Tuesday, March 8, 2016

Fresnillo plc Posted Decent 2015 Results But The Company Is Now More Expensive Than Its Peers

2015 was a good year for Fresnillo plc (LSE: FRES). Despite weak silver and gold prices, the company was able to post net profit of $117.1 million. This was due to the fact that Fresnillo has excellent assets - its mines are very efficient (low production cost) and deliver vast amounts of metals - gold, silver, zinc and lead. Yes, it is the right order - Fresnillo is no longer mainly silver producer - now the company delivers higher revenue attributable to its gold sales.

The charts below show production of gold and silver, starting from 2008:

As I noted above, Fresnillo has been very successful in cutting its costs of production:

As the chart shows, the company decreased its costs of production from $14.92 per one ounce of silver equivalent in 2012 to $12.04 in 2015 (a decrease of 19.3%). I realize that a big part of this decrease was attributable to the favorable exchange rate between the Mexican peso (all mines are located in Mexico) and the US dollar but it is still an impressive success.

Another thing - the flagship property, the Fresnillo mine, is no longer the biggest mine in the company's mineral portfolio. Now Saucito and Herradura are the mines, which took the leadership. Both mines provided the highest revenue and the biggest profits in 2015, while the Fresnillo property had ranked third:

However, in my opinion, Fresnillo shares are today overvalued against its peers. The chart below shows the current valuations of a few big precious metal miners. As a main metric I have chosen an EV / EBITDA (enterprise value to EBITDA) multiple:

The chart shows that today Fresnillo plc and Randgold are around two times more expensive than such big miners as Newmont Mining, Goldcorp or Barrick Gold.

The problem is that it is a short-term overvaluation. In the medium- or long-term, Fresnillo offers a nice leverage to the price of silver. Please, look at the chart below:

At today's silver prices (around $15 per ounce) Fresnillo shares are trading at the EV / EBITDA multiple of 20.9. However, if the price of silver goes up to $18 per ounce, the ratio will go down to 12.7. At the price of silver of $20 per ounce, the ratio (assuming that Fresnillo shares are still trading at today's level, i.e. $13.0 per share), would go down to just 10.1.

Last but not least - all these calculations do not take into account of putting into operation a few new projects (as, for example, the San Julian mine, which should be delivering 10.3 million ounces of silver in annual production).

Fresnillo accounts for the biggest share in my precious metals portfolio - and it will stay there despite the short-term overvaluation.

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