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First Majestic Silver – growth stock

Given my longer term bullish view on silver, I wanted to have two silver stocks in the portfolio.  The first pick was SLW so we could gain exposure to a quality streaming business.  I have eliminated explorers at present due to the difficult environment at the junior end of the market, whilst the majors have other issues.   Although they are well funded, many have not been run well and are not growing production.  Therefore I decided to focus on a mid tier silver producer with strong growth prospects.

First Majestic (FR) was founded in 2002 by president and CEO Keith Neumeyer and now has a market cap of over $2bn. It owns and operates four producing silver mines in the Mexico; the La Parilla Silver mine, the San Martin Silver mine, the La Encantada Silver mine and the La Guitarra Silver Mine.  The Company has a further mine under construction called the Del Toro Silver Mine which is anticipated to become FR’s fifth and largest operation.  Production from these mines is forecasts to be between 9.2m and 9.5m oz of silver equivalent or 8.4 to 8.7m oz of pure silver in 2012 (up from 1.3m oz in 2006 and 7.2m oz in 2011).   The company has stated that it wants to grow into a senior Silver producing mining company based on an aggressive development and acquisition plan with a focus on Mexico.

For me FR is the standout silver mine for several reasons.  Firstly, it is unhedged and has over 90% of revenues from silver, which makes it one of the purest silver miners around.   Secondly, the company has some of the best production growth potential in the industry and is expected to produce 16m oz in 2014, mainly due to Del Toro coming on stream.  FR own 100% of all their operations and being based in Mexico, I do not see political risk as a big issue.  FR is a low cost producer and their mines all have long lives.  In total FR has 163m silver equivalent oz in the Measured and Indicated category and 247m oz in inferred resources.   The management team is first class and the top 40 Senior Management have over 650 years of mining and management experience.

FR released Q3 results last month, which were in line with analyst forecasts and showed production of 2.2m oz of silver at average cash costs of $9.19/oz.  Average cash costs have increased 10% year on year due to the impact of the recently acquired La Guitarra mine, which is the subject of an operational efficiency and optimisation program.  Adjusted earnings per share were $0.25 and cash flow per share was $0.31.  Cash on the balance sheet was $70.9m

Here is an overview of the individual mines:

La Parilla – This is 100% owned and comprises of a 2,000 tpd dual floatation/cyanidation mill and underground mine complex which began operations in October 2004.  The property is located 65km due southeast of the city of Durango in the western part of Mexico.  The infrastructure is excellent and the mine is only 4km away from the main highway.  The La Parilla is complex of five mines surrounding the mill.  FR is currently focusing on exploration on the Quebradillas, Vacas, San Marcos, La Blanca mines and the Cerro Santiago, Viboras, San Nicolas, Sacramento areas.  Total production is 2.7-2.8m oz of silver (3.3m- 3.4m oz silver equivalent).  FR expect cash costs reduction and potential for further expansion.  They have recently expanded land holdings to 69,440 hectares covering several old mines.

San Martin – The mine is 100% owned and includes a 950 tpd cyanide mill and 500 tpd floatation circuit (in care and maintenance).  This includes a land package consisting of 7,840 hectares of which FR owns 1482 hectares of the surface rights.  The area has never been explored using modern exploration techniques.  The mine has been in production since 1983 and produces around 1.1m to 1.3m oz of silver per annum.  FR is looking at maintaining this, whilst focusing on expanding the resource.  The mine is located 250km of Guadalajara in Jalisco State and a NI 43-101 resource was completed in February 2009.  FR took control of the mine in June 2006 by buying a majority stake from First Silver Reserve and purchased the remaining stake in September 2006.  They are currently installing tailing ?lters to recirculate 80% of the water used in milling process and also developing La Esperanza, Rosarios and Huichola areas in preparation for increasing head grades and resource estimates.

La Encantada – The mine is 100% owned and is located in the “Sierra Madre Oriental” province of Mexico.  It has a newly completed 4000 tpd plant.  The mine is in the state of Coahuila and the access is through the road from Muzquiz to Boquillas del Carmen, Coah, through a 165 km paved road and a branch of 45 km dirt road, that takes approximately 2.5 hours to travel.  Annual production is around 4.2m-4.4m oz of silver pa.  The company is seeing improving metallurgical recoveries and projects reduction in diesel costs in 2013.  There is substantial exploration potential de?ned within the 4,000 hectare property.

La Guitarra – The mine is located in the Temascaltepec Mining District of Mexico, approximately 130km south west from Mexico City.  It is 100% owned (purchased earlier this year from Silvermex) and the land position covers 397 square kilometres (km).  The district has seen mining activity since the 1550s and offers production growth opportunities through modern development.  The 350 tpd Flotation Mill will increase to 500tpd by Q1 2013.  La Guitarra reported its first quarter of production for FR last month.  Immediate results have been seen in reducing average operating costs from $115/t a year ago to $65/t for this quarter.  Management is currently looking to expand towards 1,000 tpd by the end of 2013, which should see the mine producing over 2m oz of silver pa. An aggressive exploration program is planned next year, towards the goal of releasing a revised NI 43-101 resource by the end of 2013.

Del Toro – The mine is located in Chalchihuites, Zacatecas State.  Exploration is currently focused on two areas, the San Juan and Perseverancia areas.  Other areas with the project’s concessions will be explored in future drilling programs.  Exploration has been very successful in delineating a large resource base within a short period of time at a relatively low cost.  The deposit has a measured & indicated resource of 162m oz and a further 174m oz in the inferred category.  Del Toro is fully permitted for 4,000 tpd.  Phase 1 production is due to start now.  Currently, 96% of the required equipment for the floatation circuit and the 65% of the equipment for the cynanidation circuit has either arrived, installed, or is due to be delivered. The expansion plans will see 1,000 tpd cyanidation circuit to come on stream in Q3 2013 and then expand both circuits to 2,000 tpd by mid 2014.  The projected Capex of the mine is only $124m, which compares favourably with many other projects and the after tax IRR is a very impressive 49%.  Estimated operating cash flows by 2014 are around $60m and will add over 5m oz of silver to FR’s production (7.2m oz silver equivalent).

La Luz – The project is located 25km’s west of the town of Matehuala in the San Luis state of Mexico.  The property was bought by FR in November 2009 as a result of the purchase of Montreal based Normabec Mining and has 36 mining concessions covering 4,974 hectares.  FR believes this will become an important mine for the region and for the company.  At the moment, the project needs to be permitted and developed, with a construction decision made in 2014 and possible production in 2015.

As I write, FR has just agreed to acquire Orko Silver for consideration of 0.1202 of a common share of FR plus $0.0001 in cash per Orko common share. The offer implies a value a 69% premium to Orko’s 30-day volume-weighted average price.  Orko’s La Preciosa deposit is one of the largest undeveloped primary silver resources globally and will boost FR’s land position in the Sierra Madre Belt, one of the world’s most prolific silver and gold regions. At first glance I believe this deal is a good strategic fit as the mine should be producing shortly after Del Toro and La Guitarra.  La Preciosa, located in the State of Durango, is also close to First Majestic’s existing La Parrilla and Del Toro mines, so can employ its expertise in mine development and there should be many synergies.  FR know the area and have a great track record of acquisitions so I’m confident this deal will add value.  Orko has a 43-101 compliant Indicated Mineral Resource of110 Million Silver Equivalent Ounces with an Inferred Mineral Resource of 154 million Silver Equivalent Ounces (42% Indicated, 58% Inferred)

Conclusion

FR is an exceptionally well run silver producer that is growing rapidly.  It has a solid shareholder backing as institutions hold 47% of the stock and Keith Neumeyer owns 3m shares. Their mines are all have low cash costs and are long life assets.  I believe the recent acquisition of Orko Silver will prove to add value for shareholders and will deliver further growth from 2015-16 onwards that will need to be built in to analysts forecasts.  The shares trade on a 2012 PE of 23x but as we look forward to 2013, this rating falls to 12.5x, which is too low for such a quality growth stock operating in a politically stable country.  FR has one of the highest correlations of any silver stocks to the silver price and I would expect the shares to continue outperforming the metal and its sector rivals.

*All figures exclude Orko at present.