With a big turnaround in the mining sector, mineral producers could regain much of what's been lost since the highs of 2011
In the business of determining if the glass is half full, or half empty, mining companies often make good case studies.
That's because the difference isn't always clear-cut. There are, after all, many parts to the equation.
For starters, precious metals prices over the past few years have been anything but stable.
Moreover, most mining outfits have had to cope with inflation. There's also been the difficulty of defining new resource zones to replace ore that's been mined.
Little wonder that the market caps for so many mining stocks have remained at the lower end of the long-term range.
Still, there are signs that things are improving. Since the beginning of 2014, gold prices, as well as silver prices and some base metals have begun to rebound off their lows.
Indeed, a big turnaround could see a recovery in much of what's been lost since the highs of 2011.
In response, most mineral producers have been trending up. Higher prices, after all, will result in a much stronger bottom line.
As for good value stocks right now, based in Vancouver, Sierra Metals Inc. (SMT-TSX, $1.68) is a growth story with leverage to gold, silver, copper, zinc and lead. It operates two mines in Mexico, as well as one in Peru.
Given their robust ore grades, all three mines have a positive economic profile. Yet, Sierra shares have missed the rally that's now lifting the rest of the sector.
I view Sierra as undervalued. Indeed, I believe investors may have overreacted to some of its short-term issues, while ignoring its near-term potential for much stronger fundamentals.
Moreover, to enlarge its mineral inventory, the company has made it a priority to focus on extensive exploration at each of its core projects.
The work is also designed to expand on the many areas for additional discovery.
What's important to remember about Sierra is that it continued to post positive earnings even while metals prices reached a low ebb.
And although most other mines were losing money when silver fell below US$22 an ounce, Yauricocha was fully leveraged to the spot price.
Admittedly, the company's fourth quarter proved disappointing, as waste rock dilution at Yauricocha lowered average head grades, generating weaker-than-expected profits.
For the three months ended Dec. 31, Sierra's net income fell to US$1.8 million, or $0.050 a share, from $7 million, $0.194 a share, for the similar period in 2012.
Revenue, not surprisingly, was also lower, sliding to US$23.7 million from $36 million, while adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) tumbled 41.2 per cent to US$9 million.
Of course, Sierra wasn't the only mining outfit with poor earnings last quarter, although its share price still took a hit.
Yet, this represents an opportunity for the company to restore Yauricocha's operating efficiency. Then, too, Sierra's poor earnings may have already been fully discounted in its share price.
Yauricocha is an older mine with much of its resources located in a central zone that's both open to depth and along strike.
For its part, Sierra must continue to outline new zones of profitable resources closer to the surface, while striving to become more efficient. It must also stabilize its operating costs.
In the interim, the company's Bolivar mine in Mexico has been a cash cow, thanks to its high grade skarn resource zones which lend themselves to low cost bulk tonnage extraction.
Mainly a copper mine with both zinc and silver by-products, Bolivar had cash costs of just US$1.81 a pound in the fourth quarter.
Moreover, over the past 12 months, the mine's production has doubled - something that should result in better unit costs.
And although spot prices for copper have been under pressure lately, Bolivar remains well within comfortable economic margins. But Cusi, a mine close to Bolivar, is perhaps the most intriguing part of the Sierra story.
Not only has Cusi yielded some very high grade silver results over the last few years, but the company has decided to expand the operation. As a result, it's likely to become a big part of Sierra's growth over the next few years.
Although Cusi went into commercial production in 2013, it's still in the development phase.
For its part, the company has been mining about 300 tonnes a day, averaging 172 grams per tonne of silver, as well as 0.58 per cent lead from lower grade rock.
This is a nice, stable operation - one that generated about 424,000 ounces of silver at a cash cost below $15 an ounce.
But Sierra, recognizing the potential for a much bigger and more profitable mine, is investing to raise its net output.
Indeed, the company is expected to release an updated NI43-101 resource estimate this spring - and, in the third quarter - a pre-feasibility study.
In the meantime, Sierra, which continues to develop Cusi's underground infrastructure, hopes to be able to open new high grade resource zones.
Not only will this allow the company to boost the mine's output, but it will also allow it to cut its average costs.
Moreover, the processing capacity at the nearby Malpaso mill can handle higher throughput. Sierra, which will spend $9 million on Cusi in 2014, hopes to boost silver output by about 70 per cent.
In any event, the time now seems ideal for any mining outfit to strive for ambitious growth.
Indeed, boosting production and cutting overall cash costs while precious metals prices are rising, is a good combination.
Sierra should also gain operating strength from its multi-mine platform, as well as its decision to do business in mining-friendly countries. Then, too, its production is leveraged to several different metals.
To finance its growth, the company has taken on $81 million in debt. Nonetheless, liquidity won't likely be a concern, given the roughly $34 million in cash in Sierra's kitty. The company also boasts an untapped line of credit.
In the meantime, while shareholders wait for a recovery to kick in, they can take heart in Sierra's quarterly dividend.
And a recovery may occur sooner than later. After three years of dreadful markets, new money is once again flowing into mining.
So, a low cost growth story like Sierra should appeal to bargain stocks hunters, given the strong probability that its stock will start going up.
- Mike Kachanovsky, who's based in Lindsay, Ont., is a freelance writer specializing in junior mining stocks. He can be reached at mexicomines@gmail.com.
Investor's Digest of Canada, MPL Communications Inc.133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846