Silvercorp Is Deeply Undervalued (NYSE:SVM)

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Silvercorp Metals (NYSE:SVM) has put its focus on growth by doubling down on its Chinese Ying silver mining district. This has been accomplished by extensive exploration and infill drilling to increase the resource. Silvercorp has already started the construction of a new mill to almost double current silver production. There are also possibilities for inorganic growth – the company has an impressive $216M cash reserve to make an acquisition outside of China to reduce political risk. In addition, Silvercorp has a 28.2% interest in New Pacific Metals (NEWP), which could deliver future shareholder value and optionality.

Silvercorp

Silvercorp presentation

Historical production and organic growth

Silvercorp has eight producing silver mines in China, and seven are located in the Ying mining district. The company has a track record of stable production with annual silver production of around 6.5M oz., with low all-in sustaining costs. This high profitability is mainly due to the silver mines being high-grade underground mines with many lead and zinc byproducts. Since 2016, Silvercorp has produced over 82M oz. of silver and 1.2B lbs. of lead and zinc. It appears as if Silvercorp has put its focus on growth.

Historical production Silvercorp

Corporate presentation Silvercorp

Silvercorp operated the BYP mine until 2014, and since then the mine has been in a care and maintenance phase. The BYP mine used to produce lead zinc mine, but Silvercorp identified a new gold resource. The company is waiting on the permits to bring the mine back into production, which requires an investment of around $20M for an annual production of 30-40K oz. of gold. Silvercorp should provide more information about future production and costs when it receives the permits. The BYP mine is not a major catalyst, but an additional 30-40K oz. of gold is a nice sweetener. Another bonus is the acquisition of the Kuanping project, close to the Ying mining district. The project was acquired for only $13.5M. Already, six silver/lead/zinc structures and one gold/silver structure have been identified. Silvercorp is expected to drill 12,000 meters in 2022. The Kuanping district could deliver additional ounces of production in the future.

The major growth will come from investments in the flagship Ying mining district. The company drilled 660,000 meters in 2020 and 2021. For investors not familiar with the mining industry, this amount of drilling is massive for a company with a market capitalization of only $421M. Moreover, Silvercorp is expected to drill another 300,000 meters in 2023. The drill intercepts showed high-grade silver, gold, and additional copper areas to mine in the future. The new resource and reserves estimate for the Ying mining district is expected to be published in Q3. Based on the number of meters drilled, the resources and reserves could increase by a lot. The Ying mining district already has a future mine life of 15 years, which is quite long for silver mines. The new resource could make it a unique silver mining district.

Because of increased reserves and resources, Silvercorp can focus on increasing production. The company is already building a new mill to increase the combined production capacity to 5,000 tonnes per day. This would almost double the production to 12-13M oz. of silver. Investors need to remember that Silvercorp still has a cash reserve of $216M even after all the expenditures, such as the 660,000-meter drill program and the acquisition of the Kuanping project. So, the company has already paid for much of the future organic growth. The remaining cash can be used for inorganic growth like mergers and acquisitions (M&A).

Potential M&A

Silvercorp can use the cash to buy assets outside of China to reduce political risk. Silvercorp has already made a rather successful investment in New Pacific Metals. New Pacific Metals owns three early-stage silver projects in Bolivia. The Silversand project is likely a world-class open pit silver mine. Also, the current drill campaign of the Carangas project has shown excellent drill results. Silvercorp has a 28.2% interest, which is valued at $127 million. Silvercorp could increase its stake in the company or buy one of its assets. However, I wouldn’t prefer this because both the Silversand and the Carangas projects are mainly open pit silver mines. Silvercorp does not have experience in open pit mining. Investing in mining stocks is already risky, and I wouldn’t want the company to take on the additional operational risk.

New Pacific Metals assets

Corporate presentation New Pacific Metals

Silvercorp mentioned its ongoing M&A effort in its most recent corporate presentation. The company attempted to acquire Guyana Goldfields in 2020, but was outbid by Zijin Mining (OTCPK:ZIJMF). The current deeply undervalued stock price of Silvercorp clearly shows that the market does not like the Chinese political risk. The completion of the acquisition would create a great deal of shareholder value because it reduces the reliance on the Chinese government. The current depressed silver market should result in only a small acquisition premium when they acquire an asset.

Management

Silvercorp is led by founder and current CEO Rui Feng. They have an excellent track record in operating Chinese underground mines with incredible margins. For me, an important element of Silvercorp is that most of the management team has Chinese roots and a 17-plus-year track record. Mining firms need strong community and government relationships, which is much easier for native management. The management team is also shareholder-friendly as they pay a dividend and had no equity dilution since 2010. One thing that worries me about the management team is that they are very opaque. They didn’t communicate much about their massive, completed drill programs. Furthermore, they have communicated almost nothing about future growth plans, such as the start of building a new mill. I would like to see more clarity from management.

Risks

The main risk for Silvercorp is the political risk of the Chinese government. The growing tension between China and Taiwan increases this risk. The worst-case scenario would be if mining activities were stopped in China. This is similar to when all Canadian and American mining companies left Russia after the invasion of Ukraine. In this case, Silvercorp’s share price would lose its equity value of $79 million, or decrease by 19%. This does not seem like much because most of the Silvercorp value is related to investments in New Pacific Metals and cash. And the cash position might even enable them to continue elsewhere.

Silvercorp offers great leverage to the silver price. This might be an advantage in a silver bull market, but this is a huge disadvantage currently. I don’t see much more downside in silver at the current price. If investors think differently, Silvercorp might not be a compelling investment.

Valuation

The market capitalization of Silvercorp is $421M, but it has $216M and the interest in New Pacific Metals is valued at $126M. So, investors only pay an equity value of $79M for an annual production of 8M oz. of silver and 111.5M oz. of silver reserves in the ground. This valuation is very cheap and becomes even cheaper if investors include the future growth of almost doubled silver production and expected resource growth. In addition, the interest in New Pacific Metals could deliver meaningful upside to the share price of Silvercorp. New Pacific is currently drilling the flagship Silversand project and the Caranagas project. An updated MRE (mineral resource estimate) and PEA (preliminary economic assessment) on the Silversand project are expected to be published in 2022.

Conclusion

Silvercorp has doubled down on growing its Chinese mines by expanding the resource and almost doubling future production. The current share price does not reflect this, with an equity value of only $79M. This makes me believe that investors fear the political risk of China, so a potential acquisition outside of China could unlock a lot of shareholder value. I think the current valuation of Silvercorp offers significant potential reward with only limited downside. Therefore, I recommend buying a small speculative position in Silvercorp Metals.

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