Pan American Silver — Yamana bid overshadows Q322 results

On 4 November 2022 PAAS announced that together with Agnico Eagle (AEM; US$21.8bn) it has made a definitive binding offer to acquire all issued and outstanding common shares of Yamana Gold. Yamana’s board of directors determined that the PAAS/Agnico offer represented a superior proposal to the transaction between Yamana and Gold Fields announced in May 2022. On 8 November, it was further reported that Gold Fields has terminated its Yamana bid and that the plan of arrangement that Yamana entered on that day with PAAS and Agnico Eagle has become effective. The special shareholder meeting of Yamana, scheduled for 21 November to approve the Gold Fields arrangement, has therefore been cancelled.

According to the terms of the PAAS/Agnico offer, the acquisition consideration of US$4.8bn consists of 153.5m PAAS shares (c 42% of the company’s share capital post transaction), a US$1.0bn cash contribution from Agnico Eagle and 36.1m Agnico Eagle shares. This would value each Yamana share at US$5.02 based on the pre-announcement closing price as of 3 November (US$5.22 at 15 November; see Exhibit 1). The offer values Yamana at 5.6x FY22e consensus EV/EBITDA, which we believe is a reasonable multiple when compared to PAAS’s own consensus-based valuation of 10.5x and given the quality of Yamana’s assets (and the fact that this valuation essentially excludes all non-producing assets such as MARA), as well as the current uncertain market conditions. The transaction requires shareholder approval from PAAS (simple majority of 50%+1 of the votes) and Yamana (two-thirds of the votes). Shareholder votes are expected to be held in January 2023 and the transaction is anticipated to close in Q123.

As part of the transaction, at closing Yamana will transfer its interests in its Canadian assets, in particular in the Malartic mine and Wasamac, to Agnico Eagle. In turn, PAAS will acquire four producing silver and gold operations and a number of advanced development and expansion projects in Latin America (see Exhibit 2), along with all the remaining assets and liabilities (including cash and debt), thereby increasing its asset portfolio to 12 currently producing projects.

In 2021, Yamana’s Latin American assets produced 9.2Moz of silver (PAAS: 19.2Moz) and 0.53Moz of gold (PAAS: 0.58Moz; Yamana total 0.88Moz). Yamana reported combined revenues of US$1,815m and EBITDA of US$1,083m for the period, implying an impressive margin of 60%. The latest production guidance from both companies suggests that Pan American’s FY22 pro forma silver and gold output would increase to approximately 29–30Moz and 1.1–1.2Moz, respectively. In addition to the currently established producing operations, Yamana’s Latin American assets have an advanced expansion potential that could increase the company’s production by 260–330k gold equivalent ounces (GEO) per annum, according to Yamana management.

Yamana’s assets are low-cost operations. In 9M22, the four Latin American mines reported cash costs ranging from US$559/oz to US$1,001/oz (GEO) and all in sustaining costs (AISC) in the US$775–1,410/oz (GEO) range. (We note however that this cost reporting differs from the one used by PAAS, which reports costs on a by-product basis.) At the same time, these projects generated US$905m in revenues (US$1,207m annualised) and US$518m in mine EBITDA (US$691m annualised). For FY22, Yamana’s guidance implies a very competitive combined cash cost of US$710/oz (GEO) and AISC of US$981/oz (GEO) at its LatAm operations.

At end September, Yamana’s capital structure consisted of US$539m in cash and US$774m in debt, implying net debt of US$235m (we note that Yamana also has US$1.4bn in long-term tax liability). PAAS has very low gearing with a Q322 net cash position of US$119m, including US$34m in short-term investments and US$153m in gross cash. Taking into account the termination fee to Gold Fields of US$300m (50% payable by PAAS), the combined company would have pro forma net debt of c US$415m. Based on FY22 consensus EBITDA estimates of US$283m for PAAS and US$961m for Yamana (source: Refinitiv), and adjusting for Canadian Malartic’s (Yamana owns 50%) annualised 9M22 EBITDA of US$342m, this translates into pro forma combined EBITDA of c US$902m and implies a net debt to EBITDA ratio of only c 0.5x. Of note is that the company’s liquidity could be further enhanced by the recently announced cash and shares offer for Maverix Metals from Triple Flag, which values the company at US$606m, or c US$103m for PAAS’s 17% interest. It also excludes G&A synergies, which PAAS estimates at US$40–60m per year.

Overall, we believe that the proposed acquisition has clear rational for PAAS as it allows the company to acquire established silver and gold operations that are low cost, generate substantial cash flows, have relatively long mine lives with expansion potential and are located in the region where PAAS has significant operational expertise. If successful, the deal will cement PAAS’s position as one of the largest independent silver producers and following the anticipated launch of Escobal (20Moz pa historical silver output, c 15Moz feasibility study average), should bring the company’s combined silver output close to the market leader Fresnillo (FY21: 53Moz). On the flip side, the deal would further increase PAAS’s exposure to Latin America, which has relatively high political and economic risks. It will also increase the share of gold in the sales mix (and we view the gold price outlook as more uncertain compared to silver), although it should improve as the company brings Escobal back into production.

Lower commodity prices and unabating cost pressures continued to suppress PAAS’s financial performance in Q3, but at the top line level were largely offset by the higher gold sales. As a result, the company reported flat quarter-on-quarter revenues of US$339m. Similarly, silver and gold production and silver sales were broadly unchanged versus Q222 at 4,537koz, 128.8koz and 4,263koz respectively. At the same time, gold sales increased by 13% q-o-q to 134.7koz thanks to the strong production performance at La Arena and Shahuindo. Total cash production costs were slightly down in absolute terms mainly due to the lower non-cash net realisable value (NRV) inventory adjustments at the project level, which coupled with the reduction in other operating expenses resulted in an 89% q-o-q increase in EBITDA to US$34m.

However, in unit terms cost pressures remained visible during the quarter, with the silver segment cash cost increasing 21% q-o-q to US$14.6/oz and the gold segment cash cost rising 5% to US$1,184/oz. At the project level, the biggest cost increases in the silver segment were seen at the La Colorada mine (US$12.4/oz, +32% q-o-q), which suffered from lower silver grades and general inflationary and supply chain cost pressures. In the same vein, cash costs at Huaron were under pressure, up from US$4.7/oz in Q222 to US$10.9/oz in Q322. In the gold segment, the most notable cost increases came from the Timmins mine, which saw the cash cost rising 11% q-o-q to US$1,748/oz. At the same time, the gold segment saw a 21% sequential reduction in quarterly AISC due to the lower NRV adjustments at Dolores.

Despite the recovery in adjusted earnings, the company still recorded a free cash outflow during the quarter as capex of US$69m and dividend payments of US$23m outweighed the improved cash flow generation (net operating cash flow of US$54m vs US$21m in Q222). Yet, the company remains well capitalised with a net cash position of US$119m (including short-term investments of US$34m and gross cash of US$153m) and US$500m in an available sustainability linked credit facility. In line with its dividend policy, PAAS declared a cash dividend of US$0.11/share for the quarter.

With its Q322 results the company has also partly updated its FY22 production and cost guidance. PAAS now expects to produce 18.0–18.5Moz of silver (from 19.0–20.5Moz) and 550–605koz of gold (unchanged). According to the company, the revised silver production outlook is mainly due to the lower production at Dolores and lower silver grades at La Colorada. PAAS expects grades at Dolores to improve to near reserve levels (proven and probable reserves grade of 317g/t) towards the end of 2022.

On the cost side, while the company left its cash cost and AISC expected values unchanged for both segments, it noted that in the silver segment costs could be above the high end of the range due to ongoing supply chain disruptions and market distortions affecting the input costs. Earlier, PAAS guided silver segment cash costs of US$10.7–12.2/oz and AISC of US$14.5–16.0/oz. Similarly in the gold segment, cash costs are expected to be above the previously announced guidance range of US$970–1,070/oz, while AISC is anticipated to be within the earlier announced range of US$1,450–1,550/oz (excluding NRV adjustments).

We have revised our earnings estimates to reflect the Q322 results, updated production and cost guidance and the recent commodity price fluctuations. We now model silver production of 18.4Moz in FY22, a reduction of 5% versus our prior estimate, and gold production of 563koz, down 1%. We have also adjusted our cost estimates and now expect a silver cash cost of US$12.3/oz (from US$11.1/oz) and a gold segment cash cost of US$1,116/oz (US$1,090/oz), reflecting the ongoing industry cost pressures. Our revised gold segment AISC excluding NRV adjustments of US$1,467/oz (from US$1,453/oz) is within the company’s guidance.

All in all, the above adjustments lower our FY22 revenue estimate by 5% to US$1,541m and our EBITDA estimate by 26% to US$297m. We have also lowered our FY23 estimates, with EBITDA down 5% to US$484m, mainly due to the higher cost expectations as a result of the higher FY22 cost base. However, if the Yamana acquisition goes ahead, which we believe is highly likely, our current FY23 estimates for PAAS will become less relevant. We plan to revise them following the anticipated shareholder approvals of the proposed transaction.

We have updated our cash flow-based valuation of PAAS to US$25.4/share from US$27.5/share on lower earnings estimates and a slightly higher WACC (7.3% vs 7.2% due to higher risk-free rate). This valuation excludes any impact of the proposed acquisition of Yamana. We will update our valuation of PAAS following the votes by shareholders expected in January 2023. In terms of the share price drivers, although cost pressures and supply chain disruptions continue to be the main features of the financial performance in the industry, the recent better than expected October US inflation data provided renewed support to gold and silver prices, increasing expectations of less pronounced interest rates hikes and a milder economic slowdown. For silver this potentially also means lower industrial and physical demand erosion. Based on Refinitiv data, silver exchange traded fund (ETF) holdings seem to have bottomed out in late August and are now c 2% above these levels (although they are still c 5% lower year to date).

When it comes to PAAS’s valuation however, all eyes are now on the proposed Yamana takeover and the way it will affect the value of the combined company. Our ‘back of the envelope’ calculations (see Exhibit 5) suggest a pro forma FY22e consensus EV/EBITDA multiple of 6.5x for the combined company. This compares to PAAS’s current consensus FY22e EV/EBITDA multiple of 10.5x (Edison: 10.2x). Although PAAS’s exposure to gold will increase – and it appears that gold companies in general command somewhat lower valuations compared to the top tier independent silver producers – in our view this is an undemanding multiple. We note that this valuation excludes any likely synergies (but also transaction-related costs) and value contributions from the non-producing assets. Assuming US$40–60m pa in estimated G&A cost savings would lower the implied pro forma multiple to just 6.4x. Additional support to PAAS share price should come from Agnico Eagle’s decision to purchase up to US$150m in PAAS shares on the open market. At the current share price, this represents c 5% of the company’s equity.