Is there an opportunity?
As a result of a 36% drop in
silver prices last year, silver miners took a beating. Hecla Mining (HL)
plunged by almost 50%, as investor sentiment for precious metals remained
bearish throughout 2013. Metal producers, in general, are extremely vulnerable
to declining metal prices, as revenues realized are directly related to spot
prices.
Zinc and lead together
accounted for almost 30% of Hecla’s nine-month revenue, and the company has
entered into forward agreements to sell 60% of its next three-year zinc and
lead production. However, for gold and silver, the company does not use long-term
hedging and is therefore much more exposed to the risk of falling
precious-metal prices. Both metals contributed almost 70% to the company’s
nine-month revenue in 2013. Even though the company’s average price realized
for gold and silver declined substantially, Hecla posted growth in gold and
silver sales on a year-over-year basis.
The growth in revenue was
primarily due to gold sales from the Casa Berardi mine. Last year, Hecla
diversified its revenue stream by completing the acquisition of Aurizon Mines
(AZK), giving it 100% ownership of the Casa Berardi mine. For the first nine
months, the mine reported a high cash cost of $1,086 per oz., mainly due to
lower-than-anticipated ore grades. The company expects the average gold grade
to increase in the fourth quarter. With the improvement in the gold-ore grade,
it is anticipated that the company’s cash cost of producing gold to come down
in the coming quarters. Currently, a shaft-deepening project is being run at
the mine and is expected to be completed by the first quarter of 2014. Under
the project, Hecla is deepening the West Mine shaft by another 150 feet, and
the project’s completion is expected to increase processing capacity to 2,800
tons per day (tpd) from 1,896 tpd in 2012. With the increase in capacity, I
expect the company to report better production volumes, thus bringing down the
overall cost of production.
For the fourth quarter, the
company expects gold production to increase to 32,000 ounces at a cash cost of
$950 per oz. Apart from the Casa Berardi gold mine, the company’s Lucky Friday
mine, which produces silver, zinc, and lead, will also help increase future
production at lower costs. Prior to 2013, the mine was under a rehabilitation
and enhancement project. Since completion, the mine restarted production in the
first quarter of 2013. As a result, the mine has reported a consistent increase
in production at lower costs.
The mine successfully
reduced its cost of producing silver from $36.5 per oz. in the first quarter to
$16.5 per oz. in the third quarter. Going forward, the company expects to
increase fourth-quarter production to 0.77 million ounces at a much reduced
cost of $9.50 per oz. This will certainly help reduce the company’s cost of
producing silver.
Another player in the mining
industry, Coeur Mining (CDE), is one of Hecla’s close competitors. For the
first nine months, Hecla reported a cash cost of $4.18 per oz. of silver
produced, much lower than Coeur’s cash cost of $10.16 during the same period.
Hecla is clearly more efficient in production than Coeur. Moreover, with
ramping up of production at the Lucky Friday mine, I expect Hecla to report
better efficiency in production costs in the future.
What about the financials?
Even though Hecla has
countered declining metal prices by increasing production at lower costs, the
income statement reveals that the company has struggled with profitability and
lower cash flows. Moreover, Hecla raised debt of $500 million in the second
quarter to fund the Aurizon acquisition. The company will pay half-yearly
interest payments on the debt at the rate of 6.875% on Nov 1 and May 1. As a
result, the company will incur an interest expense of around $17 million in the
fourth quarter, further pressuring earnings and cash flows.
Hecla’s 2012 annual filing
reveals that it values its gold and silver reserves based on the price
assumption of $1,400 per oz. and $26.5 per oz., respectively. As seen with
Barrick Gold (ABX), such assumptions can result in extremely large asset
impairments. At the beginning of 2013, Barrick valued its reserves assuming a
gold price of $1,700 per oz., changing it to $1,300 per oz. in the second
quarter. As a result, the company recorded impairment charges of $8.7 billion
in the same quarter. In the current scenario, Hecla’s price assumptions are
well above existing metal prices, and the company will possibly review them
while declaring fourth-quarter results. A slight change in assumption could
result in impairments and further reduce the company’s earnings.
Conclusion
With the Casa Berardi and
Lucky Friday mines, Hecla is on course to increase its gold and silver
production at lower cash costs. However, the company’s past profitability
issues could widen with interest payments and possible asset impairments.
Investors may want to continue watching the stock from the sidelines as the
overall picture is unclear currently.
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