Adamo mines for value in silver sector

by Jack Adamo, editor Insiders Plus

We have reinstated our buy recommendations for Silver Wheaton Corp. (NYSE: SLW) and Pan American Silver Corp. (NASDAQ: PAAS).

First, we look at Pan American Silver; this is one the steadiest growers I’ve seen in any industry. It has more than tripled its silver production in the last 8 years. Its stock has trounced the S&P 500 over the last five, ten and twenty years.

Pan American operates in Mexico, Peru, Bolivia, and Argentina, all reasonably stable countries. Many other miners have major operations in Africa and places like Indonesia, where their fortunes change from regime to regime.

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Last quarter the company earned 31¢ a share, compared to a loss of 41¢ in 2008, a rough quarter for everyone. Silver output rose 30%; cash costs declined 35% and cash flow was a robust 59¢ a share. Full year earnings were 71¢, up 137% from last year’s 30¢. 2010 earnings are expected to jump to $1.27, giving the company a reasonable P/E of 17. The company has no long-term debt and $193 million in cash and short-term investments.

The stock is not as hot now as some of its peers because production growth will be flattish until 2011-2012, but this is my favorite company in the space. It has proved over the decades it can be profitable in good times and bad.

If silver prices fall unexpectedly, I’d rather hold a company like this. If we get the rise in metal prices I expect, the company will produce surprisingly strong earnings. Last year’s average price was just $14.67/oz., spot silver is $16.44 at the moment and should go higher.

Wall Street has a wide range of one-year price targets for this stock from $22 to nearly $26, or 19% above today’s price. I don’t know which, if any, will be right, but I expect the company to continue to deliver positive returns and beat the market for years to come. Buy Pan American Silver Corp. up to $24.50. Take a 4% position in our main portfolio.

Next, Silver Wheaton has 17 silver purchase agreements, with 14 operating mines and 3 development stage projects, whereby it acquires silver production from the counterparties for a per ounce cash payment equal to the lesser of approximately $4 or the then prevailing market price, subject to inflationary adjustments.

It also has one agreement to buy gold production at a per ounce cash payment of the lesser of $300 or the then prevailing market price, subject to inflationary adjustments.

The actual costs are higher, since they paid cash up front for these long-term agreements, but the costs are still low. For example, the most recent deal should end up costing the company about $7.57 per ounce of silver, all in.

These are not the lowest cash costs in the industry by any means, but they are very low risk, since they are largely insulated from rising fuel or labor costs -- the biggest expenses in mining. Only transportation and corporate overhead are significant variable costs. That leaves a lot of the market price left for pure profit with the current spot price of $16.44 in a long-term uptrend.

The company is expected to earn 80¢ this year, compared to 39¢ last year, more than doubling its profit, yet is sells at a P/E of 20, which is still lower than the industry average. Another positive point is that the company's silver and gold interests are located in Mexico, Canada, South America, Europe and the United States, like Pan Am, avoiding the most unstable regions.

Brokerage firms have price targets for Silver Wheaton from $19 to $22. That’s a range of gains of 21% to 40% from its current price. Buy Silver Wheaton Corp. up to $17.25. Take a 4% position in our main portfolio.

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