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In January 2017, I wrote my first SA article focused on the silver mining sector. It's called "Silver Bullets - 3 Emerging Mid-Tier Silver Producers" and it focused on three companies with at least 50 Moz of silver resources as well as a flagship project with an annual output of at least 2.5 Moz of silver. The three companies that I reviewed included Golden Arrow Resources (OTCQB: GARWF), Bear Creek Mining (OTCQX:BCEKF), and Alexco Resource Corp. (NYSE:AXU). Only the shares of the latter have delivered positive returns, which proves how challenging investing in the silver mining sector can be. Alternatively, it could also be interpreted that I'm really bad at analyzing silver miners.
Today, I'm revising Alexco Resource Corp., which has just restarted production and has a market capitalization of $329.7 million as of the time of writing. Overall, I think the company looks overvalued from a fundamentals point of view and I'm bearish. A valuation of close to $330 million looks too high even if the company's reserves were to double.
My top pick from the silver mining sector is Silvercorp Metals (NYSE: SVM), which I've covered here.
Overview of the business
Alexco owns the majority of the Keno Hill Silver District in Canada's Yukon Territory. The district is within the traditional territory of the First Nation Na-Cho Nyak Dun, which represents the most northerly community of the Northern Tutchone language and culture group.
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(Source: Alexco)
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(Source: Alexco)
The district produced over 200 Moz of silver between 1913 and 1989 with average grades of 44 oz/t. These are fantastic grades.
Alexco built the Bellekeno silver mine, which had grades of up to 1,000 g/t silver, and was the only operating primary silver mine in Canada from 2011 to 2013. Following the closure of the mine, Alexco discovered two high-grade silver deposits and in 2020 it decided to resume production. Looking at the current reserves, my opinion is that there isn't a lot of silver out there but the grades are compelling.
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(Source: Alexco)
As I mentioned in my article on Silvercorp, silver is usually a by-product of mining other metals, such as gold, zinc, or lead. Primary silver mines are very rare, especially ones with high grades.
There is a good amount of resources at Keno Hill and I think it's likely that some drilling at Bermingham is likely to significantly boost the reserves of the project. In 2021, Alexco plans to drill over 25,000 meters and deliver a new resource estimate.
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(Source: Alexco)
According to the latest reserve mine plan, Keno Hill is expected to produce around 35.5 million ounces of silver over a mine life of just over eight years. This isn't short in terms of mine life, especially after you take into account the progress Alexco has made over the past few years. Back in January 2017, the company had a sixyear, three million ounces annual silver production mine plan.
Looking at the key financials, Keno Hill has an after-tax net present value (NPV5) at a 5% discount rate of C$154.3 million ($123.7 million) at silver prices of $22.09/oz. The after-tax internal rate of return ((IRR)) is a compelling 295%. The reason for this is that most of the mine infrastructure is already in place thanks to Bellekeno. The total working capital cost was just C$10 million ($8 million).
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(Source: Alexco)
Turning our attention to revenues and cash flow, Keno Hill should begin to shine in its second year.
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(Source: Alexco)
Alexco has a silver streaming agreement for Keno Hill, but the latter covers just 25% of the production. The price that the company receives under the deal is calculated using the following formula.
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(Source: Alexco)
However, this isn't detrimental considering that Keno Hill's costs should be some of the lowest in the world. The average life-of-mine all-in sustaining costs (AISC) are estimated at C$11.59 ($9.29) per ounce of silver and this number includes corporate costs and working capital. Grade is king as they say.
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(Source: Alexco)
Looking at the balance sheet, the situation is solid. Alexco has no debts and cash and equivalents are around C$40 million ($32 million) following a $28.75 million ($23.05 million) bought deal offering that closed in June. Stock dilution risk should be minimal at the moment.
However, Alexco is valued at $329.7 million as of the time of writing, which I think is too much considering Keno Hill has an NPV of $123.7 million and there are $32 million in the bank. The mine is still ramping up and there is technical risk. However, even if everything goes smooth and Alexco reaches an annual production rate of over 4 Moz of silver, reserves would need to triple for a valuation of almost $330 million to make any sense. Either that or silver prices would need to skyrocket.
It seems that silver prices are the main risk for the bear case. They are almost impossible to forecast as it's an opaque and somewhat small market. I can think of numerous attempts at manipulation over the years, the most infamous of which is probably Silver Thursday.
Investor takeaway
Alexco has a relatively small silver mine in a great jurisdiction and the grades are compelling. The exploration potential is good and I can see Keno Hill doubling its reserves in the next few years. However, even if this happens, a market valuation of close to $330 million doesn't seem justified.
In my view, Alexco is overvalued and investors can take advantage of this by short-selling the shares or buying put options. According to Fintel, the short borrow fee rate stands at 11.32% as of the time of writing.
In case you prefer to protect the downside, I think long-dated put options could be a good idea.