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Mining - Silver Stock Outlook: Near-Term Prospects Cloudy

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Silver has been on a bearish run so far this year owing to trade war apprehensions emanating from the ongoing imbroglio between the United States and China, and stronger U.S. dollar. Another factor working against silver is the possibility of the Fed raising interest rates. Notably, a robust economy gives the Fed a reason to raise interest rates. Higher U.S. rates dent the appeal of silver as it does not offer interest. Consequently, an interest rate hike, which is likely at the FOMC meeting on Sep 25-26, is likely to hinder silver further. All these factors have dragged silver prices down by 16% over the past year. 
 
However, every cloud has a silver lining. Silver has multiple industrial applications which accounted for 60% of global silver consumption in 2017. Growing industrial activity will provide the much-needed boost for silver demand. China and India will remain major growth drivers. Meanwhile, the metal’s supply growth is likely to lose pace owing to the lack of new mines and expansions. Consequently, we are looking at a potential silver deficit, which in turn sets the stage for higher silver prices in the long haul. 
 
Industry Lags on Shareholder Returns
 
Looking at shareholder returns over the past year, it is quite apparent that investors’ confidence on the industry’s prospects has taken a beating. Prospects of a rate hike and constant threat of trade war have kept the industry under pressure.
 
The Zacks Mining – Silver Industry, which is a 13-stock group within the broader Zacks Basic Materials Sector, has underperformed both the S&P 500 and its own sector over the past year.
 
While the stocks in this industry have collectively declined 19.7%, the Zacks Basic Material Sector and the Zacks S&P 500 Composite have increased 2.2% and 16.3%, respectively.
 
One-Year Price Performance
 
 
Valuation Picture
 
One might get a good sense of the industry’s relative valuation by looking at its Enterprise Value to Earnings before Interest Depreciation and Amortization (EV/EBITDA). This valuation is a good measure for the industry’s given its complicated and capital-intensive nature. It helps investors compare silver mining companies with various capital structures and gives a more accurate feel of the financial health of a miner as well as whether it is undervalued in comparison with its peers.
 
The industry currently has a trailing 12-month EV/EBITDA ratio of 10.5, which when compared with the highest level of 13.4 over the last year and median level of 11.1, reflects the fact that there is more room to run.
 
The space also looks inexpensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.9 and the median level is 11.6.
 
EV/EBITDA Ratio (TTM)
 
 
However, a comparison of the group’s EV/EBITDA ratio with that of its broader sector reveals that the group is trading at a premium. The Zacks Basic Material Sector’s trailing 12-month EV/EBITDA ratio of 7.9 is lower than the Zacks Mining – Silver Industry’s EV/EBITDA ratio of 10.5.
 
EV/EBITDA Ratio (TTM)
 
 
Underperformance May Continue Due to Bleak Earnings Outlook
 
Rising industrial demand and broader economic growth present solid growth opportunities in the silver- mining space. However, it’s hard to ignore lower silver prices, and weak margins stemming from high costs of operations. This certainly weighs on the near-term results of the companies in this space.
 
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
 
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. Clearly, a downward trend has been witnessed in both the years.
                              
Price and Consensus: Zacks Mining - Silver industry
 
 
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
 
Please note that the 15 cents 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks – Silver Mining industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings of 15 cents 'per share' of the industry for 2018, but how this number has evolved recently.
 
                         Current Fiscal Year EPS Estimate Revisions
 
 
As you can see here, the 15 cents 'EPS' estimate for 2018 is down from 41 cents at the end of March and the peak of 44 cents attained this time last year. In other words, the sell-side analysts covering the companies in the Zacks -Silver Mining industry have been lowering their estimates.
 
Zacks Industry Rank Indicates Blurs Near-Term Prospects
 
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.
 
The Zacks Mining – Silver industry currently carries a Zacks Industry Rank #244, which places it at the bottom 3% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
 
Our proprietary Heat Map shows that the industry’s rank has been languishing in the bottom half over the past eight weeks.
 
 
Silver Miners Lags in Long-Term Growth 
 
The long-term (3-5 years) EPS growth estimate for the Zacks Mining - Silver industry has remained stable at 3% over the past year. This compares unfavorably with 9.8% for the Zacks S&P 500 composite.
 
Mean Estimate of Long-Term EPS Growth Rate
 
 
The reason behind this tempered long-terms EPS growth expectation could be unsteady pattern trend in the top line that silver miners have been experiencing over the past two years. From the figure below, we can see that revenues had peaked in the first half of 2016, but have lost steam since then. The revenue picture has been quite unstable of late. Global silver mine production fell by 4.1% in 2017, experiencing its second consecutive annual decline, mainly owing to a series of supply disruptions across the Americas.
 
 
Moreover, a decline has been noted in EBITDA, which is a key element in valuation of gold mining stocks, as mentioned earlier. Its worth noting that at the beginning of 2016, the industry’s earnings began to improve, however it started declining since June 2016. This can primarily be attributed to increasing costs.
 
 
Bottom Line
 
There’s no denying that companies operating in the silver-mining space have been reeling under lower silver prices. Escalating trade war fears and imminent rate hikes are other roadblocks have been hindering its run.
 
The companies in this space are focused on high investments in R&D, underground development and exploration that are likely to result in higher production and lower costs. The companies are investing in more efficient extraction and processing. Lowering costs through better management seems to be the call of the hour.  
 
The fundamental image surrounding silver appears quite strong. The demand for silver continues to increase, especially with expanding uses in technology as the world develops more electric cars and robotics. The ongoing revolution in green technologies, aided by the exponential growth of new energy vehicles (and investment in solar photovoltaic energy, should bolster global industrial demand for silver further over the next decade and beyond.
 
China will continue to be a major driver in the global silver market for years to come, fueled by continued industrial demand and silver mining activity. China is by far the largest consumer of silver globally, accounting for around 18% of global fabrication demand. In fact, China’s robust demand for the metal makes it a major destination for imported silver products fabricated in the United States, Japan and other countries. Moreover, China is also the third largest silver producing country worldwide and is a key nation for processing primary raw materials globally. Further, India’s cultural affinity for silver underscores the country’s importance as a leading source of demand in the global silver marketplace. India will emerge as a major consumer driven by increased investor interest and growth in silver jewelry, decorative items and silverware fabrication.
 
The prospects of a dwindling supply loom large on the industry. This is due to the absence of a healthy pipeline of new projects, declining ore grades and depleting reserves. A potential silver deficit will provide a strong ground for silver prices.
 
While these factors make us optimistic about the long-term prospects of players in the silver-mining industry, we are cautious regarding the near-term scenario. That said, here are a few stocks from the industry investors should steer clear of.
 
Avino Silver & Gold Mines Ltd. (ASM - Free Report) : This Vancouver-based silver-mining company has lost almost 46% in the past year. Also, the Zacks Consensus Estimate for the current fiscal EPS has gone down 25% in the past 60 days. It carries a Zacks Rank #4 (Sell). '
 
 
Price and Consensus: ASM
 
 
Great Panther Silver Limited (GPL - Free Report) : The consensus EPS estimate for this Vancouver, Canada company declined to a loss per share of 3 cents from an earnings of 2 cents per share for the current year over the last 60 days. The stock currently has a Zacks Rank #5 (Strong Sell). The company’s shares have plunged 28% over the past year.
 
Price and Consensus: GPL
 
 
Hecla Mining Co. (HL - Free Report) : This Idaho-based company has a Zacks Rank #4. Its stock has dipped 40% over the past year. The Zacks Consensus Estimate for the current EPS has gone down 40% in the past 60 days.
 
Price and Consensus: HL
 
 
Tahoe Resources Inc. (TAHO - Free Report) : The consensus EPS estimate for this Reno, NV-based company declined to a loss per share of 10 cents from earnings of 8 cents per share for the current year over the last 60 days. The stock currently has a Zacks Rank #5. The company’s shares have plunged 48% over the past year.
 
Price and Consensus: TAHO
 
 
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