Valuing SSRI

November 18, 2002

In my most recent Gold-Eagle.com article I discussed the theory behind valuing a mine. This article attempts to apply that theory to derive a valuation for Silver Standard Resources Inc. (SSRI)

Disclosure and Disclaimer

  1. The writer has a personal interest in 1,000 shares of SSRI
  2. Other than reference to SSRI's Q2 report, and Pan American Silver's (PAAS) 2001 Annual report, no Due Diligence has been done
  3. All assumptions which underlie the calculations are articulated below. If these assumptions turn out to be incorrect, then the conclusions will clearly be incorrect.

Conclusions

  1. Assuming zero value of all "inferred resources" at end of mine life: At its current price of US$4.22 per share, SSRI's market capitalization appears to be factoring in a Silver Price of approximately US$10.35 per ounce.
  2. Assuming that "inferred resources" have the same Net Present Value per ounce in 14 years time as the "measured resources" have today: Factoring in a price of $10.35/oz of Silver, the value of SSRI today is $4.49 per share.

Assumptions

  1. SSRI - which is not yet in production in any of its mines - will only commence production when the Silver price approaches or exceeds $US5.50 per ounce
  2. Its $17 million cash pile will be sufficient to allow the company to gear up its production
  3. Production will be as follows: Yr 1: 2mm oz, Yr2: 8mm oz, Yr 3 onwards: 16mm oz per year

Comments

  • The PAAS 2001 Annual report talks of 9mm oz production as "Steady State", and 11mm oz is its target production for 2003. That company has 611mm reserves and resources as compared with SSRI's 500mm, although there is less certainty attaching to the SSRI number
  • At an assumed rate of production of 16mm ounces per year, SSRI's "Measured" resources will have been depleted in 14 years.

     4. Production costs per ounce will be US$4.40

Comment

PAAS 2001 Annual Report shows that group's production costs were significantly in excess of this number, but that a target of $4 per oz is possible. We have assumed $4.40 because 10% premium offers a reasonable buffer for unforeseen circumstances

5. Administrative overheads will be negligible in the scheme of things

6. Tax will be payable at 30% of Pre tax profits

7. 100% of after tax profits are paid out by way of dividend

8. The fully diluted number of shares at exit will be 44,909,301 assuming all warrants and options are converted into ordinary shares

9. Any additional equity raisings will be for the purposes of acquisitions - which will have no material impact on value per share.

10. Given the high risk that more than one of the above assumptions will prove to be inaccurate, it has been assumed that investors will demand a risk premium, and that the Return On Investment will need to be a least five times the "risk free" Long Bond Rate; or approximately 24% p.a.

Two valuations were done:

  1. Assuming a zero value of the "Inferred" resources in 14 years' time when the "Measured" resources have been depleted:

 

Comment

The above capitalises the business at $189,400,404.89 and places an implied Net Present Value of "measured" silver resources at US$0.84 per ounce

  1. Assuming a zero value of the "Inferred" resources in 14 years' time when the "Measured" resources have been depleted:

2. 2.Assuming that in year 14, today's "Inferred" resources will be worth $0.84 per ounce (ie The company will have a value a exit of $231mm)

 

 

           

 

 

Comments

  1. If the price of Silver rises to $10.35 per ounce, an investment in SSRI at up to around $4.50 per share will yield a Return On Investment of 24% p.a. over a period of 14 years, provided all the underlying assumptions are met.
  2. Conversely, if the price of Silver does not rise above (say) $5.50 per oz it should be recognised that even if a Return On Investment of only three times the Long Bond Rate (approximately 15% p.a.) is acceptable, then the NPV of SSRI is probably somewhere around $0.82 per share

Overall Conclusion

An investment in SSRI is hugely leveraged to the price of Silver.

Technical Analysis

The question now arises: Will the Price of Silver break up above $5.50 per ounce?

Below is a monthly chart of Silver going back to 1994. It seems clear that Silver bottomed at US$4 per ounce and is now struggling to enter a new Primary Bull Market. Of interest is the fact that its highest level in the past eight years the price of Silver has not exceeded US$7.50 per ounce.

(Source: http://futures.tradingcharts.com/chart/SV/M )

Notwithstanding the above, a broader perspective of the Silver price can be achieved by reference to the chart below:

(Source: www.gold-eagle.com/silver_section/silvermonthly.html )

Clearly, in the past 23 years, Silver has demonstrated a capacity to reach levels much higher than $9.35 per ounce, but has not been able to sustain these levels for more than a few months at a time.

Equally clearly, for Silver to sustain a price of $9.35 or greater per ounce for a period of 14 consecutive years in the future, a structural change in the demand for Silver will need to occur.

Personally, (as explained in a previous Gold-Eagle article entitled "Why the US Federal Reserve is Impotent") I believe that Human Society is about to enter a new era of Social Maturity regarding the importance of sustaining its Host Environment, and that for this reason a structural change in behaviour in general is on the cards. (We must adapt our behaviour, or we ourselves will become extinct).

In this context, the structural change in the demand for Silver will likely be driven by "chemical free" Water Disinfection and High Temperature Superconductor applications - for which Silver is uniquely suited.

Of course, in the immediate future, the price of Silver may be heavily influenced by a re-alignment of the forces of supply and demand for conventionmal applications - which have gone out of balance as a result of ill considered, artificial interference. In addition, (and a purely co-incidental matter) the era of "fiat" currencies appears to be drawing to a close, and a heightened perception of Silver as a vehicle of investment (store of value) may also give rise to an added boost to the demand for this unique product in the short - medium term.

In summary, (and heavily influenced by Mr Warren Buffet's $500 million commitment to Silver) I have managed to convince myself that the above factors support the conclusion that Silver and related instruments may turn out to be one of the most profitable long term investment opportunities in today's environment. But, the words "long term" need to be emphasised. Given the current debt and derivatives problems that beset some developed (and most Third World) economies today, it may be several years before the next up-leg in the Long Economic Cycle develops a sustainable momentum.

Silver Standard Resources is one of several Silver focused opportunities available to investors, and it has two added advantages:

  • The company is well capitalised
  • It's mines have a long life expectancy

There are also other opportunities - outside the USA and Canada - which do not expose non-US residents to the Sovereign Risks associated with US Dollar denominated investments - which, in turn, are vulnerable to fluctuations in the value of the US currency. Intriguingly, some of these opportunities (outside of the USA and Canada) appear to have less of a premium factored into their current prices.

Gold is the official state mineral of Alaska.

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