Gold and silver producers have had a torrid time lately. Fresnillo’s (LSE: FRES) share price, for example, is down over 50% since it went on an incredible bull run as the pandemic struck in 2020. However, it’s at times of maximum pessimism that savvy long-term investors are presented with an opportunity to buy quality UK shares at bargain prices. Fresnillo, I believe, is one such company.
A gold and silver gem
Fresnillo is the world’s leading silver producer and one of Mexico’s largest gold producers. It has a near 500-year history of mining precious metals in South America. Its mining concessions extend to approximately 1.7 million hectares where it operates both underground and open pit mines.
In 2021, revenue was $2.8bn, representing a 9% increase on the previous year. This was mainly down to average realised silver prices, which rose 16% during the year.
It possesses a rock-solid balance sheet. Its earnings before income tax depreciation and amortisation (EBITDA) stands at $1.2bn. With a net debt of $1.1bn that means its net-debt-to-EBITDA ratio is negative.
Silver – a versatile metal
Like its more expensive cousin gold, silver is predominantly viewed as a monetary metal. However, it also has many industrial applications too. With the greatest electrical and thermal connectivity of all metals, silver is a key component in solar panels, semiconductors and electric vehicles.
Decarbonisation of the global economy together with the ‘internet of things’, in which hundreds of billions of physical devices are connected to the internet, are two unstoppable megatrends that should ensure silver remains in high demand well into the future.
Silver also acts as an inflationary asset. In the early 1980s, when inflation was rampant, the price of silver hit $50 an ounce. More recently, during the Covid crash, silver prices rose as the general stock market tanked.
What I like about silver is that the metal looks historically undervalued relative to other commodities, including gold. That’s why I have been buying shares in Fresnillo over the last few months as I don’t know when it’s likely to bottom. But in light of the structural forces highlighted above, it’s a fair bet that Fresnillo’s share price should be higher in the long term.
Challenging environment
As one would expect of a cyclical commodities business, Fresnillo’s dividend has ebbed and flowed over the past decade. However, it has increased its dividend for the past three years. Its policy is to pay out between 33% and 50% of profit after tax each year. In 2021, the payment was $245m.
Like so many mining companies, Fresnillo has been particularly impacted by soaring energy prices, which it relies on to fuel its transport fleet.
And last year, the Mexican government introduced a law that prohibited the use of contractor labour. This hit the business particularly hard. Long term though, it’s likely to provide it with greater operational resilience.
Overall, I believe that the prospects for the company are good. Later this year, a major new mine, Juanicipio, comes on-line. This will boost gold and silver production significantly. As Fresnillo’s share price languishes at multi-year lows over recessionary fears hitting silver demand, I recently bought more shares for my Stocks and Shares ISA.