Fresnillo PLC (LON:FRES) shares gained as UBS upgraded its recommendation to ‘buy’, saying it thinks the risk versus reward is attractive.
The Mexico-focused precious metals miner on Wednesday reported record annual silver production, up 5.3% to 61.8mln ounces, due to its first full year of operations at San Julian.
Gold production rose 1.35 to 923,000 ounces, boosted by a higher ore grade an recovery rate at ate at Saucito, the contribution of the new Pyrites Plant and the higher ore grade at Fresnillo.
READ: Fresnillo reports record annual silver production but expects output in 2019 to be slightly lower
However, Fresnillo said silver production is expected to be slightly lower for 2019, in the range of 58mln to 61mln ounces, while gold production is expected to be flat, in the range of 910,000-930,000 ounces.
The company also said 2018 silver production missed expectations due to lower than expected ore grades at the Saucito and Fresnillo mines as well as operational issues.
Market expectations too low, says UBS
“After more than two years of operational disappointments at the Fresnillo mine & medium-term production guidance downgrades, in our view market expectations are low,” UBS said.
It added: “With the risk vs reward for gold/silver prices skewed to the upside, valuation undemanding (vs FRES history) and the risk of negative stock specific headwinds materially lower, we believe the risk vs reward is attractive.”
The investment bank believes Fresnillo has the potential to become the “go-to stock” for European gold exposure following the delisting of Randgold Resources Ltd from the London Stock Exchange and NASDAQ as part of its merger with Canada’s Barrick Gold Corp (NYSE:ABX).
Risk of changes to Mexican mining policy seems 'materially lower'
UBS said Fresnillo has recovered by about 15% from a sell-off seen at the fourth quarter following comments from the Mexican government about mining policy changes.
“Following statements from the new Mexican mining undersecretary Francisco Quiroga (appointed by AMLO) in late 2018, the risk of material changes to Mexican mining legislation seems materially lower,” UBS said.
“Quiroga specifically stated that there would be no retroactive changes to mining concessions/permits that could result in existing licenses being cancelled and there has been no mention of increases to mining royalties.
“We acknowledge comments in Jan-18 from Senator Napoleon Gomez Urrutia calling for higher mining taxation and expect 'noise' in the press to continue, but on balance we believe public statements from Francisco Quiroga reduce the risk of any changes in 2019.”
Less potential for further disappointments
In 2019, UBS does not expect a material improvement at the Fresnillo mine and thinks labour availability could remain an issue. But expectations are low after weak fourth-quarter results and 2019 guidance, reducing the potential for further disappointment, it said.
“We see ~5% downside risk to 2020 silver production guidance (update 26-Feb); but we believe the market should be aware of the issues driving the expected downgrade to 2020 guidance (Fresnillo, Saucito & Juanicipio delay),” UBS said.
UBS thinks Fresnillo’s stock is inexpensive following a de-rating in the second half of 2018 and expects a 20% increase in production over the next four years to drive earnings growth in a flat price environment. Lower capital expenditure will lead to a material improvement in free cash flow, the bank added.
UBS raised its rating to ‘buy’ from ‘neutral’ and lifted its target price to 1,100p from 900p.
Shares rose 3% to 918p in late morning trading.