We've been shying away from precious metals miners since prices went into a tailspin last April. Over the past 12 months the price for an ounce of gold has fallen by over a quarter, silver by over a third, while the plight of the miners has been reflected in a 37 per cent contraction in the Dow Jones Precious Metals index. As ever, debate rages about the likely trajectory of gold and silver prices, but we think there is at least one viable recovery play following the sector meltdown: Mexican silver/gold producer Fresnillo (FRES).
- Low-cost producer
- Expanding production base
- Dividend growth rate
- US indutrial recovery
- Falling precious metals prices
- Free cash-flow constraints in 2014
Admittedly, Fresnillo's performance over 2013 makes grim reading. The world's biggest primary silver producer lost more than two-thirds of its value relative to the blue-chip index, making it the worst performing FTSE 100 stock. Aside from dwindling receipts linked to its precious metals output, Fresnillo has had to contend with cost pressures domestically, while an as yet unresolved suspension of its explosives permits at the Herradura and Soledad mines has reduced guidance on 2013 gold production by 8.4 per cent to 425,900 ounces (silver production guidance of 41m ounces for 2013 remains unchanged). Matters weren't helped by analysts at JPMorgan Chase who recently reduced their price target on the stock from 1,000p to 965p a share.
| FRESNILLO (FRES) | ||||
|---|---|---|---|---|
| ORD PRICE: | 672p | MARKET VALUE: | £5.0bn | |
| TOUCH: | 672-674p | 12M HIGH / LOW: | 1,770p | 658p |
| DIVIDEND YIELD: | 2.1% | PE RATIO: | 25 | |
| NET ASSET VALUE: | 323¢ | NET CASH: | $571m | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2010 | 1.41 | 1.02 | 93.0 | 44.8 |
| 2011 | 2.19 | 1.53 | 126 | 103 |
| 2012 | 2.16 | 1.16 | 103 | 57.9 |
| 2013* | 1.64 | 472 | 31.0 | 24.0 |
| 2014* | 1.79 | 690 | 29.0 | 23.0 |
| % change | +9 | +49 | +22 | -4 |
Normal market size:2,000 Matched bargain trading Beta:1.21 *JPMorgan Cazenove estimates £1=$1.65 | ||||
So despite the short-lived rally in gold and silver prices at the start of this year, Fresnillo's shares now trade close to their 12-month low. At this level, there is certainly reason to suggest they've been over-sold.
The group trades on an enterprise-value-to-operating-profit (EV/EBIT) multiple of 14 times, which is 16 per cent below the sector average rating and half that of its nearest rival Hochschild Mining (HOC). Relative to its peers Fresnillo has historically traded at a 12 per cent premium on a EV/EBIT basis, based on two years of Bloomberg consensus data. Applying Fresnillo's historic premium to the 16.6 average multiple commanded by competitors implies a share price of about 900p - a third higher than the current level.
That said, the shares have lost some dividend support recently based on the forecasts of a large fall in the payout. While the majority ownership of Fresnillo by Mexico's Industrias Peñoles means long-term dividend largesse can be expected, spending commitments are likely to hamper payments in coming years. The group is intent on driving up production to 65m ounces of silver and 500,000 ounces of gold by 2018. To fund this expansion capital expenditure is expected to rise from $690m to $875m this year, which combined with the gold/silver price falls, will constrict free cash flows. However, the group's ability to return cash to shareholders will improve through 2015. JPMorgan Cazenove anticipates that cash profits for the group will rise from $962m in 2014 to $1.23bn in the following year.
