First Majestic: Good Assets And Share Dilution At A High Price

Thesis

I love mines and banks. However, investing in favorite industries is easier when approached as an art of exclusion. In other words, instead of asking why to invest, we have to ask why not to invest. Assessing a mining stock as uninventable is not a simple task.

The company`s presentations contain promising data with exaggerated achievements and suppressed failures. First Majestic (NYSE:AG) is an excellent example answering my question of why not to invest. In the following article, I will explain why for you.

A successful mining business is built on five pillars:

• Excellent deposit
• Prudent and experienced management
• Growing reserve base
• Growing annual production
• AISC below industry median

All pillars are mandatory for any mining enterprise to survive the turbulent period typical for the mining industry. Once the spark in the face of growing spot prices is present, shares of such quality companies are ready to make a parabolic move.

First Majestic owns excellent silver deposits in Mexico except Nevada Jerritt Canyon. The latter has exuberantly high cash costs and AISC close to 3000 $/oz. Management qualities are questionable, given the progressive share dilution. This is more typical for junior miners with a market cap below $100 million. On top of that, we have a tax dispute with Mexico for $ 500 million. Given all the drawbacks, Mr. Market values First Majestic very generously.

I firmly believe that every macro investment, such as investing in commodity producers and miners, must be focused on high-quality companies. We, as investors, are more often wrong than right. That said, wrong about the timing and market direction. Choosing an excellent business limits our downside risk in case of not-so-precise timing, which most often is the case. However, by picking mediocre stocks, the market can prematurely take us out just before the anticipated bull run.

That said, I give First Majestic a sell rating. Other precious metal miners cover all five pillars, thus being much better investments for our hard-earned cash.

Company Overview

First Majestic's stockholders disappointed its shareholders with mediocre performance due to rising AISC and profit margin compression. Jerritt Canyon gold mine in Nevada, which they are currently putting into care and maintenance, is another anchor dragging down the company`s performance.

The company has three operating mines in Mexico, one in care and maintenance in Nevada, and a few more projects. The image from the last company presentation below represents the company portfolio.

Having mines in only two countries simplifies the company`s activities and mitigates the operational risk caused by different country peculiarities. Primary revenue sources are the San Dimas and Santa Elena mines in Mexico. The table below shows AG 2023 guidelines.

The Mexican mines generate over 90% of the company`s annual production.

First Majestic has a silver steam offer from the Springpole mine, which First Mining Gold is now developing in Canada. Over the mine's lifespan, they will receive 18 million ounces and will only be required to pay a maximum of $7.50 per ounce. Additionally, they might generate more money by selling extra milling capacity at their Jerritt Canyon mine.

Santa Elena and San Dimas mines are Tier 2 assets with grades higher than average but AISC around the median and LOM of 8-12 years. The table below shows AG`s mines parameters.

Due to the Primero transaction and how the silver stream is taxed (from 2010 to the present), AG could owe a sizable tax amount of up to $500 million, including interest on tax liabilities.

First Majestic is currently negotiating this obligation with the Mexican tax department, but a court case may soon be necessary to settle the matter. They might have to dilute shares to cover the tax liability if they lose.

Mining companies finance their operations in a few ways. However, one of them is best for miners and worst for shareholders. Yes, I mean share dilution. This is due to the high share dilution (4%) that it caused. Approaching 290 million First Majestic shares are outstanding, an increase of more than 38% from year-end 2019 levels. The image below from the last financial statement illustrates the company`s share count.

Holding gold and silver bullion makes sense if you invest in precious metals because you probably don't want your purchasing power to decline. However, buying miners is suitable if you seek leverage on precious metal price moves.

The latter hypothesis, however, only holds if a producer maintains or increases its metrics per share, i.e., production, reserves (or resources). I will illustrate that statement with a table comparing plausible reserves per share. This multiple shows the company`s share`s sensitivity to spot price variations. The higher the number of ounces per share, the higher the leverage to spot price changes.

Pan American Silver (PAAS) and Fresnillo (OTCPK:FNLPF) are similar-sized enterprises, while Gatos Silver (GATO) and MAG Silver (MAG) are smaller. By buying one share of PAAS or FNLPF, we receive more ounces of plausible reserves than buying AG shares.

Q2 2023

First Majestic Silver Q2 results show a yearly 4% rise in silver production. However, while gold production plummeted by almost 24% to 45,000 ounces, marking the lowest quarter for gold output in more than three years, silver production increased year over year.

The Jerritt Canyon gold mine in Nevada, which had a partial quarter of production (about 4,400 ounces produced), had mining and processing activities suspended as of late April, contributing to lower gold production. Additionally, the shutdown of the Jerritt Canyon operation will keep pressure on gold production going forward.

The image below represents AG`s mine metrics, such as revenue, cost of sales, operating earnings, and CAPEX.

Jerrit's results are a massive drag on the company`s bottom line. I like precious metal miners running both gold and silver projects. However, in AG`s case, the silver segment feeds the gold one. Given AISC at 3267 $/oz, closing the mine and reconsidering its presence in the company`s portfolio is better.

Company Financials

The company balance sheet is more than healthy. Using fundamental liquidity ratios such as CR and QR, First Majestic has adequate liquidity. The table below shows AG`s solvency and liquidity metrics. The data is from the company`s last financial report.

AG has low debt compared to its equity and total assets. At first glance, this seems impressive. However, as mentioned above, the shareholders pay the price for a healthy-looking balance sheet, taking constant share dilution.

The First Majestic performance is in line with last quarter's poor results. The data is from the previous financial report.

AG pays negligible dividends. In the long term, higher silver prices will increase the dividend yield. I like dividends, too, but given the AG situation, I prefer that its management team reinvest in its best properties and stop increasing the share count.

Valuation

Gold mining is not an industry where you can project steady future growth. Its cyclicality, lack of pricing power, and asset-heaviness make cash flow predictions often misleading. I value companies in the mining and precious metals sector using the following methods:

• Net asset value
• EV/Sales and Price/Cash Flow
• EV to annual production (AP) and EV to plausible reserves (PR)

I calculate net assets as follows:

NAV = PR*(SP-AISC) + cash + inventories + total receivables - total liabilities

PR (plausible reserves) = 100% * P&P Reserves + 50%*M&I Resources + 30%*Inferred Resources

I examine two scenarios. One conservative with spot silver 18 $/oz. The other is the base scenario using the 22 $/oz price.

Conservative NAV per share = $ (4.37)

Base NAV per share = $ 1.70

AG is among them. However, I will compare it against silver/gold miners because pure silver miners are rare. The companies below are:

• Pan American Silver
• Fresnillo PLC
• Gatos Silver
• MAG Silver

I use EV/Sales and Price/Cash flow to estimate the company`s relative standing. Despite the poor performance, Mr. Market values AG generously compared to its major competitors. However, using both multiples, AG is in the middle between Fresnillo and Pan American.

Last but not least is comparing AG with another silver major on EV/Annual production and EV/Plausible Reserves. AG is cheaper than Fresnillo and Pan American using EV/AP. However, it is more expensive based on EV/PR.

Risk

The political risk is minimized due to the mine's location in Mexico and USA. The financial risk seems nonexistent at first sight; however, it comes at a high price for the shareholders due to gradual share dilution. Thus, AG management keeps the company`s balance sheet neat and clean. Geological and metallurgical risks are impossible to assess for most of the retail investors. San Dimas and Santa Elena mines are located in Mexico, where five of the ten largest silver mines are located. Operational risk is present in the face of Jerrit Canyon mine. In my humble opinion, the low-hanging fruits have been picked already, and AG has to divest Jeritt. By doing so, AG will cut the burden caused by futile Nevada operations and provide capital for expanding its best assets in Mexico.

Conclusion

Mining is a complicated business. Deciding where to invest in challenging tasks requires an analyst`s time and effort. However, using the right mental models can help. The inversion or asking why not to invest is one of those models. My report on First Majestic answers that question. Continuous share dilution like a junior miner, holding an unproductive asset like Jerritt, and higher than average AISC are good reasons not to buy AG shares. On top of that, Mr Market offers a high price for the company`s value. I give First Majestic a sell rating due to all the mentioned reasons.