Silver Price Expectations of Silver Stock Investors
Silver Stock Report
by Jason Hommel, Oct 30, 2003
Somebody asked me a very good question: "What level does the price of Silver or Gold have to rise to, to justify the current stock price in the market?"
I have seen writers attempt to summarize the entire industry in gold stocks by saying, "The gold shares are pricing in a gold price of $350 right now." But such a blanket opinion is too general to be of any good use, and wrongly assumes there is no significant differences between different metals stocks. But we can calculate an answer for individual stocks, and I will show you how you can do this.
Some silver stocks won't be significantly profitable until silver reaches a significantly higher price, but that is also hard to quantify in advance, and it is actually illegal for a company to do such pricing projections for you. When doing a bankable feasibility study, a mining company has to use trailing price averages, and has to also assume metals prices will go down; they cannot, by law, assume and predict for price inflation. Crazy, I know.
This is also why I calculate a price in silver for the silver stocks. It removes the dollar from consideration, and is equally useful for investors around the world.
For example, if a silver stock like Mines Management (MNMM.OB) gives you 40 oz. of silver in the ground for one oz. of silver's worth of stock, that's just a great deal, period. I expect their profits will be significantly greater than 1/40th of an oz. of silver for each ounce they eventually mine, and that's how I figure I'm getting a really great deal, even though I don't yet know or even care what their ultimate profits may be.
Now, what will the profits be for a silver miner when the dollar is destroyed and has no value? I have no idea whether the margins of a silver miner will be 30% or 50% or 300% or 1000% or more. For example, they might be able to mine an ounce of silver for a "cash cost" of 1/10th of an oz. of silver, or for 6/10ths of an oz of silver, but I don't yet know a possible historical range for that. Costs will depend on future labor and future energy costs, and whether people are using silver for money again, which makes silver much more valuable.
Mining will be much more profitable if miners are paid only about 7/10ths of an ounce of silver for a day's wage, (a silver dollar) which was the norm in the early 1900's before the Fed was created and distorted prices by printing paper money.
Stock prices must always reflect expectations for earnings, and go down or up to reflect changes in earnings, and/or earnings expectations.
The reason I feel that I have found so many silver stocks so cheap today is that the vast majority of mainstream investors believe we will have silver prices in a range of about $5.00 long into the future. And at this price, most silver stocks will never have any significant profit. But I believe the silver story is not well understood by the market, and I believe that silver stocks are even less well understood, which creates the opportunity that currently exists. The entire silver stock market is simply too small for professional Wall Street types to even look at seriously like I'm taking the time to do in my weekly report.
Nevertheless, as a significant number of people have begun to understand and anticipate the bull market in metals, they have bought stocks like HL, and pushed the price up for that stock.
So, let's look at Hecla Mining. I believe their stock price is anticipating a silver price much higher, and let's calculate that. To "value" HL, and to see what silver price the stock price is projecting, you also have to have a "rational" P/E ratio, which is not the kind of number that everyone can agree on.
For example, a P/E of 10 might be rational for an expectation of a 10% return on your money, but such a P/E might be too low if there is serious inflation. (So, I'll use two numbers below, a PE of 10 and 20.)
Price information as of the market close Tuesday, October 28, 2003:
Phone: (208) 769-4100
109 mil shares @ $5.90 share
$647 million Market Cap (MC)
near zero debt, cash: $113 mil
(est. 2003 production 9 mil oz. silver)
Total silver = 53.7 million oz.
Plus 412,000 oz. gold x 10 = 4.1 mil oz silver equiv.
Total silver equiv. reserves = 57.8 mil oz.
Total production costs are $3.68/oz./silver.
HL produces 9 mil oz of silver a year, at a "cash cost" of $3.68/oz.
Total cost = $3.68/oz. x 9 mil oz. = $33.12 million.
First, if we assume a rational P/E ratio of 10, then, with a market cap of $647 million, they need $64.7 million in profit, so that the price (market cap) is ten times the earnings.
To get $64.7 million in profit, with $33.12 million in cost, they need a total realized price of $64.7 + $33.12 for the 9 mil oz. That's $97.82 million for 9 million oz. of silver, or $10.86 dollars per ounce.
In other words, HL investors who are expecting a P/E of 10, are expecting HL to produce at least 9 million ounces of silver for the next ten years, and have an average realized sale price for their silver of $10.93/oz.
Or second, if HL investors expect only a 5% annual return on their investment, or a P/E of 20, then they would expect only half the earnings. This would be $32.35 million + $33.12 million "cash cost" = $65.47 million / 9 mil oz. which is $7.24/oz. This means that HL investors might only be anticipating a silver price of $7.24/oz. if they think a PE of 20, and 5% annual returns are a good investment.
Expected earnings for HL right now can be found by subtracting the "cash cost" from the current silver price, multiplied by their annual production. This would be: $5.10/oz. - $3.68/oz "cash cost" = $1.42 x 9 million oz. annual production = $12.78 million annual earnings.
Earnings estimates for HL can also be found at the company website from http://phx.corporate-ir.net/phoenix.zhtml?c=63202&p=irol-Estimates which give an annual earnings estimate of $.13 per share for 2003. With 109 million shares, that works out to $14.17 million, close to the $12 million number calculated by the current "cash cost" for the silver.
Let's compare HL now with Canadian Zinc. In a previous article at http://www.gold-eagle.com/editorials_03/hommel102303.html I inferred from company statements a few different earnings estimates for Canadian Zinc of between US $13.3 million/year and US $28.75 million/year.
CZN's expected earnings are about the same, or about double, HL's earnings. And yet, now compare the current market cap (cost to the investor to buy the stock) between the two companies:
HL Market Cap: $647 million US (at 109 mil shares outstanding and $4.90/share)
CZN.TO Market Cap: $47.5 million US (at 65 mil shares fully diluted and $.95/share CAN x .77)
$647/47.5 = 14
Based on comparable expected earnings alone, CZN looks like it might rise by a factor of 14 compared to HL, or more. But I think HL is overvalued, so please don't mistake me here, I don't think CZN's stock price will rise not even ten fold any time soon with the silver price where it is today. But CZN's share price may go up from US $.73/share to between US $2.04/share and US $4.42/share, or up 279% to 605% from here if a P/E ratio of 10 is expected. And, of course, if the silver price really moves up, then I'd have to re-calculate everything.
But the key point is this: If the market cap for CZN and HL are equal about six months to a year from now, at about $250-$300 million each, then for the investor of HL stock who sells it for CZN now, his decision will be a 14-fold gain for him.
(Investors will also be forced to think this way when considering selling the overvalued dollar to buy undervalued silver.)
Note, since September 22, 2003, when I wrote my first weekly report, "Silver Stock--comparative valuations," the price of HL has declined from $6.82 down to $5.90, while the price of CZN has gone up from $.41 to $.95 as of the close October 28th.
With Canadian Zinc, the current share price is NOT yet factoring in or reflecting an expectation for higher silver prices, because the share price is still well below the earnings estimate with current silver prices.
You can only do calculations like this if you know the market cap, the cash cost, and the annual production numbers. In the case of non-producers, or explorers, you have to trust their pre-feasibility studies, which I'm doing in this case for Canadian Zinc.
Also, the cash cost number is not a perfectly reliable number, since you never can estimate true profits (and dividends) for a company based on it alone, because there are always other things they spend their profits on, such as exploration or other non-fixed one-time expenses.