Ignore the Stagnant Outlook for Silver and Buy Pan American Silver (TSX:PAAS)

The latest news indicates that now is the time to acquire Pan American Silver Corp. (TSX:PAAS)(NASDAQ:PAAS).

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This year has been a very difficult time for silver investors and miners. The white metal has fallen by over 16% since the start of 2018 to be trading at around US$14.60 per ounce, and there are signs that a recovery is a long way off.

Nonetheless, this shouldn’t deter investors from acquiring primary silver miner Pan American Silver Corp. (TSX:PAAS)(NASDAQ:PAAS). Recent developments indicate that there is considerable potential upside ahead for the miner regardless of silver’s poor outlook. 

Now what?

While third quarter 2018 revenue remained relatively flat compared to a year earlier, only dipping by just under 2%, Pan American reported a US$9 million net loss for the quarter against an US$18 million profit a year earlier. This was despite silver production rising by 6% year over year to 6.3 million ounces and gold output increasing by 3% to 42,000 ounces.

The key reason for Pan American’s loss was a combination of weaker metals prices and higher operating expenses. For the third quarter, the miner only realized an average silver price of US$14.88 per ounce, which was 11% lower year over year while the average price for each ounce of gold sold was 5% less at US$1,212 per ounce. Base metals prices were also weaker with lead, zinc and copper all falling compared to the same period in 2017.

Of greater concern is that Pan American’s costs for the third quarter increased significantly. The miner’s cash costs rose by a massive 68% year over year to US$5.24 per ounce produced, while all-in sustaining costs (AISCs) were a shocking 58% greater at US$13.73 an ounce.  This noticeable increase in costs can be attributed to a combination of Pan American boosting the tempo of operations at its Mexican mines and lower by-product credits because of weaker base metals prices.

Regardless of this weak performance, Pan American restated its 2018 full-year guidance issued in early August, apart from reducing capital spending to US$40 million.

Nevertheless, substantially weaker silver doesn’t bode well for Pan American’s fourth quarter performance. Unless it can significantly rein in expenses, it’s likely that it will post another quarterly net loss.

Clearly, Pan American’s performance will remain under pressure for as long as precious and base metals prices are weak. On that note, there appears to be very little optimism for the foreseeable future, with many analysts expecting silver to remain stagnant and slowing global growth expected to weigh on base metal prices.

What has boosted interest in Pan American was its November 2018 offer to acquire deeply-troubled silver miner Tahoe Resources Inc. (TSX:THO)(NYSE:TAHO). Tahoe has struggled to deliver value for shareholders since operations at its flagship Escobal silver mine in Guatemala were shuttered after the courts suspended its licence.

Escobal was responsible for the majority of Tahoe’s precious metals production, hence its earnings. Since operations at the mine were suspended, Tahoe has reported a loss for every quarter since the second quarter 2017. While Guatemala’s Constitutional Court has provided a clear path to resolving the issues and restarting the operations, the required process is unlikely to be completed for a long time.

The suspension of operations at Escobal triggered a sharp sell-off of Tahoe that saw its market value plunge by around 50% since the start of 2018, although its stock rebounded significantly after Pan American made its offer.

Pan American intends to acquire Tahoe for a base purchase price of US$3.40 per share with an implied equity value of US$1.3 billion. It will give Pan American ownership of Escobal and the considerable upside that exists should the mine recommence operations. It appears that a change of ownership may be the only means by which operations can recommence.

The deal also boosts Pan American’s gold production adding around 400,000 ounces annually, which will reduce its dependence on silver, hence the impact of the poor outlook for the white metal. It also adds Tahoe’s portfolio of other assets located in the mining friendly jurisdictions of Canada and Peru, further bolstering Pan American’s potential upside.

So what?

While the prospects for silver are poor and there is every sign that the precious metal will continue to trade at below US$15 an ounce for some time, the Tahoe transaction certainly boosts the miner’s investment appeal. Pan American’s attractiveness as a contrarian investment is enhanced by the fact that unlike any investment in bullion, it rewards investors with a regular dividend that’s yielding around 1%.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

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