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Fresnillo remains a high quality precious metals play
Precious metals boost
Mexico focused miner Fresnillo (LON:FRES) stands out due to its status as the world’s second largest silver producer. The commodity accounted for just over half of 2011 revenue with gold making up most of the remainder. Plans to grow silver output by half by 2018 remain but with the stock price up with events we rate the shares a hold.
Recently Fresnillo’s shares have sold off; this looks to be partly due to the weakness in precious metals while at the same time Fresnillo is a relatively highly rated stock within its space and is experiencing industry-wide cost pressures.
Fresnillo does stand out for the quality of its operations, balance sheet and dividend policy. The group operates in Mexico which is a safe jurisdiction, has a strong net cash position and pays out around half earnings as dividends. The company is also diversified across gold and silver with 52% of 2011 revenues coming from silver and 44% from gold – the remainder were from Zinc and Lead. The prices of these precious metals are the key earnings driver along with output performance and cost inflation.
Fresnillo is targeting 65m ounces of silver per year and 500 ounces of gold in 2018. This compares to 41.8m ounces of silver produced in 2011 and 449 koz of gold and so represents an increase a 55% increase in silver output and a 11.3% increase in gold output.
In 2011 the story was of a robust increase in precious metals prices more than offsetting cost inflation. Output growth was driven by gold as silver production fell slightly.
Looking in more detail and the average realized gold price was up 26.6% to US$1,585 in 2011 while the average realized silver price was up 62.5% to $34.75 in 2011. Clearly silver was the stand-out performer with this being driven by investment demand.
Both commodities benefited from the second half sovereign debt crisis which drove investors to precious metals. Silver so far in 2012 has traded below the average realized sales figure of 2011 except for one week. Gold meanwhile has so far traded mostly above the average realized sales figure Fresnillo saw in 2011.
The Fresnillo mine produced 51% of group gross profits in 2011 and according to Fresnillo is the world’s primary silver producing mine with 2.8% of global production. To improve safety output was restricted in 2011 to ensure adequate backfilling and ground control which saw output fall.
The group notes that at the Fresnillo mine the: “challenge is to compensate for the trend of declining grades in current reserves by identifying new high grade areas and increasing the volume of ore processed, while profitably mining the plentiful, lower grade resource. To do so, we continue to explore the mine’s area of influence and plan to expand capacity from 8,000 to 10,000 tpd in 2013-2014.”
Turning to gold and the group’s three producing gold mines – Herradura, Seledad-Diplolos and Cienga – all saw higher output.
Importantly the group has seen robust resources growth in 2011 with a 23% increase in silver resources to 1.8 billion oz and a 17% increase in gold resources to 23.5m oz. This will underpin long-term output growth.
Turning to the bottom line and adjusted revenues rose 56% to US$2.3bn which drove through a 60% increase in gross profits. This was as production costs and profits sharing charges mitigated the effect on profits. Profit before tax rose by 50% but due to a higher tax charge profits after tax were up 38.6%.
Fresnillo remains a high quality precious metals play with the advantage of limited political risk. Fiscal risk is always present in any country given the recent propensity of Governments to introduce resource taxes.
This report was produced by Senior Research Analyst, Andrew Latto
