June 2007 Archives

I am not sure what to make of the markets. Of course, everyone has been focused on the Bear Stearns story (see WSJ Page One article Wall Street Fears Bear Stearns Is Tip of an Iceberg subscription required). My hunch is that this imbroglio is much ado about nothing, though I could be completely wrong and this is the tip of the proverbial iceberg.

Although I am cautious about the markets overall—and have been for quite some time—I am net long. As part of the net long position, I hold precious metal stocks and oils. I think those assets should do well regardless of financial skirmishes.

With the summer doldrums on their way, I am inclined to be even more passive with regard to my investing than I am normally. I keep watching the oils and when they fall, I add to my positions. Aside from that small tinkering, the portfolio is on autopilot.

It had been raining in Edmonton the prior few days and it was a cool, overcast day on the 14th. The grass was wet and the mosquitoes were ferocious. Nonetheless, we took several photographs in the two hours we had available. Juliana was fantastic to work with as she tolerated the cold and mosquitoes to pose elegantly for the shots.

The photograph of Julia Kennedy is hosted at Flickr. If you click on her picture above, you will be taken to where you can view a larger version.

Tobey Kai is a wonderful Calgary model. She was an absolute joy to work with because she was knowledgeable, extremely friendly, and enthusiastic. I took pictures of her on Wednesday, 13 June 2007 at the Calgary Zoo. We were very fortunate because it rained the day before, just after we were at the zoo, and again the following day. So we were lucky to just miss the rain and enjoy the terrific warm weather.

The photograph of Tobey Kai is hosted at Flickr. If you click on her picture above, you will be taken to a larger version.

David J Phillips, publisher of the The 10Q Detective was kind enough to leave a detailed comment on my blog regarding my article Not Paying Attention To The Blue Nile Bears. Rather than responding in the comments section where few people will see his comment and my response, I have decided to promote his comment and respond to it in this article.

Kevin:

If I may--you are misinformed with respect to your comment: "That means that the sale was affected pursuant to a Rule 10b5-1 trading plan adopted by the reporting person. The sale would have happened regardless of the most recent financial results...."

Although These trading plans provide an insider with an "affirmative defense" against any allegation that trades executed under the plan were based on inside information--AS LONG AS THE NAMED EXECUTIVE OFFICER FILES AN 8-K, HE/SHE IS FREE TO TERMINATE the PRIOR-pre-arranged sale of the fully-disclosed amount of shares.

Ergo--If management truly felt the stock was headed materially higher, as long as they filed their intent--they could prematurely end their insider sales.

http://10qdetective.blogspot.com/2007/05/is-luster-off-blue-nile.html

Best-
David J Phillips, Publisher
www.10qdetective.blogspot.com

FULL DISCLOSURE: The 10Q Detective is short Blue Nile

Yes, David, you are technically correct. But that does not change my argument. As I stated in my article, I believe the shares are rich now. Moreover, I believe that Blue Nile is doing exceedingly well and that the share price will be higher this time next year. But if I were a stock or option or both rich Blue Nile executive, I would take some off the table as well. I too would enter into a trading plan.

Does that mean if I were a rich executive that I lack faith in the company or its stock? No, not at all. Rather it means that I have lived through the last bubble and know how turbulent the markets can be. I further know that if I am smart, I need only get rich once. So I begin selling with a trading plan. If Blue Nile gets taken private at a much higher price or company continues to do well and the stock is much higher this time next year, that is okay. What I am guarding against is an unforeseen negative event. It could be company specific, or it could the economy in general. Whatever, I would take appropriate measures today.

So unless I expected wildly different prices—either higher or lower—I would be inclined to leave my trading plan as is.

As mentioned, I believe the company will continue to do well. While it represents a reasonable portion of my portfolio, it is still a manageable risk. So I am content to sit and monitor.

I did read your article, and I found nothing alarming. I am not concerned about margins. They are making money and buying back stock. With regard to diamonds and international sales, international growth rates are exceptionally strong, in part because they are starting from a very low base. In Canada, however, our economy is doing exceptionally well, especially out west.

Traditional retailers are going to offer their own stores and fight back. Maybe, but their brick and mortar stores are being clobbered. I do not recall the exact data, but I believe Zales online stores average ticket is a couple hundred dollars while Blue Nile is above one thousand dollars. For Zale Corporation and others, their biggest worry is that online does catch on exceedingly well. Then what do they do with all the brick and mortar stores?

Listen to the conference calls of both companies. One company is consuming money and needs high margins to barely survive and the other is throwing off money with low margins and having fun all the while. I have listened to both Zales and Blue Nile conference calls for a few quarters, and from my vantage point, the difference in companies and their outlook could not be starker.

While I disagree with your viewpoint, I certainly appreciate your arguments. So it will be interesting to watch Blue Nile over the next several quarters.

Thank you for your comment. I think it is good for readers to see both sides of an argument and reach their own independent conclusions.

Disclosure: I am long Blue Nile and short Zale.

There is a brief and interesting article at Seeking Alpha concerning Pan American Silver Corporation (PAAS), a company that I follow and comment on.

FP Trading Desk submits: Pan American Silver Corp. (PAAS) shares were down significantly following the company's announcement Wednesday it was buying an additional 40% in the San Vicente silver-zinc mine in Bolivia for US$9-million, bringing its total interest to 95%.

The company also announced a mine expansion at the site that, once complete, is expected to produce 2.8 million ounces of silver per year at a cost of U.S.$2 per ounce, net of zinc by-product credits. The cost of the expansion is expected to be US$40.5 million.

Richard Grey, analyst at Blackmont Capital, increased his production estimates by 1.5-million ounces and increased his net asset value from C$21 to C$21.25.

However, he added that Pan American's expansion and ownership increase also raises the company's exposure in Bolivia, a country with high political risk.

He maintained his "buy" rating on the stock and left his C$40 price target unchanged.

I hope to provide some perspective on Pan American's recent press release Pan American Silver Plans Production Expansion at San Vicente Mine (PDF, 108k).

VANCOUVER, BRITISH COLUMBIA – Pan American Silver Corp. (“Pan American”)(PAAS: NASDAQ; PAA: TSX) today announces it plans to proceed with a project (the “Project”) to expand production at its San Vicente silver-zinc mine located near Potosi, Bolivia (“San Vicente”). The Project will include the construction of a new 750 tonnes per day processing facility, together with the related underground mine development necessary to achieve sustained production at this rate.

In connection with expanding production at San Vicente, Pan American has purchased Empresa Minera Unificada S.A.’s 40% interest in Pan American Silver (Bolivia) S.A. (“PASB”), the operating entity of San Vicente, for $9.0 million plus a 2% NSR payable only after Pan American has recovered its capital investment in the Project and only when the average price of silver in a given financial quarter is $9.00 per ounce or greater. As a result of this purchase, Pan American has increased its ownership interest in PASB to 95%, with Trafigura Beheer B.V., an international commodities trading company, retaining its 5% minority interest.

Based on engineering studies conducted for the Project1, Pan American estimates that, once the Project is complete and the mine is operating at capacity, San Vicente should produce approximately 2.8 million ounces of silver annually, on a 100% basis, at an average cost of less than $2.00 per ounce, net of zinc byproduct credits, for the first five years of the operation. Based on 100% of the mine’s proven and probable reserves of approximately 3.1 million tonnes2, San Vicente should have a 13 year mine life. The Project should take 18-20 months to complete, at an estimated capital cost of approximately US$40.5 million, which includes a 10% allowance for unforeseen escalation in construction costs, in addition to a 15% contingency.

At price assumptions of $9.00 per ounce of silver and $2,100 per tonne of zinc, Pan American’s 95% share of the mine is expected to provide an undiscounted after-tax value of $64.8 million, generate an internal rate of return (“IRR”) of 26% and have a capital payback of 2.6 years.

In my view, the key question is, Is Pan American deserving of a reduced valuation because of its investment in Bolivia? My answer is a resounding no.

The press release was issued on 6 June 2007, when the closing price was $28.40, which translates to a market capitalization of $2.17B. The closing price on Friday, 8 June was $26.85, which translates to a market capitalization of $2.05B. That is a market capitalization loss of $120M, yet the purchase price and construction costs combined are less than $50M. So if we believe that Pan American has been penalized because of its investment in Bolivia, that penalty was overdone.

However, I do not believe that the share price fell because of the press release. If you look at a Kitco's graph of silver's price in June 2007, you will note that silver dropped about $0.40 over the three day period.

Moreover, I believe the information in the press release is positive. While it is true that the mine is in Bolivia, a country that has recently given the mining as well as oil and industries fits, I trust that Pan American has had some conversations with government officials. The mine itself is very profitable at $9 per ounce silver prices with an internal rate of return (not the best measure to use) of 26% and a capital payback period of only 2.6 years. Obviously with today's prices of $13+ per ounce for silver, the IRR will be significantly higher and payback period even shorter. The company has already anticipated the higher tax rates recently proposed by the Bolivian government. Assuming no further tax rate increases and no nationalization during the 20 months of construction followed by 2.6 years of operations, the company will do well with its investment.

Commenting further on the tax and nationalization risks, I believe Bolivia is unlikely to raise taxes again within a short window. It wants and needs foreign investment, so it is likely to keep its new tax rates for a few years at least. If it wants an operating plant, Bolivia is unlikely to nationalize the project during the construction phase. So that leaves the remaining 2.6 years. My belief is that Pan American management has managed its risk in a prudent manner by first, having a strong economically viable project with a short payback, and second, having meaningful discussions with various government officials. None of this guarantees a good result, however, but at least the company has assessed its risks in a prudent manner and should have a strong viable project.

I began writing this article before the market opened, and I note that today Pan American Silver is up slightly. I remain positive on Pan American.

Disclosure: I am long Pan American Silver stock.