Pan American Silver Corp (PAAS) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Pan American Silver Corporation first quarter 2005 earnings conference call. (Operator instructions) It is now my pleasure to turn the floor over to your host, Ross Beaty. Sir, the floor is yours.

Thank you very much, operator. Good morning, ladies and gentlemen. Welcome to Pan American’s Q1 results conference call. As usual, we will follow my introduction with a Q&A period. To help answer any questions, I have with me here in Vancouver Geoff Burns, Pan American’s President and CEO; Rob Doyle, our CFO; Andy Pooler, Senior VP of Operations; and Brenda Radies, our VP of Corporate Development.

Yesterday afternoon was our annual general meeting, where all our directors were reelected for another year. While this is a routine corporate event, we also use it as an excuse to bring all of our senior management to Vancouver for some in-depth management discussions, and to give our board a chance to discuss company matters directly with all of our senior team. It also serves as a reminder to me the caliber of our management team. It is a cliché to say that we have a great team, but it is true and I want to remind our shareholders of the huge strengthening of our team over the last couple of years.

This process is now complete and I think our existing team is capable of really driving our growth over the next five plus years as we seek to double again and then double again our silver production.

The biggest item of discussion at this year’s board and management meetings associated with our annual general meeting was, where are the earnings? Our financial results that were announced this morning were disappointing, in view of the 4 percent stronger silver and 20 percent stronger base metal prices we are now seeing relative to a year ago.

While our operations are generating adequate cash flow, about $4.7m in Q1 and positive net operating earnings, about $1.5b in Q1, our internal earnings target was not met. So I am going to go into some detail on what happened this quarter.

To summarize, our revenue went up 79 percent. That is pretty good growth, and that was due to strong growth in our silver production, up 27 percent and to more concentrate shipments in the quarter than we had a year ago. But our costs went up even more, and eroded the benefits of our higher revenue. Here is the current picture.

We are experiencing higher fuel, power, shipping and timber costs at our operations. Timber is used, of course, in underground operations at all three mines, in Peru particularly, so it is a significant cost of our operation there. Those costs have all gone up.

Now some of these costs will come down during the balance of 2005 and others will persist. It is very hard to predict what is going to happen particularly to fuel prices in terms of the oil price and also in some less related way, power rates, because a lot of our power rates depend on water flows and so forth, particularly in Peru where we have mostly hydro power.

We also expect shipping rates will come down as more shipped are deployed to bulk carrying, but we don’t know when that will happen.

We also saw in the first quarter about an 8 percent increase in our labor and other costs associated and denominated in Peruvian and Mexican currencies, as there has been an 8 percent devaluation of the U.S. dollar against those currencies. This devaluation didn’t happen much in 2004, but in Q1 there was a market appreciation of these currencies against the U.S. dollar.

Now again, this devaluation or appreciation, relatively speaking, may or may not continue, and we are not ready if there are any questions on this, and just to answer that question if it exists, we are not yet ready to hedge our local currency exposure against the dollar. We are paying higher charges to the smelters as well that treat our concentrates, due to price participation clauses normal to such contracts.

And then we have just paid, for the first time, $0.5m in Q1 for a new royalty in Peru. This is a very regressive type of tax. It is a gross net smelter return royalty and we hope the Peruvian government will reverse this in due course once it appreciates the very negative effect of such a royalty on the investment climate of Peru.

We are also paying much higher income tax, or in fact, we are also paying income tax really for the first time in Peru. We started paying this in the latter half of last year and we expensed $1.2m this quarter compared to nil in 2004. Now having said that, I never complain too much about paying true income tax, since it does mean our operations are profitable. But I very much object to paying gross royalties which are payable even if a mine is losing money, and that is where the new tax in Peru is regressive.

Other costs impacting us this quarter were increased general and administrative costs, due to number one, our expanded management team, and number two, because much of this team is paid in Canadian dollars which in fact appreciated 20 percent against the U.S. dollar in the last year. Actually very little of our cost base is payable in Canadian dollars, but the head office here in Vancouver is and that has obviously caused our G&A to go up to some degree.

We are also incurring unusual costs to make us compliant under the new Sarbanes Oxley Act, and that cost will not recur in 2006. Even with all these extra costs though, we would still have reported positive earnings but for two other items. Firstly, we put some base metal hedges in place over the last two years to avoid the risk of us having to sell our base metals at the really low prices of three or four years ago. Now we locked in prices lower than we would have realized with no hedges, using the benefit of hindsight. This cost us about $2m in foregone revenue in Q1. But obviously, we are trying to protect our downside here and we thought it was a prudent thing to do at the time.

I should say that we are not doing any current base metal hedging, but I wouldn’t preclude that from happening again in the future to the extent we would see unsustainable spikes in the price.

We also expenses $1.5m in exploration in Q1, about $1m more than last year and all of this went to our bottom line as a cost. All of the increase was spent at our Manantial Espejo project where we are nearly finished a feasibility study and costs after we complete the feasibility will be capitalized. So this expense will not recur, however we do plan on carrying out an expanded exploration program in 2005 and 2006 beyond what we’ve done in the last couple of years. We think our growth – and so we will have continued exploration expenses, because we are going to drive a lot of our growth now with, we hope, successful discoveries as opposed to major acquisitions. So we are really going to kick up our exploration effort for silver.

Now that might be more detail than you wanted on our cost structure, but I felt it was important to indicate that our cost structure has increased, not permanently in many cases, but certainly there will be a higher cost structure as we see in the future as long as things stay as they are today, and we are taking this very seriously. We are working very hard to eventually reduce unit costs through, for example, better productivity.

Our silver and copper production was also modestly below our budgeted levels, and this cost us about $2m particularly at our Huaron mine in Peru. We do expect though that our annual silver production will be at our budgeted target of $13.5m in 2005 as we expect Huaron and to a less extent, Quiruvilca a slight shortfall we had at Quiruvilca to our expectations, will catch up production in the balance of 2005.

There are a host of issues at those two operations that caused slightly lower production than our plan, and those issues are absolutely correctible, most of them are corrected already, and as I said, we expect to catch up production. None of them are serious and none of them are major.

So those are some of the negatives of our Q1 results. I would like to also briefly talk about some positives that happened in Q1. Firstly, our new Morococha mine operated very, very well producing at budget grades and below budget costs. But for me, the most exciting part is we’ve received some very, very good exploration results that will bode well for the future with respect to lowering our unit costs for operating through discovery of a very wide zone there that is new. We are going to get into that and try to develop it as soon as we can. So that will lower our cost and it will also allow us to expand our production in due course. So very exciting exploration results there, and good operating results.

Our La Colorada mine in Mexico also had its best quarter ever. It reached designed capacity and had its best safety record as well. We are still working on resolving the water problems there that prevent our sulfide mine from restarting, but we hope this will occur by late 2005 and again, this will really drive costs there down much lower than we are now seeing.

Also in Mexico, as most of you know, we made a decision to build our newest mine, Alamo Dorado. This operation will begin in late 2006 and again, should drive our operating costs lower while enabling us to produce about 22m ounces on an annual basis, starting in about 15-16 months. Our senior team has been completely assembled there. We’ve advanced all of the lead time, the large lead time purchases, we have all of our equipment now ordered and in place. We don’t have any timeline issues as far as we know right now. Permits are in place and we are really rocking and rolling right now in getting that mine up and running. We expect to start moving dirt when, Andy, in about October? Starting mining operations in October and we should have first production coming out in the fall of ’06.

Finally, we also embarked on a program to market pure silver coins and bars for investors interested in buying physical silver. These beautiful silver products – and I mean, they really are beautiful – will offer investors an inexpensive way to buy Pan American Silver from our Mexican mine, from La Colorada and it will also stimulate silver demand on a long-term basis, so I am really looking forward to the success of that program. So far we’ve already sold over 50,000 ounces of our silver products. If any of you have questions on how to order these, absolutely tell us, phone Brenda Radies and she will give you links into the website of the mint that is doing the minting for us, or the telephone number to place orders.

So our strong growth will continue. We are working hard on our Manantial Espejo project in Argentina and on our San Vicente project in Bolivia. Both of these projects will allow us to expand our silver production again, and improve our leverage yet again to silver faces. We are going to really focus on our costs for the balance of 2005, and I certainly hope to report improved results for the balance of the year, especially in the second half.

Our objective of becoming the largest primary silver producer in the world will be met shortly, and we remain steadfast in our mission of delivering the best leverage to the silver base of any company in the world. I expect silver price will remain strong for the foreseeable future. With our expanded production at our new mines, Morococha San Vicente and Alamo Dorado producing at lower cash costs throughout the operations, I am certain our costs will decrease. We will become more productive and we will deliver better earnings growth to our shareholders, in addition to strong capital gains growth as we grow our silver reserves and resources.

Our share liquidity remains the best in the silver industry. We have an excellent balance sheet with over $100m in working capital and no debt, and we continue to have the best growth profile in the industry. While I could go on and on, particularly about how and why I think silver prices will remain firm. Bottom line, I think we are in the early stages of a commodity super cycle and Pan American is very well positioned to benefit from this on a long-term basis. I want to close on that note and open the call to questions, and hopefully can refine some of my comments today with further detail from Geoff or Rob to the extent that you have questions. Thank you again for joining us today. I would like to open the call now to questions, operator.

Thank you. (Operator instructions) Our first question is coming from Steve Butler; Canaccord Capital.

We just thought we’d give you a bit of a scare there, guys. Just kidding. It is a busy day and you have a conflict with the Kinross call at the moment, but that’s okay. I wanted to ask you a question about grades, I just noticed at least with respect to my model, maybe not with respect to your quarterly plans, how the zinc grades were substantially lowered. It seemed asynchronously lower at Huaron and Morococha. Maybe you can comment just on the sequencing, because I found that that was a particularly disappointing grade profile, at least in the quarter. I didn’t really have specific Q1 guidance, guys.

Okay. Did you want to tackle that one, Andy?

Sure, thank you. This is Andy Pooler, SVP of Operations. Zinc has trailed off a little bit with other production numbers in the first quarter at [RON]. We’ve taken majors to offset that going into the second quarter. We do have one high-grade zinc vein that we are working on off of the metallurgical issues at [RON] so we set that aside for the first quarter. Morococha we have a zinc area of the mine, in the upper area, and a silver ridge in the lower. [Al Alta] has experienced mechanical issues in the first quarter, so those grades will rebound in the second quarter, I think, and get back on track.

What is the forecast grade for the year, Andy, that we can be given guidance on?

It will be right back to budget level forecast. I can look it up.

Yes, why don’t we look it up.

Okay. We will give you the budget level on that, Steve, in just a second. But as I said, we should get back to those levels. And we had above budget zinc grades – you don’t see that in the results here, from Morococha we had above budget zinc grades in the quarter. So on balance, we are actually not doing too bad.

If we round out Morococha we not only had above budget, but we increased the recovery of our zinc by 10 percent at Morococha and will also add on several hundred tons of zinc per month of production from Morococha, and rising as well.

Yes, if you want to put it in a model, we expect right now to produce about 1,300 tons more zinc at Morococha than we budgeted, primarily because of the better recoveries but also because their grades are a little bit better. And that will offset anything we lose out of Morococha.

Did you guys experience – has it been a pretty dramatic increase in TCRCs or can you broadly speak to those?

Sure. Well actually, Rob, do you want to speak to that? I mean, it is not really the TCRC increase I was speaking to, it is the price participation clauses which just means you don’t get all the benefit of the higher price on the base metal side.

And typical of zinc and zinc contracts, the buyers of our concentrate are just placing in escalators, so that could be as much as $0.38 on every dollar. So in other words, for every dollar that zinc goes higher, $0.38-0.40 might go to the smelter or the buyer of the concentrate.

Rob, is that above $0.45 zinc, generally?

Typically, well our threshold is right around 1,000 the base is 1000 for 10. Yet –

The $0.45. It is pretty close, Steve.

Okay, and how about on lead, what is the basis there?

The basis actually varies from contract to contract, Steve, and I can certainly get back to you with more detail. Unfortunately, the basis on quite a lot of our lead is very large, around about 500 although we do have some contracts where the basis is closer to 700.

It makes for good pulling the hair out, analyzing your TCRCs.

Oh yes, for sure. For sure.

Last question, do you expect to expense an additional $1.8m for the Manantial Espejo feasibility, so that will be a Q2/Q3 sort of split?

No, I’m sorry, Steve. We don’t have that much in our budget for the balance of the year for Manantial Espejo I forget what the exact number is. Is it $3m for the balance of the year, Rob?

From the end of Q1 to the rest of – so for the 2005 calendar year.

I’m sorry, Rob, I stand corrected. It will be another $1.5m of Pan American’s interest.

Right. You are expecting this, I could reasonably split that in Q2 and Q3?

I think so, yes.

For expensing purposes.

Yes, that is fine. And then it will drop right off and should be nothing in Q4.

Okay. Thanks very much.

I do have the numbers relative to the zinc grade. Actually on the grade relative to budget, we were fairly close, but we will see about an 8 percent increase over the next two quarters from both mines, up to the 3.25 percent level of zinc, and then our production will be right no track, if not a little ahead of track.

Thanks, Andy.

Thanks.

Thank you. Our next question is from Tom Jacobowski with BMO Nesbitt Burns.

Hello, guys.

Good morning, Tom.

Good morning. I just have a couple of questions, the first one being your cash cost calculation. You guys are using a base for the payables, the payable cash costs right now. Is that going to be going forward?

Yes it is, Tom. And then it would change from previously added, more in line with industry standards.

And so that will be happening going forward as well?

That’s correct.

Are you still maintaining your USD $4.25 per ounce forecast for the year? I mean, you came in I think at $4.50 for Q1 if I am not mistaken. Do you think you are still going to be able to meet the $4.25 for the year?

Yes, Tom. This is Geoff. To answer your question, I believe that we will get to the $4.25. In Ross’ comments he noted that we were a little bit below our expectations on our silver production in the first quarter, and the other area we were behind where we thought we were going to be is actually on copper production, which contributes a fair bit to our by-product credit. We believe over the balance of the year that we are going to meet that 13.5m ounces and by bringing back in the higher levels of the by-products I think we are going to make that $4.25.

The only caveat I would have to that Tom is right now we are still working hard to get San Vicente moving forward. If we do not get that moving forward in the next month or so, that could have a little bit of a negative impact on that $4.25. I am confident that we will, but that would be the only caveat I would put on it.

Okay. Okay, that is it. Thanks guys.

Thanks, Tom.

(Operator instructions) Our next question is coming from Michael Vint; CIBC World Markets.

Hi. Just a question, you mentioned labor as being a contributor to your earnings going down. I was wondering if you could break that down a little bit more for me as to what percentage it has gone up and why you think it has gone up.

Do you want to tackle that one, Rob, or Geoff?

Let me take that one, Michael. I think the biggest part in terms of labor is really the currency impact on the labor. We obviously are paying our local workforces in Peruvian Soles in Peru and Pesos in Mexico. That approximately is 35 percent of our cash cost basis on our on site, so the 8 percent change in the devaluation of those currencies relative to the U.S. dollar is the biggest contributor.

In terms of on location, we have had some increases or have put in place some increases, particularly at Morococha. We did, as you know, we took over that operation last year and I can tell you that we are trying to bring that operation and the workforce in line with what we are paying at our other two mines which will, in my view, keep our workforce in tune and keep the productivity higher than they have been in the past. So that has contributed to a little bit of the labor increase.

Great, thanks.

We had some questions last year on when the U.S. dollar devalued so sharply against so many currencies globally like the Euro and Canadian Dollar and Australian Dollar and South African Rand and so forth. That was going on in Mexico and Peru, and at that time, most of last year actually the Peruvian Sole and the Mexican Peso were relatively stable and, in fact, devalued along with the dollar relative to all those other currencies. So we were fairly happy. We are producing basically dollars, we are producing in U.S. dollar denominated commodity and we were paying our expenses primarily in U.S. dollar denominated local currencies.

Now the Mexican Peso has appreciated modestly, about 4-5 percent in the last six months, really last three or four months, against the Dollar. We don’t see that as likely to continue particularly, because the Mexican economy is so closely tied to the U.S. economy. It may a little bit, but it is not likely. So it has been very much a function of the strong oil prices and the fact that Mexico is a big oil exporter.

In terms of Peru, the Peruvian Sole has in fact appreciated 8-10 percent against the U.S. Dollar in the last five or six months. This has been a bit of a surprise to all of us. Obviously if we had known it was going to happen we would have hedged, but we were somewhat surprised. It is a function of quite a strong Peruvian economy right now. Lots of demand for Peruvian money and a very healthy mining industry, particularly in Peru. Lots of big new projects and to the extent that continues, I suppose it is not going to get a lot better. We just don’t think it is going to get a lot worse either, so at the moment we are not really inclined to do any hedging and suffer those attendant risks to predict things.

Okay. The next question was the royalty in Peru. I didn’t get a chance to read in detail the report there. What is that number? The other one was a quick question on those silver coins.

If you want to ask the question, we will give you all of the answers.

All right. So the silver coins, what do you expect for margin on that? What kind of premium are you selling them at, or how should I value that?

Sounds good. The first question on royalties. I’m sorry, this is a tough [inaudible] I just think this was a – regressive is the most polite word I can use. It is a 1-3 percent gross royalties on mineral product exports or production from any Peruvian mine, full stop. It is a gross royalty. We pay 1 percent, the 1-3 percent depends on your revenue from the mine, and we are just under the 1 percent if we segregate each mine and pay it separately. If we had to put them all together we would have to pay more than 1 percent.

It is a significant cost, and I would say it is –

It is 1-3 percent?

It is 1 percent for us, 3 percent for a very big producer like Anicocho or Southern Group Ops. Or some of the big, big mines there. A big, big expense comes right off the top and – or right off the bottom line, really, and I just think it is foolish because it does definitely reduce the – I think it makes the investment climate worse in Peru. It makes mining projects less competitive compared to anywhere else.

What the Chileans are trying to do right now is make it more of a profit-based tax, you can dispute the need for a country to tax anybody or anywhere, but if they decide to tax, fair enough, they have that right to do that. It is how they tax that I object to, and this particular tax is going to scare away investment and it doesn’t need to. Peru is a great country, it is a terrific mining country and I think it is just not good economic policy. That is the bottom line.

And from our standpoint, it is costing us about $2m a year, basically on the high about $0.12 an ounce.

On the silver coin question, we are not making a nickel on those coins, Mike. We are simply offering the – exactly. This is marketing, this is stimulating demand for our products, we are offering it to the mint more or less at cost and they are taking a very, very low margin on this of between $0.50-0.70 per ounce for actually doing the refining and the production of the bars and the coins, and in so doing are able to offer these.

Why we like this plan is we are able to offer these products to investors, pretty well the lowest cost physical silver that they can buy anywhere. I mean, you compare that to say Silver Eagles or Canadian Maple Leafs, which you can go down to a coin dealer and buy for double their face value and these are coming out. These are true monetary products. They will also be resalable. The mint will buy them at a slight discount off the spot price and so these are true bullion products. This is money.

It is? Okay. All right, well thanks.

Thank you. Our next question is coming from John

Hi, guys.

Good morning, John.

Ross, can you maybe comment on what you are seeing in terms of supply/demand for the silver market? Maybe also comment on the Chinese government sales of silver?

Sure. I will try to make that brief. The demand side is broad-based, as strong demand is going to grow this year relative to a slight decline last year because [inaudible] is off. The photography demand is down, that is, however, offset by less the photography scrap coming back into the market. So the photography side is only a very slight on the total supply/demand balance, but it is a slight negative, it is not a positive.

The strength this year is going to be in India where they are buying the silver again. They just simply stopped buying silver last year when silver went up above $6. The silver market in India, of course, is the only real price sensitive market and they have traditionally stopped buying on spikes up but heavily when the price is low. They are price sensitive.

I think when the price took off last year many people who had been in a traditional buy – sell on spikes, buy on dips kind of a trading pattern – didn’t realize that the fundamentals of commodity markets right now have changed profoundly. I think, as I said already, we are in a super cycle and I think many, many people agree with that. It is not for no reason I say that, there are a lot of reasons behind that. But to the extent we are in a super cycle, the price will not retreat below $6 and I think silver, really, we can look forward to many, many years of good prices relative to the last five or 10 years.

Now that has also been accepted in India and in places where the Indians buy through, such as Dubai, where they are now buying silver to satisfy the historical, the cultural, the religious reasons that they have been the world’s number one silver market for millennia. So they are now back in the market.

In jewelery and silverware dropped 8 percent last year and that was almost entirely the Indians stopping their purchase of silver. So now to the extent they are back in the market we should see returned growth to that sector, certainly up over last year and that is going to bring the total silver demand much higher than it was a year ago.

So that side is pretty strong right now. And I think you are also seeing those numbers coming through in the gold and platinum group metals, prices for jewelry and silverware. Other than certain markets for platinum, that is another story.

So on the demand side, things are pretty good. On the supply side, things are also pretty good. We are seeing more or less static demand, supply growth this year from the number one source of supply which is mines. We are not seeing significant byproduct supply entering the market, and there is no new silver mines coming on stream right now, i.e. this year, that are going to impact that much.

I’ve done a supply study of mines that are opening, but by the same token there are mines shutting down, just because they are exhausted. There has been a number of those in the last couple of years, and that will continue in the next few years. So even though there is some big new production coming on stream in say two or three years, Yauliyacu in Chile and Apex’s [Crostola] mine in Bolivia are two examples, the net new production is still relatively modest looking out five years. And this year, it is probably going to be maybe 1 percent, in that order.

Scrap supply is down, mine supply static, investment demand is there and the investment supply is seriously depleted. Now that supply that is coming from above ground stock piles to satisfy what has been a deficit market for the last 15 years has largely come from China in the last five years. These are government stockpiles sold out of China.

We don’t have good numbers, but we think those sales are dramatically reduced if not – those stockpiles are dramatically reduced, if not depleted completely. They might have 50-80m ounces left, it is a guess. It is Gold Sales guess, Gold Sales does the annual silver survey, but it is just a guess.

Now India is the only other government that has significant known stockpiles. They have about 80m ounces they announced last year – when was it Brenda, earlier this year? That they were going to dispose of those at a rate of about 20m ounces a year for the next four years. So none of those numbers are big enough to provide any supply shock to the markets. On balance, there are many, many reasons to be bullish about silver prices really long-term, and that is why we continue to be bullish.

We don’t see, barring a shock, barring a real crisis when silver of course could go through the rough, we see modestly improving prices. Not dramatically improving prices. That is kind of what we hope will happen as well, because of course it improves markets long-term if there are modest things that happen. Of course, markets don’t really usually perform that way, but we like to think they will. I hope that answers your question.

Yes, thank you.

Thank you. At this time there appear to be no further questions. I would now like to turn the floor back to Ross Beaty for any further comments.

Well thank you. I am not going to say anything more. I think that covers things off. You, I am sure, detected a note of disappointment in my voice over the results, we are very, very serious about wanting to build our bottom line instead of having it shrink. We are very serious about wanting to build a company with good, solid earnings because we think we have delivered everything else that creates wealth to our shareholders and that is why we are so conscious about trying to improve our bottom line results, build our production base even further and increase our margins to the extent we can.

A lot of this is a function of luck in a certain sense in that mines are what they are, Mother Nature gives you a cost base that if they are mines like we have, which are narrow, very labor intensive mines. You have a built-in cost structure you can’t do too much about, but within that there are ways to make it better and that really comes to management.

I feel we do have the strongest management team in the silver sector and so to the extent we can wring every single last nickel out of these operations, we are quite steadfastly focused on doing that.

Apart from that, I think everything else is pretty good. We are a pretty happy company right now, and we know where we are going. It is a particular honor to see all of our operating managers here in Vancouver this week to share the experience, I guess.

On that I will close. Thank you again and give us a call if you have any further questions. Bye, bye.

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time.