Friday, April 22, 2016

Hochschild - An Interesting Company Unluckily Hedged At A Wrong Time?

In my opinion, Hochschild is a very interesting company. It is a medium-sized silver / gold producer, operating four mines. Three of them are located in Peru:
Arcata, Pallancata and Inmaculada. The fourth one is San Jose in Argentina (this operation is shared with Mc. Ewen Mining; Hochschild holds a 51% stake). 

Two mines, namely San Jose and Inmaculada, are really good operations. Arcata is just a decent mine while Pallancata is a laggard.

In the previous years the company was struggling to cut its operating costs. These costs were really high, indeed:

source: Simple Digressions and the company's reports

For example, in 2012 the lowest-cost mine was Pallancata but it is hard to tell that production costs standing at around $20 per ounce of silver were low.

Fortunately, as the red arrow shows, the company's management was able to put production costs under its control and in 2015 generally all mines were extracting metals at a cost of around $15 per ounce of silver equivalent. 

What is more, the company is confident that this trend will continue in the coming years. If such is a case, Hochschild may become not only an interesting company but also a decent one.

Let me discuss a few issues, which are, in my opinion, crucial to understand this company.


As I noted above, Pallancata is a lagging operation - look at the charts below:

source: Simple Digressions and the company's reports

source: Simple Digressions and the company's reports

The first chart shows the amount of ore produced (milled) at Pallancata. Most recently this mine was processing less and less ore. What is more, to solve this problem, the company was mining the ore of higher grade (recovery rates were following higher grades). I think that Hochschild, to sustain production at Pallancata, was probably high-grading. 

If such is a case, this mine may be over. However, the company is confident that at the end of 2016 it will start mining at the Pablo deposit, which is a high-grade deposit, most recently discovered at Pallancata. 

Well, maybe the company's management is right but looking at Pablo's basic metrics I see that this deposit is going to be rather a marginal issue for the company (NPV of $40.5 million): 

                        source: the company's presentation

In my opinion, it is more probable that the future of Pallancata looks like the history of another Hochschild's Peruvian mine, Selene (closed in May, 2009):

source: Simple Digressions and the company's reports

I think that the above presented charts look similar to those showing Pallancata now...

Fortunately for the company, the lagging Pallancata should weigh less and less in the coming future:

source: Simple Digressions and the company's reports


Last year Hochschild put into operation its newest mine, a 100%-owned Inmaculada. It is another mine located in the so-called Southern Peru cluster (apart from Pallancata, Arcata and a closed mine Selene) so I would say that Hochschild is an expert company in that region. This year this mine should deliver 14 million ounces of silver equivalent, which means that Inmaculada is going to be the biggest mine in the company's portfolio. What is more, it is going to be the lowest-cost mine as well (all-in sustaining cost of $9 - 10$ per ounce of silver equivalent). 

According to the company, ramping - up production at Inmaculada should decrease total all-in sustaining costs from $12.9 per ounce of silver equivalent to $12.0 - $12.5 per ounce of silver equivalent - look at the chart below:

                         source: the company's presentation

However, according to my own calculations, the break-even price of silver is around $16.5 per ounce. It means that if the price of silver is higher than $16.5 per ounce, Hochschild should show operating profits. Today silver is trading at around $17 per ounce so the chances for an operating profit in 2016 are quite high. However, there is at least one problem - the company's hedge strategy.

Hedge strategy.

Last year Hochschild had hedged part of its production against lower prices of gold and silver: 

                              source: the company's presentation

Well, the management's timing could not be worse. Shortly after this decision the prices of gold and silver started to go up. In such a case, the hedged positions may start working against the company. Let me measure the potential effect that the company's hedges may have on Hochschild's bottom line.  

Assuming today's prices of silver and gold ($17 and $1,240 per ounce, respectively) the company should incur the following paper loses in 2016:

                       source: Simple Digressions and the company's reports

As the table shows, Hochschild may lose around $18.8 million if the prices of silver and gold stay at today's levels. Is is much?

Assuming $16.5 per ounce of silver as a break even-price, the company should make an operating profit of $16 million this year (32 million ounces of silver eq x $0.5 per ounce of silver eq). It means that if the prices of silver do not go higher than $17.0 per ounce the company should not show positive results this year.

Summarizing - in my opinion, Hochschild looks like a decent company for those interested in a silver / gold producer, trading at a multiple of enterprise value / EBITDA of 8.75 (which is quite a low reading, compared to Hochschild's peers). However, the hedge strategy, established most recently by the company's management, may have a big negative impact on the company's bottom line this year. 

1 comment:

  1. Good article! Shares selling near 52 week highs, paying no dividend, losing money (or at best breaking even) per ounce sold, this company has no appeal to me. Here are the AISCs of the top silver companies: SLW $7.00 / TAHO $10.27 / AG $12.25 / GPL $12.60 / SVM $12.79 / SSRI $14.00 / Fortuna $14.33 / Avino $14.40 / Coeur $14.61. All numbers in USD. FYI.