak balance sheet, with $192 million in debt and a potential large tax liability. Until that tax liability is paid and they reduce their risk, it will impact their valuation. Note that they do have $235 million in cash, so cleaning up their balance sheet won’t be difficult if silver prices rise.
They only have 289M FD shares, which is low for a company of their size. Hopefully, they won’t have to dilute in the near future. I’m confident they will remain investor-friendly, but if silver prices drop, share dilution is always a possibility.
Risk/Reward
As I mentioned at the beginning, this is a high-risk stock, along with all of the reasons why. I also showed the high upside potential if silver prices rise. You must balance these two to decide if you want to accept that risk.
I’m not risk averse and do not mind holding high-risk stocks such as First Majestic, although I keep my cost basis allocation low (generally 1% or less of my total cost basis) so that I won’t get hurt.
The biggest risk is that PM prices won’t rise, or inflation will cause costs to rise significantly, reducing our expected margins. Plus, political risk in Mexico seems to be increasing. Of course, those are not the only risks. This is speculation investing, and many things can go wrong.
Another risk is the debt. However, the majority of their $192M debt is a convertible bond, with a very low 0.375% interest rate. They have to pay less than $5M in interest over the life of the bond, so their debt servicing costs are very low. But the principal amount owed on the loan is still substantial. My understanding is that they have no principal payments due until 2027.
As long as silver prices remain over $20, they should not get into trouble. Of course, that’s an assumption, but one I’m willing to make. And once silver gets above $25, their FCF begins to look strong. So, $20 to $25 is the neutral zone. Below $20 is the danger zone. And above $25, is the positive zone. Above $30 and their balance sheet begins to look strong, as they begin to accumulate cash.
Investment Thesis
I like this stock because it will participate if silver runs from $30 to $50. Many of my silver stocks are development stocks that need projects to be built, which will take a few years for that outcome. I want to own a few producers that will immediately benefit from higher silver prices.
When silver gets to $50 or $75, I want to own silver producers that are experiencing massive FCF from these high prices. This will allow them to clean up their balance sheet and acquire other companies with their large cash inflows. They also will be able to buy back shares and pay out dividends. Plus, with a clean balance sheet, they should receive a high FCF multiple. I’m valuing First Majestic with a 10 multiple, but I think a 20 multiple is possible, which would potentially double the valuation.
I do realize that this is a high-risk stock that may not achieve my assumptions. They will need to restart JC and not have problems. They will need to control their costs. They will need to resolve their tax liability. Plus, they will need to avoid a plethora of things that can go wrong. But if we have a chance at high returns, we should also be willing to accept high risk.
One final note. The odds seem to imply that the stock market will have at least one more correction once the recession arrives. For that reason, it would not be a bad idea to consider a lower entry price than the current $5.35 level. Perhaps $4.50 would be a good entry target, or perhaps even $4.
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