cfa institute research challenge 2017 reporte pe&oles_final

CFA Institute Research Challenge Hosted by

CFA Society Mexico

Executive Summary Industrias Peñoles S.A.B. de C.V. is a Mexican mining group, holder of Fresnillo PLC and part

of Grupo BAL S.A. de C.V., a privately held diversified consortium of independent Mexican

companies. The company integrates the following operations: exploration, extraction, smelting,

refining and selling of both Precious metals and Base/Non-ferrous metals. The company is

divided in four segments: Precious Metals, Base Metals, Metallurgical and Others.

Investment Recommendation

We issue a Buy recommendation on Industrias Peñoles with a 12-month target price of MXN

$566.0 per share, with a projected total return (including dividends) of 17.90% from its

January 20, 2017 closing price of MXN $488.24 per share. Our target price is calculated by

using a tailored valuation approach. Our recommendation is driven by our:

Investment Thesis and Outline

Backed by (1) a positive outlook on precious metals, (2) a strong US Dollar (USD) and weak

Mexican Peso (MXN), (3) an attractive pipeline of growth projects coming in the following

years, and (4) a positive trend in the Base Metals and Metallurgical segments EBITDA margin,

Industrias Peñoles is well positioned for both revenues and earning margins further growth. The

result of the valuation suggests that PE&OLES* shares are presently undervalued, and this

represents an opportunity to invest. After determining Peñoles’ exposure to investment risks

and evaluating the corresponding impacts on valuation, we arrived to a Buy recommendation

(Figure 1).

Strong Precious Metals Outlook – Per our forecast, gold and silver spot prices (the most

important drivers of Peñoles’ revenues and stock prices, see Figure 2 and 10) will improve

marginally in 2017, and continue that upward trend thereafter. Our forecast is based on an

analysis of the main drivers of gold and silver prices, including investor demand for haven

assets, the US Treasury Bond yields, and the US equity markets.

Favorable USD/MXN Outlook – Peñoles benefits from a strong US Dollar and a weak

Mexican Peso. The main drivers of these two exchange rates support a positive outlook for

the USD and a negative one for MXN.

Competitive Positioning – Peñoles is the world’s top producer of refined silver, metallic

bismuth, and sodium sulfate, and it is the Latin America’s leading producer of refined gold

and lead. Furthermore, the company has an important pipeline of projects ahead that should

allow it to maintain and improve its current positioning.

Valuation – We derived our target price using a tailored valuation approach, employing

Discounted Cash Flow and Multiples Valuation methodologies.

Investment Risks – Quantifiable risks such as market and operational risks, qualitative

risks like country risk, and other risks were assessed for impact and likelihood and ranked

in a risk matrix, and subsequently modelled through a Monte Carlo simulation (Figure 3).

The simulation results show: 58.3% of the simulations support a buy recommendation,

39.1% support a hold recommendation, and 2.6% support a sell recommendation.

Figure 1: Summary of Market, Financial and Valuation Data

Market Data

PE&OLES*

Ordinary Shares

Closing Price (MXN$) $488.24

Shares Outstanding (millions) 397.48

Avg. Volume 436,390.00

Market Cap. (MXN$ mm) $190.81

Enterprise Value (MXN$ mm) $223.28

EV/EBITDA (LTM) 11.35

EV/Reserves (FY2015) 4.00

Financial Data

2011 2012 2013 2014 2015

Gross

Margin

34.54% 29.48% 27.74% 26.11% 20.59%

EBITDA

Margin

32.63% 26.64% 23.85% 22.13% 20.58%

EPS

(MXN$)

32.09 25.24 11.98 3.02 (2.18)

Capex/

Sales

9.93 11.74 16.36 14.76 17.7

ROE 38.24% 24.19% 11.38% 2.71% -1.75%

ROA 18.72% 12.40% 5.47% 1.25% -8.30%

Interest

Coverage

60.33x 40.19x 13.2x 5.6x 3.49x

Debt/

Equity

15.82 18.45 35.75 39.88 37.3

Valuation Results

($MXN)

Price from Relative Valuation 524.18

Weight of Relative Valuation 40%

Price from Intrinsic Valuation

(DCF)

593.89

Weight of Intrinsic Valuation (DCF) 60%

12-Month Target Price 566.00

Price Per Share (January 20,

2017)

488.24

Annual Dividend 9.62

Total Return 17.90%

Source: Bloomberg, Thomson Reuters, Team Estimates

This report is published for educational purposes only by students

competing in The CFA Institute Research Challenge.

Date: 20-Jan-2017

Ticker: PE&OLES*

Closing Price: $488.24

MXN$1.00:US$0.0465

Recommendation: Buy (17.9% Total Return)

Target Price: $566.00 (US$26.32)

Figure 2: PE&OLES Stock and Gold Spot Prices Since U.S. Election

Day:

Source: Thomson Reuters

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November 8, 2016: U.S. election day

Figure 3: Monte Carlo Simulation Summary

Source: Team Estimates

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Sell Hold Buy

Student Research Precious Metals, Materials

Mexican Stock Exchange (“MSE”)

Industrias Peñoles S.A.B. de C.V.

1

Business Description Industrias Peñoles is a Mexican company founded in 1887, and listed in the stock exchange of

the same country since 1968 under the ticker PE&OLES*. It is part of Grupo BAL S.A. de C.V.,

a privately held diversified consortium of independent Mexican companies. Peñoles has

operations in Latin America, mainly in Mexico, while their sales are directed primarily to the

United States and Europei.

Industrias Peñoles is a mining group with integrated operations focused on mining, smelting

and refining of precious and base/non-ferrous metals. It is also involved in the production of

chemicals, being sodium sulfate one of their most important chemical products. The company

has four major segments: Precious Metals, Base Metals, Metallurgical and Others (chemical

segment). Precious Metals segment focuses on the mining and production of gold, silver and

doré concentrates (ore concentrates). Base Metals include the mining and production of zinc,

lead and copper concentrates. The Metallurgical segment focuses on the smelting and refinery

of precious and base metals concentrates. The last segment incorporates the production and sale

of chemical products. The company is also involved in rail transportation and water treatment

operations under government concessions.

In 1961, Industrias Peñoles merged with Compañía Minera Peñoles, forming Metalúrgica

Mexicana Peñoles. Industrias Peñoles was then established as the holding company in 1968,

and listed its shares in the Mexican Stock Exchange under the ticker PE&OLES*. In 2008,

Peñoles restructured its mining operations into two major groups: base metals and precious

metals. The former is managed by Minas Peñoles, while the latter is managed by its subsidiary

Fresnillo PLC. Industrias Peñoles currently owns 74.99% of the shares of Fresnillo PLC, which

is listed separately on the London Stock Exchange under the ticker FRES.

Exploration

In order to deliver production growth and replenish mining reserves, Peñoles has a rigorous

exploration focus. Some of the current growth projects are listed belowii.

Selected Key Growth Projects

Project

Type of Metal

Stage

Expected Start of Operations

Reserves2

Centauro Deep Gold Under Construction 2018 Gold: 4.3 moz

San Julián1 Gold, Silver Under Development 2017 Silver: 146.0 moz Gold: 420.0 koz

Orysivo Gold Advanced Exploration 2018 Gold: 8.9 moz Silver: 420.0 koz

Juanicipio Gold, Silver Advanced Exploration 2018 Silver: 120.2 moz Gold: 578.0 koz

(1) San Julián’s mine is developing a project to expand the production through a floatation plant.

(2) Proven and probable reserves

Mining

Peñoles is the world’s number one producer of refined silver, and Latin America’s number one

producer of refined gold. Operations include 14 mines, 3 metallurgical centers and 3 chemical

processing centers, all of which are located in Mexico. Some of the most representative Peñoles’

mines include Saucito and Fresnillo, the world’s 1st and 3rd lowest cash-cost, and 3rd and 5th

world’s largest silver producers respectively. Moreover, La Herradura is the second largest gold

mine in Mexico, La Velardeña is Mexico’s second largest Zinc mine, while Madero Bismark

and Tizapa are amongst the five largest zinc mines in Mexico.

Selected Key Mine Holdings Currently in Operation

Mine Type of Metal Owning Company Ownership (%) Reserves1

Saucito Gold, Silver, Zinc, Lead

Fresnillo PLC 100 Silver: 130.7 moz Gold: 730 koz

La Ciénega & San Ramón

Gold, Silver, Lead Fresnillo PLC 100 Silver: 69.2 moz Gold: 810.0 koz

La Herradura Gold Fresnillo PLC 100 Gold: 5.34 moz Fresnillo Gold, Silver, Zinc,

Lead Fresnillo PLC 100 Silver: 201.6 moz

Gold: 525.0 koz Noche Buena Gold Fresnillo PLC 100 Gold: 1.01 moz

Soledad-Dipalos Gold Fresnillo PLC 100 Gold: 0.71 moz

(1) Proven and probable reserves

Chemical Division

This division produces chemicals with a wide range of applications, including those in the steel,

cement and fertilizer industries. The raw materials used to produce these chemicals are obtained

from the by-products resulting from the fumes and waste produced in the smelting operations.

Industrias Peñoles counts with the largest sodium sulfate plant in the Western Hemisphere and

the 3rd most important worldwide, which is Química del Rey.

Figure 4: Industrias Peñoles’ Corporate

Structure

Source: Company Filings

Figure 5: Industrias Peñoles’ Holders

Source: S&P Capital IQ

Figure 6: Location of Industrias

Peñoles’ Mines in Mexico

Note: See full geographical location of Industrias

Peñoles’ mines and offices in Appendix B8.


Figure 7: Industrias Peñoles Integrated

Operations


Figure 8: Industrias Peñoles

Consolidated Reserves Total Reserves

Gold (koz) 10,794

Silver (koz) 675,174

Lead (kton) 1,609

Zinc (kton) 5,579

Copper (kton) 621 Note: proven and probable reserves calculated by

the company in 2015.


44%

42%

4%3%

1%

6%

González, AlbertoBaillères (Chairman)

Albacor, S.A. De C.V.

BlackRock, Inc.(NYSE:BLK)

First Eagle InvestmentManagement, LLC

The Vanguard Group,Inc.

Others (137)

2

Industry Overview and Competitive Positioning

Industry Overview Industrias Peñoles revenues come from metals and minerals sales, from which precious metals

account for 69% of total sales (Figure 9). Since most of the revenue comes from precious metals,

Peñoles revenues are very sensitive to changes in gold and silver spot market prices (Figure 10).

Gold

Gold Seen as a Haven Asset by Investors

In the latest years, gold prices have been significantly influenced by investor related demand in

gold ETFs, futures and derivatives contracts (Figure 3), whereas physical demand hasn’t been

as significant to changes in gold prices (Appendix B1). Furthermore, gold has become the

number one choice as a haven asset for investors, hence gold trades more than many other major

financial assets like the S&P 500, with nearly 200 US$bn/dayiii. Since gold is seen by investors

as a safe haven, changes in economic indicators drive wide movements in gold prices. The US

10-Year treasury bond yield is one of the most important drivers of gold prices, when the yield

goes up the gold price goes down and vice versa (Figure 12).

Trump Administration Impact on Gold Outlook

With the Trump administration, investors are foreseeing an uncertain economic outlook in the

US. On the one hand the market is speculating about a stronger than anticipated US economic

growth (GDP growth) and a higher inflation rate resulting from the policies that President

Trump proposed. This economic growth would come mostly from higher corporate investments

in the US, better employment numbers, a higher disposable income rate and an improvement in

the domestic consumption rate. As a result of these expectations, the S&P500 has been rallying

since the day of the US election until today, breaking all-time highs repeatedly (Figure18), the

US Dollar risen significantly relative to the major currencies since the day of the election (but

has been weakening since the Fed December meeting), and the US 10-Year Yield rallied since

the day of the election as well (and stopped the rally the day of the Fed’s December meeting).

Allover, these caused the gold prices to plummet from the day of the election to the day of the

Fed’s December meeting. However, this positive economic narrative changed the day after the

Federal Reserve held their December meeting on December 14, 2016. The minutes from the

Fed showed uncertainty over how President-elect (now President) Trump’s policies would

impact the pace of interest-rate increasesiv. The Fed officials also suggested three (instead of

two, as proposed in the previous meeting) rate hikes would be appropriate for 2017. The Fed’s

meeting minutes raised uncertainty in the market about the new US administration, and caused

major inflation fear. Thus, the US Dollar has been weakening since then until today, the US 10-

Year yield has also been weakening, and gold has climbed to a seven-week high as the market

demands for haven assets given the current investors’ sentiment about an uncertain U.S.

economic performance (Figure 13). The U.S. economic uncertainty along with expected market

volatility in Europe because of elections (Germany, France and Netherlands elections) in 2017,

should further increase investor’s appetite for haven assets. Given the mentioned above, we

forecast 2017 gold prices to be at $1,217.5/oz, and to keep rising marginally in the following

years as U.S. growth/inflation mix deteriorates through the President Trump’s administration

period.

Silver

Silver has proven to move in synergy with gold prices over the past years, having a sharp fall

since the US presidential elections until the Fed’s December meeting, and then rallying sharply

until today (Figure 13). Like gold, silver prices are mostly affected by investor demand in silver

ETFs, futures and other derivatives contracts (Figure 14), despite having a considerable amount

of physical demand (Appendix B2). Hence, we forecast 2017 silver prices to be at $17.21/oz,

and then to keep rising marginally along with the rise of gold spot prices.

Zinc

Zinc price movements are mainly driven by physical supply and demand (Figure 15). World

zinc supply is forecasted to decline, as one of the biggest Zinc mines in the world

(Glencore/Nyrstar) announced suspensions and more production cutbacks for the year 2017

(this mine started the production cutbacks in 2016v). Furthermore, average zinc concentrate

inventory levels at China smelters, which account for almost half of the world’s refined zinc

smelters, have dropped down from eight-weeks’ worth at the beginning of the year 2016 to just

3 weeks at some smelters in the 3rd quarter of 2016vi. More to this, the China’s zinc smelting

industry has lowered its fees for turning ore concentrates into refined metals by 20% (Treatment

charges or TCs), in an effort to be more competitive against a heated-up zinc market, this move

signals a tightening in zinc world supplyvii. The TCs fall-off came after some of the world’s

largest zinc mines, such as Century in Australia and Lisheen in Ireland, suddenly ran out of ore.

Figure 9: Industrias Peñoles Sales by

Product


Figure 10: Industrias Peñoles Quarterly

Revenues vs. Gold Spot Prices


Figure 11: Gold Futures and Options

Net Position of Managed Money vs Gold

Price

Note: Monthly bars from December 2015 to December

2016.


Figure 12: Regression of Gold Spot

Price vs US 10-Year Yield

Note: Data from 1999 to 2016.

Source: Thomson Reuters, Team Calculations

Gold41%

Silver28%

Zinc12% Lead

6%

Ore Concentrates4%

Copper4%

Sodium Sulfate3%

Other2%

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In the other hand, zinc demand is expected to grow as China, the world’s biggest zinc consumer,

incentivizes its domestic economic growth with supportive fiscal and monetary policies. Given

the above mentioned we foresee a positive zinc outlook ahead, we forecast 2017 zinc prices to

be at US$ 2740.0 a ton, and to keep rising from there (Appendix B4).

Lead

Like zinc, lead prices are mainly driven by physical supply and demand (Appendix B5). China,

the world’s biggest producer and consumer of lead (lead is mostly used to make batteries), is

expected to suffer a supply tightening in 2017, as lead smelters struggled to keep up with lead

production levels in 2016viii. Following the zinc story, global mine shutdowns over the year

2015 and 2016, moves by lead producers to cut output, along with low lead prices, have

tightened the supply for lead. Thus, given the current and expected lead fundamentals, we expect

to see a stronger lead price environment in 2017 and thereafter (see Appendix B5 for the full

lead prices forecast).

Copper

Copper prices are generally driven by physical supply and demand (Appendix B3), however the

recent rally on copper from USD 2.1/lb on October 24, 2016 to USD 2.6/lb on January 20, 2017

is thought to be mainly a speculative game of investors anticipating a stronger China demand

in 2017, but fundamentals stay intact for now. We expect investor’s speculation to keep driving

copper prices in the short to medium-term, but prices should correct after the actual data on

copper supply and demand is released by China in the second half of 2017ix. (see Appendix B3

for the full copper prices forecast).

Precious Metals Industry, High Barriers to Entry

The precious metals industry is characterized by important entry barriers for new players:

mining concessions, limited mineral resource base and capital intensity (full Porter’s 5 forces

analysis in Appendix B7). Capital intensity is associated with mining equipment needs,

specialized work force, energy costs, water supply and transportation needs, as well as

development of environmental protection programs. These high entry barriers make it difficult

for new entrants to come into the precious metals and base metals industry, so current

competitors can expect to see their market share untouched by new players.

Competitive positioning Industrias Peñoles focus on exploration drives a solid reserve replacement

history: Peñoles has a solid history of constant reserve replenishment, as an example

of this; its flagship Fresnillo mine has been in operations for about 500 years

(operational since 1554) (Appendix B8). The key strategy supporting this success

history is the company’s vigorous focus on exploration across economic cycles.

Peñoles also has one of the largest areas of exploration concession in Mexico, with

over 3.4 million hectares, and concessions in South America as well, primarily in Peru

and Chile where it holds numerous mining projects with excellent prospects.

Fresnillo PLC, 75% owned by Industrias Peñoles: Fresnillo comprises the precious

metal segment of Peñoles, which accounted for 69% of Peñoles sales in 2015. Fresnillo

is characterized by (1) a strong focus on operational excellence, (2) quality volume

growth, and (3) the market’s favorite play on silver stocks, enjoying from a continued

premium to precious metals peers on earnings multiples.

Organic growth track record: Peñoles has a strong history of growth through an

organic route (Appendix B8). Recent project deliveries include Saucito, Noche Buena

and Velardeña. Saucito is a silver-gold mine, and it is among the richest silver mines

in the world, with silver reserves of 130.7 MOz and gold reserves of 730.0 KOz. Noche

Buena mine has gold reserves of 1.01 MOz, and Velardeña mine has silver reserves of

about 25.6 MOz. Additionally, the company is expected to continue with this narrative

with future growth projects.

Base metals and metallurgical assets complement each other: Peñoles'

metallurgical operations are complementary to its mining operations as together they

allow the company to capture a broader spectrum of value and reduce operational costs,

compared to most of its peers with only mining assets.

Financial Snapshot of Peñoles’ peer group

Industrias Peñoles is the largest silver producer in the world and one of the largest

gold producers within the primarily-silver producer: We established a strict peer

selection criteria to build the peer group for Peñoles (Appendix A6). Peñoles is the

largest silver producer in the world, and the largest silver producer within its peer group

with 54.5 million ounces produced in 2015, while the second largest silver producer

within its peer group is Goldcorp (Goldcorp ticker: “G”) with 40.6 million ounces

Figure 13: Gold and Silver Spot Price

Since U.S. Presidential Election


Figure 14: Silver Futures and Options

Net Position of Managed Money vs

Silver spot price

Note: Monthly bars from December 2015 to December

2016


Figure 15: Zinc prices vs world zinc

surplus/ deficit balance


Figure 16: Peer silver production

Source: Bloomberg

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produced in the same period. Furthermore, Peñoles is the second largest gold producer

within its peer group just below Goldcorp.

One of the lowest cash costs in the industry: The cost structure of Fresnillo mine is

among the most competitive within the industry (Appendix B8). Having access to

world-class assets is one of the primary reasons for the company’s low cash cost

structure. The company’s Fresnillo mine is the richest primary silver mine in the world,

while the Saucito mine which started operations in 2011, has high-quality silver

reserves as well. Other than this, operating at 100% capacity and optimizing the mining

methods to maintain high recovery rates are key factors in achieving a lean cost

structure.

Investment Summary We issue a Buy recommendation on Industrias Peñoles with a 12-month target price of MXN

$566.0/share (see Figure 30 for the valuation summary) with a projected total return (including

dividends) of 17.90% from its January 20, 2017 closing price of MXN $488.24. We derived our

target price using a tailored valuation approach consisting in two methodologies: Discounted

Cash Flow to the Firm, and Trading Multiples.

Investment Drivers

Gold and Silver Prices to Improve Marginally in 2017 and Continue that Trend from 2018

Gold and silver prices movements are the two most important factors that make Peñoles’ stock

price move (gold being the most important of the two), hence it is crucial to have a clear outlook

on these precious metals prices (Figure 17). Gold and silver prices rallied temporarily on Donald

Trump’s election victory. However, investors sentiment made a dramatic U-turn after the

election date. The sharp rise in the US treasury yields combined with the rally in the US equity

markets in an environment of positive investor sentiment on the US economy, triggered a

substantial rally in the USD, causing a crash in the gold and silver prices (Figure 18 and 13).

However, the gold and silver bearish trend ended on December 14, 2016, just after the Federal

Reserve published their December meeting minutes (Appendix B10). The Fed’s December

meeting minutes showed uncertainty over how President-elect (now president) Trump’s policies

would impact the pace of interest-rate increasesx. The Fed’s officials reiterated that a “gradual”

pace of rate hikes over 2017 and the coming years would likely remain appropriate, generating

speculation that officials will step in to counter inflation with higher borrowing costs. This has

caused major inflation fear in the market, triggering a gold rally that has pumped the gold spot

price more than 8% since the Fed’s minutes were released, silver has rallied similarly. We

expect the current market narrative of uncertainty to remain in 2017, this should support a

continuation in the gold and silver rally for 2017. We forecast 2017 gold and silver prices to be

at $1,217.5/oz and $17.2/oz, respectively. Moreover, we expect a continuation of the 2017 gold

and silver trend from 2018 onwards. In 2018, we expect the US growth/inflation mix to

deteriorate (given the inability of the Trump’s administration to further boost economic growth),

meaning that US growth will slow down while inflation will remain relatively high.

Furthermore, we expect US dollar to peak in 2017 and then to weaken marginally in 2018, and

we also expect the US 10-year yield to peak in 2017 and then get lower in 2018. Altogether this

should give an incentive for investors to further position in gold and silver. This, together with

higher jewelry demand from China given the low gold and silver prices in 2017 relative to 2016,

should support a gold and silver price recovery (Figure 19).

Low Gold and Silver Prices Outlook to Boost Physical Demand

In the recent past, Peñoles’ refined gold and silver production has changed in congruence with

the world’s gold and silver physical demand year over year changes (Figure 20). With the

forecasted low gold and silver prices in 2017 (relative to 2016 prices), we expect physical

demand for these metals to increase. This demand increase should make Peñoles’ refined

production to increase as well, and this would absorb some of the negative effects that the low

gold and silver prices (low relative to 2016 prices) could have on the company’s revenues in

2017.

Base Metals Segment to Benefit from Higher Zinc Prices and Lower Costs

Base metals segment EBITDA jumped 41% QoQ in 3Q 2016. This performance was supported

by higher zinc prices and mining cost reductions, as well as a recover in zinc and lead QoQ

production. Given the current macroeconomic fundamentals, we expect zinc prices to keep

rising, which should support a continuation in the improvement on base metals EBITDA

margin.

Future Mining Projects Should Fuel Organic Growth in the Coming Years

Looking ahead, Peñoles has an attractive pipeline of projects that should allow an estimated

annual growth of 12% in silver production by 2018 (Appendix B8). Most of the growth projects

are focused on the precious metals business. Some of the near-term precious metals projects

Figure 17: Industrias Peñoles Price vs.

Gold Spot Price


Figure 18: USD Index and S&P500

Behavior Since Trump Election Day


Figure 19: Gold and Silver Prices

Forecast

Note: Gold and Silver prices are calculated using a multi-factor econometric model developed by the Team (see

Appendix C2 for more details on the Team’s model).


Figure 20: Peñoles refined gold

Production vs Gold Physical World

Demand

Source: Company Filings, CME Group.

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23

1,000.00

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Peñoles gold production (kOz)

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include: Juanicipio (with 10 MOz Silver, and 30 KOz Gold expected production, expected to

begin operation in 2018), Centauro Deep (225 KOz Gold, 2020) and Orisyvo (136 KOz Gold,

2021). Moreover, Peñoles is also planning growth projects in the base metals business, the near-

term projects include: Racaycocha (potential open pit copper-molybdenum, 2022), and Humos

(copper, 2022).

Focus on Exploration Drives a Solid Reserve Replacement Ability

Peñoles has a remarkable history of constant reserve replenishment, reflecting an important

ability of replenishing their metal and mineral reserves in a cost-efficient way (Appendix B8).

Peñoles also has one of the largest areas of exploration concession in Mexico, with over 3.4

million hectares, and concessions in South America as well, primarily in Peru and Chile where

it holds numerous mining projects with excellent prospects. Thus, we expect this successful

reserve replenishment ability to persist in the coming years and the long run (Figure 22).

Strong USD is Positive for Industrias Peñoles

Almost 100% of Peñoles’ revenues are denominated in USD, while only ~50% of the costs are

based in MXN (Appendix A1), furthermore Peñoles reports its revenues in MXN. Hence, a

strong USD and a weak MXN is positive for Industrias Peñoles (especially positive for Peñoles’

EBITDA margins), which is the case we are forecasting for the following years (Figure 21).

With the recent macroeconomic events, such as the Trump victory as president of the United

States, and some automakers (Fordxi, Fiat-Chryslerxii and General Motorsxiii specifically)

canceling or postponing their plans to invest in Mexico as they rather prefer to invest in the US

(this because Trump has promised a low tax reform and threatened automakers to create new

tariffs on imports from Mexico to the US), the MXN has weakened to the USD significantly,

and it is expected to stay weak in the following years (yet marginally stronger than the current

rate). In the other hand, the USD has been strengthening to all other currencies in the world

(Figure 18), this is happening because investors are expecting an overall stronger US economy

with the Trump administration, despite the recent concerns risen by the Fed.

Valuation Methodology We derived our target price using a tailored valuation approach, employing Discounted Cash

Flow and Multiples Valuation methodologies. We assigned a greater weight to the DCF

methodology since we think it more accurately reflects our precious metals prices forecast

(Figure 19), and as mentioned above (Figure 17), the gold and silver prices movement is the

number one factor that makes Peñoles’ stock price and revenues move. The peer group used in

the Multiples Valuation was chosen in a rigorous manner, and we believe that comparison to

selected companies is fully justified.

Investment Risks Quantitative, qualitative and other risks were assessed for impact and likelihood, ranked in a

risk matrix (Figure 42), and subsequently modelled through a Monte Carlo simulation (Figure

3). The simulation results show: 58.3% of the simulations support a buy recommendation,

39.1% support a hold recommendation, and 2.6% support a sell recommendation

Valuation Two valuation methodologies were used in deriving a price target to Industrias Peñoles,

including a five-year DCF and a Relative Multiples Valuation. We believe that the utilization

of these two approaches is most appropriate given the different characteristics of (1) the precious

metals industry dynamics and its high correlation with precious metal price fluctuations, and

(2) the specific characteristics of Industrias Peñoles, including its refined production structure

(In the recent past Peñoles produced ~50% of its refined gold and silver from own mined

resources, and the other ~ 50% from third party mines, see Appendix B8), and its stock price

behavior relative to peers’ stock prices in the past.

DCF Model We used a discounted cash flow analysis to estimate the intrinsic value of Industrias Peñoles

share price because of the inherently reliable relationships of earnings and cash flows with

respect to changes in gold and silver market prices. The model is forecasted five years, mainly

due to the degree of error and uncertainty in forecasting gold and silver prices for the long term.

The cash flows in this model are calculated using Free Cash to the Firm (FCFF) because of the

current capital structure of Industrias Peñoles (Figure 23). FCFF is calculated as Net Operating

Profit Less Adjusted Taxes (NOPLAT), plus Depreciation, minus Capex, minus Change in

Working Capital, and it measures the cash flow available for all the claimholders of the firm

(debt and equity claimholders) (see Figure 24 for FCFF forecast).

The base case for this model was calculated using guidance from the company’s historical

financial performance, the industry and precious metals prices outlook, an assessment of

Figure 21: USD/MXN Forecast

Source: Bloomberg, Team Estimates

Figure 22: Industrias Peñoles’ Reserve

Replenishment Ability

Source: Company Filings, Team Estimates

Figure 23: Industrias Peñoles’ Capital

Structure

Capital Structure as for 2016 Q3 (Millions of $MXN)

Value % Market Cap 177,896.60 84.83% Short Term Debt 3,558.80 1.70% Long Term Debt 28,256.50 13.47%

Total 209,711.90 100.00%

Source: Bloomberg

Figure 24: Industrias Peñoles’ Free

Cash Flow to the Firm Forecast


Figure 25: DCF Valuation Summary

DCF Valuation Key Elements ($MXN

millions) (+) Sum of PV of FCF 83,986.5 (+) Present Value of Perpetuity

183,871.6

(=) Present Value of FCFF (EV)

267,858.1

(-) Interest Bearing Debt 32,085.3

(=) Peñoles Equity Value 235,772.8 # Shares Outstanding (millions)

397

Peñoles Target Price Per Share ($MXN)

593.9


10

12

14

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18

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22

242

014

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13,523.10

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Industrias Peñoles competitive positioning, and company guidance on revenues and earnings

growth. The accuracy of the implied enterprise value for Industrias Peñoles is dependent on the

following model inputs:

Weighted Average Cost of Capital (“WACC”)

The cost of equity was calculated using the CAPM model (Figure 26). We used the 10-Year US

Treasury Bond Yield as the risk-free rate, a levered beta regressed against the MEXBOL Index

for 5 years, a mature market equity risk premium and a country risk premium to arrive to an

appropriate cost of equity. To correctly calculate the equity risk premium, we utilized an

historical implied equity risk premium for a mature market (obtained by looking at the implied

premium for the S&P500, based on A. Damodaran’s1 estimationsxiv). To estimate the country

risk premium, we used a country credit default spread for Mexico based on a Moody’s rating

(obtained by estimating the default spread for the Moody’s rating over a default free government

bond rate, based on A. Damodaran’s estimationsxv). We believe that the methodology of using

the S&P500 equity risk premium and adding a country risk premium is the best way to calculate

the cost of equity, since a mature market is more helpful to accurately estimate the equity market

risk. The cost of debt was calculated using the total pre-tax cost of debt (obtained by estimating

the weighted average of the short-term debt note rates and the long-term bond rates), and then

estimating the before-tax cost of debt (Figure 26).

Revenue Growth

Revenue growth for Industrias Peñoles is based primarily on (1) higher gold and silver market

spot prices, (2) new investments in successful exploration projects that should expand total

reserves and increase mine metal production, and (3) new investments in plant, property and

equipment to increase the total refined metal production output. However, most of the growth

in Peñoles’ revenues expected in 2017 (Industrias Peñoles revenues are reported in Mexican

Pesos) will come from a higher value of the USD to the MXN. Since we expect gold and silver

prices to stay low (relative to 2016 prices) at about $1,217.5 USD/Oz and $17.2 USD/Oz

respectively in 2017, the revenue growth for this year will come mainly from a high USD/MXN

rate and a refined metal production output increase. This production increase should be the result

of a higher gold and silver demand (resulting from the relatively low prices). Nonetheless, we

expect gold and silver prices to continue emerging in 2018 and onwards, which along with an

increasing mine production output coming from new mining projects should boost Peñoles’

revenue growth (Figure28).

Terminal Growth

The terminal growth rate is based on (1) the global economic conditions which affect the prices

of the precious and base metals that Peñoles sells (Appendix B10), (2) the company’s

exploration expenses and ability to replenish reserves, and (3) Peñoles’ competitive production

costs against other miners around the world (Appendix B8). Taking into consideration the

aforementioned factors, we determined the terminal growth rate of FCFF at 2.0%, which is

aligned with the long-term growth in GDP.

Capital Expenditures (“Capex”)

Due to new growth projects in Juanicipio (10 MOz Silver, and 30 KOz Gold, E2018), Centauro

Deep (225 KOz Gold, E2020), Orisyvo (136 KOz Gold, E2021), Racaycocha (Copper-

molybdenum, E2022), and Humos (Copper 2022), future capital expenditures are expected to

be significant. Per our estimates, the mentioned growth projects will lead to a Capex CAGR of

~4% from 2017 to 2022 (Appendix A3).

Relative Valuation Having previously chosen the appropriate peer group (see the peer group criteria in Appendix

A6), we conducted multiplier pricing using P/E, EV/EBITDA, and EV/Reserves as benchmark

ratios, the three of them based on two-year forward medians. There was a long-term discount

observed on Industrias Peñoles market price regarding EV/EBITDA multiple relative to its peer

group in the past, meanwhile there was a long-term term premium observed regarding P/E and

EV/Reserves multiples. This means that Industrias Peñoles usually trades at a discount to its

peers in EV/EBITDA multiple, and at a premium to its peers in P/E and EV/Reserves multiples.

Thus, we applied the appropriate discount/premium to each multiple to estimate Peñoles’ price

more accurately. The factors supporting the historical discount in EV/EBITDA multiple

include:

Country risk: most of Peñoles’ mines and offices are in Mexico (Appendix B8), which

is an emerging market with presence of drug cartels. Drug cartels affect the miners’

operations from time to time, though not directly robbing the miners, drug cartels are

1 Aswath Damodaran is a Professor of Finance at the Stern School of Business at New York University, he is best

known as the author of several widely used academic and practitioner books on Valuation.

Figure 26: WACC Analysis

WACC 9.16% Cost of Equity: 10.05%

Beta 1.05 Risk Free Rate 2.34% Country Risk 1.71% Equity Risk Premium 5.69% Cost of Debt: 4.92%

Before Tax Cost of Debt 7.57% Marginal Tax Rate 35.00% % Equity 84.70% % Debt 13.30%


Figure 27: Industrias Peñoles’ Capex

Forecast


Figure 28: Industrias Peñoles’

Revenues Forecast


Figure 29: Relative Valuation

Summary

Multiple $MXN Weight

Price from P/E 436.8 33.3% Price from EV/ EBITDA 461.5 33.3% Price from EV/ Reserves 670.0 33.3%

Total average price 522.8


Figure 30: Valuation Summary

Valuation Method ($MXN)

Price from Relative Valuation 524.18 Weight of Relative Valuation 40% Price from Intrinsic Valuation (DCF)

593.89


12-Month Target Price 566.0 Price Per Share (January 20, 2017) 488.24

Upside Potential 15.93%


13,787.76

17,579.39

14,063.52

10,899.22

13,624.03

16,348.84

20

16

E

20

17

E

20

18

E

20

19

E

20

20

E

20

21

E

$M

XN

mill

ions

78,589.9

96,238.3 101,906.3

112,001.6

124,796.9 131,582.9

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E

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7

a logistic obstacle for miners in Mexicoxvi. Furthermore, the Mexican Stock Exchange

(MSE) has a significant liquidity shortage in comparison to NYSE and LSE, where the

rest of the peer group trades, therefore MSE has lower trading multiples.

Few shareholders risk: only two shareholders have about 70% of all Industrias

Peñoles’ shares, this is could potentially be risky because few shareholders controlling

the company gives room for manipulation activities (though this is improbable).

Conversely, the factors supporting the historical premium of Industrias Peñoles relative to its

peer group in P/E and EV/Reserves multiples include:

Reserve replenishment history: Industrias Peñoles has a proven track record

replenishing its reserves in a cost-efficient fashion, and this should continue on ahead.

Metallurgical segment: about 50% of Peñoles refined gold and silver production

comes from third party mines, and the other 50% comes from Peñoles’ mines, whereas

many peer group members are more dependent on their property mines production.

We treat P/E, EV/EBITDA and EV/Resources multiples equally in our relative valuation, as we

believe there is no evidence of predominance of one over the other. The results obtained from

the relative valuation suggest a price of MXN $524.18 per share, and together with the DCF

price of MXN $593.89 per share, the valuation suggests a total price of MXN $566.0 per share,

this using a 60% (DCF) - 40% (Relative Valuation) weight procedure (Figure 30).

Financial Analysis

Selected Key Financials (in millions of MXN, except %) 2011 2012 2013 2014 2015 LTM Sep-

30-2016 Total Revenue 96,864.1 97,199.4 66,550.9 61,555.6 64,896.5 76,214.5

Growth Over Prior Year 48.9% 0.3% (31.5%) (7.5%) 5.4% 18.0% Gross Profit 33,459.9 28,654.5 18,464.0 16,071.8 13,360.5 21,532.0 Margin % 34.5% 29.5% 27.7% 26.1% 20.6% 28.3% EBITDA 31,610.2 25,896.2 15,869.2 13,619.3 13,356.1 22,610.6 Margin % 32.6% 26.6% 23.8% 22.1% 20.6% 29.7% EBT 26,657.8 20,111.0 9,330.8 4,779.8 3,571.4 9,096.8 Depreciation and Amortization

4,172.7 5,573.0 6,269.2 6,740.5 8,595.1 9,697.0

Change in Net Working Capital

6,980.1 2,299.0 (1,281.9) 601.5 2,830.1 2,826.6

Capital Expenditures (9,614.8) (11,406.5) (10,905.4) (9,084.9) (11,489.8) (11,697.3) Capital Expenditures as % of Sales

9.93% 11.74% 16.39% 14.76% 17.70% 15.35%

Unlevered Free Cash Flow

4,695.0 4,550.3 2,611.6 1,347.8 (2,752.7) 3,244.1

Ex-Fresnillo Results Continue to Improve on Better Base Metal Segment

After seeing an inflection point in 1Q-2016, ex-Fresnillo (“Excluding Fresnillo”, Fresnillo

accounts for the precious metals segment of Peñoles) EBITDA has continued to rise quarter

over quarter, with a 18% QoQ jump in 3Q 2016 (Figure 35). Furthermore, base metals segment

EBITDA jumped 41% QoQ. This performance was supported by improved zinc prices and

mining cost reductions, as well as a recovery in zinc, silver and lead QoQ production. Finally,

these jumps in earnings were also supported by a decline in expenses. Expenses were 6% lower

QoQ driven mainly by lower exploration expensesxvii (Figure 35).

Healthy Balance Sheet with Current Debt Obligations Ending in the Coming Years

Industrias Peñoles has maintained a very conservative capital structure of low Net Debt to

EBITDA (low relative its peer group) over the past 5 years (Figure 32). Additionally, the

company has a history of paying all its debts in a timely manner. In 2015, US$130 million of

structured notes issued in 2010 in the Mexican financial market matured and were timely paid

to bondholders. With the current debt maturity profile, all bonds are set to be amortized when

they reach maturity in the following years: US$ 400 million in 2020, US$ 200 million in 2022

and US$ 800 million in 2023 (Appendix A7).

Revenues and EBITDA Reversal

Industrias Peñoles has been underperforming since its 2012 all-time high; nonetheless, EBITDA

margin is expected to recover towards 2012 margins in 2017, driven mainly by an increase in

gold production and by a weakened Mexican peso. The USD/MXN rate jumped 24.9% from

2014 to 2016 and we expect it to stay high for the following years (Figure 21). Thus, we are

forecasting a solid growth in revenues and EBITDA for the following years driven mainly by

(1) a high USD/MXN rate, (2) stronger precious metals (gold and silver) prices, (3) stronger

organic growth with CAGR of 10% and CAGR of 7% in silver and gold equivalent production

respectively by 2019, and (4) lower costs in the base metals segment (Appendix A1).

Figure 31: Industrias Peñoles sales,

EBITDA & EBIT Growth

Sources: S&P Capital IQ & Team Estimates

Figure 32: Industrias Peñoles Debt and

Leverage


Figure 33: Peñoles’ EPS & DPS


Figure 34: DuPont Analysis


Figure 35: Ex-Fresnillo EBITDA

Recovery


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EPS Dividends per Share

Industry

Median 2015 2014 2013 2012 2011

Profitability

Gross Margin 22.8% 20.0% 25.6% 27.2% 29.2% 34.3%

EBITDA Margin 14.1% 21.5% 23.2% 25.3% 26.5% 32.7%

Operating Margin 6.7% 6.1% 10.6% 14.3% 20.7% 28.3%

Pretax Margin 1.9% 5.5% 7.8% 14.0% 20.7% 27.5%

Effective Tax Rate 24.2% 113.9% 64.2% 36.3% 29.7% 33.4%

Net Margin 1.0% (0.8%) 2.8% 8.9% 14.5% 18.3%

DuPont/Earning

Power

Asset Turnover 0.55 0.62 0.64 0.76 1.20 1.37

x Pretax Margin 1.9% 5.5% 7.8% 14.0% 20.7% 27.5%

Pretax ROA 1.2% 3.4% 5.0% 10.7% 24.9% 37.8%

x Leverage

(Assets/Equity) 2.39 2.12 2.12 2.21 1.95 1.95

Pretax ROE 3.1% 7.2% 10.8% 22.3% 48.5% 76.3%

x Tax Complement 0.75 (0.24) 0.25 0.51 0.50 0.48

ROE 0.9% (1.8%) 2.7% 11.4% 24.2% 36.5%

0

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8

Pipeline of Projects Conducive for Further Capex Growth

The company has a total of 10 projects ahead over the next six years, some of the most relevant

projects in the pipeline are: Pyrites Plant (optimization project, US$155 million investment),

Juanicipio (US$305 million investment), Centauro Extension (US$120 million investment), and

Centauro Deep (US$200 million investment) (see Appendix B8 for specifications on all

projects). With all these investments ahead, we expect Capex to increase sharply in 2016 and

2017, and then to normalize from 2018 onwards (Figure 32). Dividend Yield to Move in Synergy with Earnings

Revenues have been declining in the last five years and this has been affecting the company’s

EPS and DPS as well. However, we are expecting revenues to start a reversal trend from 2016,

this should further provide higher FCF generation resulting in a higher dividend yield (Figure

33). DuPont Analysis

Peñoles has been performing above the industry median in terms of asset usage efficiency and

operating efficiency (Figure 34). Moreover, the amount of financial leverage shown by the

equity multiplier is below the industry median. The analysis also shows that even though

Peñoles has a lower amount of financial leverage than the industry, it profits almost at the same

rate. In the other hand, the company has been suffering from a decreasing net margin over the

last five years, and this margin is lower than the industry median, but this effect is caused mainly

by substantially higher tax rates than the industry median (these substantially higher tax rates

are a fiscal consequence of the wild movements in the USD/MXN exchange rate over the last

years). Following this narrative, Peñoles’ pre-tax ROE outperforms the industry median;

however, this is not the case for ROE after tax complement considerations. Low CAPEX/Sales Ratio Relative to its Peers

In the last 5 years, Peñoles registered an average Capex to Sales ratio of 14.1%, which is the

second lowest among the peer group. However, within the eight peers compared, five of them

have a Capex to Sales ratio between 10% and 30%, hence Peñoles is in the healthy range near

the peer group’s median of 24.1%.

Hedging Instruments

Industrias Peñoles contracts derivatives with various financial institutions to reduce its exposure

to possible changes in the pricing of its transactions, specially to reduce exposure to

commodities price fluctuations and exchange rate movements (Appendix A8). However, the

current number of derivatives contracts that the company has, could only hedge a portion (about

45% from 2017 to 2019) of its metal production in the scenario of a wide price deviation.

Investment Risks Market Risk

Commodities’ Prices Volatility [MR1]

Industrias Peñoles’ stock prices and earnings are heavily exposed to external factors, not

controlled directly by the company’s operations. This is because the company shows a great

dependency on commodity prices, and a great relation to economic cycles (Figure 36).

Consequently, the company is exposed to macroeconomic events including: changes in

monetary policies, inflation, GDP growth and unemployment rates. Peñoles is covered from

price fluctuation with commodity derivatives, however hedged production adds up to only a

45% of expected metals production from 2017 to 2019 (Appendix B11). Moreover, the

valuation can be potentially biased towards a specific result. For instance, making a valuation

from the figures of a specific fiscal year (or years) that had a certain economic climate, may

point towards a result inclined to a specific (biased) direction. Thus, any assumptions made on

future earnings will reflect a degree of error that can further affect the target price.

Strong Inverse Correlation with the U.S. Dollar [MR2]

The most important geographic segment for Industrias Peñoles, in terms of sales, is the United

States of America with 72.8% of total sales (Figure 39), and almost 100% of Peñoles’ sales are

denominated in USD (while only ~50% of costs are based in MXN). Therefore, the company is

mostly exposed to one geographical segment and one currency. As such, a weaker-than-forecast

USD should deviate the company’s financial performance negatively relative to our estimates,

and vice versa.

Insiders’ Overweight of Ownership [MR3] The top 2 holders of Industrias Peñoles are: Mr. Alberto Bailléres and Albacor, S.A. de C.V.

The former is the company’s founder, and the latter is an institution from Grupo BAL (which is

the owner of the conglomerate that includes Industrias Peñoles). The two holders add up to a

Figure 36: PE&OLES* Close Price vs.

Gold Spot Close Price Regression

Source: Thomson Reuters, Team Calculations

Figure 37: Allocated Reserves by

Currency for 2016Q2

Source: Currency Composition of Official Foreign

Exchange Reserves (COFER), International Financial

Statistics (IFS)

Figure 38: Gold Spot Price vs. US

Dollar Currency Index


Figure 39: Sales by Region


Figure 40: Gold Ore Reserves versus

Grade


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198

7

198

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199

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201

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Pts

.

$U

SD

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XAU= Bid Close .DXY Trade Close

73%

18%5%

3%

1%

United States of America MexicoEurope Other CountriesSouth America

0

0.2

0.4

0.6

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1.0

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1.4

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0

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20

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To

nn

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P&P Ore Reserves (T)

P&P Reserves Grade (g/T)

g/

ton

ne

mill

ed

9

68.82% of ownership of all outstanding shares (Appendix B9). On the one hand, this situation

should be positive because holders are interested in making the business more profitable. But

on the other hand, this situation could lead to negative results such as filings manipulations that

could affect investor’s confidence and ultimately the company’s stock price (though this has

never happened before and is improbable to happen).

Operational Risk

Assumptions on Ore’s Grade, Size of Deposits, and Costs of Extraction and Exploration

[OR1]

These three factors directly affect the overall operational costs. A low ore grade, a small deposit

and increased costs will eventually lead to a higher cost per ounce (or ton) of material produced.

Costs of extraction and exploration are the only ones that can be tracked and managed, but to a

certain degree. As an example of this, the company shows an increase in reserve holdings but a

decrease in their grades, resulting in a softened increase in net gold reserves (Figure 40). On the

other hand, even when an exploration operation is conducted on an ore deposit, the size and

grade of the deposit are not certain. This can result in write-down charges as further operations

may not be economically viable.

Geological Disasters: Floods [OR2]

When performing excavation activities there is a degree of uncertainty about the existence of a

body of water coming from a geohydrological structure in the mine, and if the body of water is

drilled this could cause partial or total floods. Such an event has already happened to Industrias

Peñoles at its Naica mine in Chihuahuaxviii. When such an event happens, mines can lose their

value partially or totally. Moreover, sold-in-advance production and derivatives must be

refunded in cash as the commodity cannot be delivered.

Country Risk

Yielding Regulatory Governance [CR1]

In 2009, Soledad-Dipolos mine was suspended due to lawsuits carried out by communal

landowners (ejidatarios). Even though, the mining activities were conducted in accordance to

the governmental concessions and environmental permits legally granted at the time, the

Agrarian Court (which was the one conducting this case) ordered to vacate 1,824 hectares of

land arguing environmental rehabilitation measures.

Corporate governance

Board of Directors

The Board Chairman is elected by the members of the board, and he/she must not hold an

executive position within the company. Moreover, the elected Chairman must not be part of the

Board. The composition of the Board has been structured to ensure that no one individual can

dominate the decision-making processes of the Board. The current Chairman Alberto Bailléres,

holds interests of more than 50% of the share capital of the Company. From all the members of

the Board, 14 are Proprietary Board Members, and 13 are alternates.

In 2011, Peñoles implemented the new “Code of Conduct, Living our Values”, which governs

the behavior expected of all employees who work in the Company within a framework of ethics

aligned with the Institutional Values, thus reinforcing the transparency and accountability of the

stakeholders. Furthermore, Peñoles also counts with an Internal Audit Division that works in

coordination with External Auditors to review policies and internal control systems in

accordance to the Corporate Governance Code. We believe these practices are positive for the

company’s earnings prospects, since they enhance worker’s productivity and efficiency.

Corporate Governance Focus & Results

Industrias Peñoles was chosen to be part of the Sustainable Index of the Mexican Stock

Exchange (MSE) in 2011, becoming the first Company in its sector to achieve this recognition.

It will also receive the Sustainable Company seal from the MSE, because of its competitive

level in the adoption of sustainable policies and systems. The election of the winner of this seal

was conducted by the EIRIS (Empowering Responsible Investment) and the Center of

Excellence in Corporate Governance of the Universidad Anahuac del Sur, who were hired by

the MSE to analyze the 70 largest stock issuers in the MSE and rate their degree of adoption of

international practices in this area. The parameters used for the election of the winner were: The

Organization's Principles for Cooperation and Economic Development (OECD), the UN

Principles for Responsible Investment (UN-PRI) and the recommendations of the International

Corporate Governance Network (ICGN). In this way, Industrias Peñoles became a pioneer by

integrating the selected group of companies that have received both distinctions.

Figure 41: Gold Spot and S&P500 Rate

of Change since 1Q 2005

Source : Thomson Reuters

Figure 42: Risk Matrix


Figure 43: Monte Carlo Statistical

Summary Sample / Iterations 500,000 Mean $566.97 Median $564.52 Standard Deviation $75.07 Variance 5634.82 Skewness 0.2074 Kurtosis 3.27 Coefficient of Variation 0.1324 Minimum $191.50 Maximum $1007.04 Standard Error 0.11

Mean – 2 Std. Dev. $416.84 Mean – 1 Std. Dev. $491.90 Mean + 1 Std. Dev. $642.04 Mean + 2 Std. Dev. $717.10


Figure 44: Industrias Peñoles’ Ethics

and Compliance Program


0%

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10

Section A: Financial Analysis and Valuation

Appendix A1: Industrias Peñoles’ Income Statement Historical & Expected Values

Historical Income Statement

Projected Income Statement

(MXN Millions) 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E

Total Revenue 96,864.1 97,199.4 66,550.9 61,555.6 64,896.5 78,589.89 96,238.28 101,906.33 112,001.56 124,796.89 131,582.88

Cost of Goods Sold 63,404.2 68,544.9 48,086.8 45,483.8 51,536.0 54,227.02 66,885.60 69,805.84 76,161.06 84,237.90 86,844.70

Gross Profit 33,459.9 28,654.5 18,464.0 16,071.8 13,360.5 24,362.87 29,352.67 32,100.49 35,840.50 40,558.99 44,738.18

Selling General & Admin Exp.

3,538.8 4,043.9 4,263.7 4,700.5 4,950.3 4,715.39 4,330.72 3,821.49 3,640.05 4,367.89 4,605.40

Other Operating Exp., Total

6,022.4 8,331.4 8,864.0 9,193.0 8,599.5 8,959.25 8,228.37 7,260.83 6,916.10 8,298.99 8,750.26

Operating Income (EBIT)

27,437.5 20,323.1 9,600.0 6,878.8 4,761.0 15,403.62 21,124.30 24,839.67 28,924.40 32,260.00 35,987.92

EBITDA 31,610.2 25,896.2 15,869.2 13,619.3 13,356.1 24,858.23 31,997.10 36,527.93 41,489.28 45,453.12 49,840.70

D&A 4,172.72 5,573.02 6,269.19 6,740.53 8,595.10 9,454.61 10,872.80 11,688.26 12,564.88 13,193.12 13,852.78

Net Interest Exp. & Other Exp.

779.7 212.1 269.2 2,099.0 1,189.6 1,375.32 1,539.81 1,528.59 1,512.02 1,559.96 1,644.79

EBT 26,657.8 20,111.0 9,330.8 4,779.8 3,571.4 14,028.30 19,584.49 23,311.07 27,412.38 30,700.03 34,343.13

Income Tax Expense 8,895.4 5,972.4 3,387.1 3,067.3 4,067.4 6,312.73 7,246.26 8,625.10 10,142.58 11,359.01 12,706.96

Minority Int. in Earnings 5,007.5 4,107.2 1,183.0 513.4 370.0 2,986.42 3,849.53 4,585.78 5,320.07 6,239.84 6,908.10

Net Income 12,754.9 10,031.4 4,760.7 1,199.1 (866.1) 4,729.15 8,488.70 10,100.19 11,949.73 13,101.18 14,728.07

EPS 32.09 25.24 11.98 3.02 (2.18) 11.91 21.38 25.44 30.10 33.00 37.10

Dividends per Share 20.09 9.3 9.23 1.51 1.51 4.76 9.62 12.72 15.05 18.15 20.40

Payout Ratio % 26.6% 79.4% 138.6% 62.9% - 40% 45% 50% 50% 55% 55%

Historical Income Statement Common Size Analysis Projected Income Statement Common Size Analysis

(MXN Thousands) 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E

Total Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost Of Goods Sold 65.46% 70.52% 72.26% 73.89% 79.41% 69.00% 69.50% 68.50% 68.00% 67.50% 66.00%

Gross Profit 34.54% 29.48% 27.74% 26.11% 20.59% 31.00% 30.50% 31.50% 32.00% 32.50% 34.00%

Selling General & Admin Exp. 3.65% 4.16% 6.41% 7.64% 7.63% 6.00% 4.50% 3.75% 3.25% 3.50% 3.50%

Other Operating Exp., Total 6.22% 8.57% 13.32% 14.93% 13.25% 11.40% 8.55% 7.13% 6.18% 6.65% 6.65%

Operating Income (EBIT) 28.33% 20.91% 14.43% 11.17% 7.34% 19.60% 21.95% 24.38% 25.83% 25.85% 27.35%

EBITDA 32.63% 26.64% 23.85% 22.13% 20.58% 31.63% 33.25% 35.84% 37.04% 36.42% 37.88%

D&A 4.31% 5.73% 9.42% 10.95% 13.24% 12.03% 11.30% 11.47% 11.22% 10.57% 10.53%

Net Interest Exp. & Other Exp. 0.80% 0.22% 0.40% 3.41% 1.83% 1.75% 1.60% 1.50% 1.35% 1.25% 1.25%

EBT 27.52% 20.69% 14.02% 7.76% 5.50% 17.85% 20.35% 22.88% 24.48% 24.60% 26.10%

Income Tax Expense 9.18% 6.14% 5.09% 4.98% 6.27% 8.03250% 7.5295% 8.4638% 9.0558% 9.1020% 9.6570%

Minority Int. in Earnings 5.17% 4.23% 1.78% 0.83% 0.57% 3.80% 4.00% 4.50% 4.75% 5.00% 5.25%

Net Income 13.17% 10.32% 7.15% 1.95% -1.33% 6.02% 8.82% 9.91% 10.67% 10.50% 11.19%


Appendix A2: Industrias Peñoles’ Balance Sheet Historical & Expected Values

Historical Balance Sheet Projected Balance Sheet


Total Cash & ST Investments

15,931.2 11,482.1 19,720.2 15,596.7 13,993.7 12,594.37 6,297.18 8,816.06 13,224.09 9,256.86 10,182.55

Accounts Receivable 2,719.7 2,715.4 2,062.3 2,463.3 2,550.5 3,188.08 2,869.28 3,586.59 4,303.91 3,873.52 4,067.20

Other Receivables 2,847.0 6,883.1 6,998.7 6,980.6 5,549.9 6,937.38 6,243.64 7,804.55 9,365.46 8,428.92 8,850.36

Notes Receivable 77.2 314.6 91.6 94.5 70.1 87.68 78.91 98.63 118.36 106.53 111.85

Total Receivables 5,643.9 9,913.0 9,152.6 9,538.4 8,170.5 10,213.14 9,191.82 11,489.78 13,787.74 12,408.96 13,029.41

Inventory 16,625.6 13,534.0 11,817.6 13,173.2 16,016.9 20,021.10 18,018.99 22,523.74 27,028.49 24,325.64 25,541.92

Prepaid Exp. 188.5 - - - - - - - - - -

Other Current Assets 484.2 766.3 1,193.8 1,278.4 2,075.3 2,594.07 2,334.66 2,918.33 3,502.00 3,151.80 3,309.39

11

Total Current Assets 38,873.5 35,695.4 41,884.2 39,586.7 40,256.4 50,320.49 45,288.44 56,610.55 67,932.66 61,139.39 64,196.36

Net Property, Plant & Equipment

37,183.3 41,748.9 46,481.1 53,788.9 65,318.5 81,648.15 83,689.35 87,873.82 92,267.51 94,574.20 96,938.55

Long-term Investments 2,216.5 3,160.5 2,201.6 2,580.0 2,079.6 2,599.48 2,664.47 2,797.69 2,937.58 3,011.02 3,086.29

Other Intangibles 561.4 - - - - - - - - - -

Accounts Receivable Long-Term

191.3 - - - - - - - - - -

Loans Receivable Long-Term

- 279.5 201.3 62.6 48.2 - - - - - -

Deferred Tax Assets, LT

1,660.7 - 1,908.4 1,938.8 1,240.0 1,550.00 1,588.75 1,668.19 1,751.60 1,795.39 1,840.27

Other Long-Term Assets

44.1 129.9 351.2 495.7 1,916.6 - - - - - -

Total Assets 80,730.7 81,014.3 93,027.8 98,452.6 110,859.3 138,574.15 142,038.50 149,140.42 156,597.45 160,512.38 164,525.19

LIABILITIES

Accounts Payable 2,150.2 1,530.3 1,550.5 1,887.2 1,820.5 2,548.71 2,931.01 3,224.11 3,546.52 3,812.51 4,098.45

Accrued Exp. 2,455.3 2,599.5 2,352.6 2,278.6 2,290.6 3,206.88 3,687.91 4,056.70 4,462.37 4,797.05 5,156.82

Short-term Borrowings 148.0 - 535.1 - - - - - - - -

Curr. Port. of LT Debt 393.5 435.8 134.7 2,068.4 205.5 287.75 330.91 364.00 400.40 430.43 462.71

Curr. Income Taxes Payable

558.2 235.6 309.5 398.9 439.5 615.27 707.56 778.32 856.15 920.36 989.38

Unearned Revenue, Current

335.0 510.8 581.0 248.1 230.5 322.65 371.05 408.15 448.97 482.64 518.84

Other Current Liabilities 2,374.9 1,969.3 1,284.5 2,489.8 1,964.2 2,749.88 3,162.36 3,478.59 3,826.45 4,113.44 4,421.94

Total Current Liabilities

8,415.0 7,281.3 6,748.0 9,371.0 6,950.8 9,731.12 11,190.79 12,309.87 13,540.86 14,556.42 15,648.16

Long-Term Debt 8,798.2 10,309.5 20,323.8 20,839.3 24,173.4 30,216.71 30,972.13 31,746.43 32,063.90 32,865.50 33,194.15

Pension & Other Post-Retire. Benefits

450.7 683.0 789.3 1,215.5 1,598.7 1,998.34 2,048.30 2,099.51 2,120.50 2,173.51 2,195.25

Def. Tax Liability, Non-Curr.

7,855.8 4,702.9 5,346.3 6,098.3 8,094.1 10,117.69 10,370.63 10,629.89 10,736.19 11,004.60 11,114.64

Other Non-Current Liabilities

2,997.8 4,039.4 4,411.1 4,985.9 6,049.1 7,561.33 7,750.37 7,944.12 8,023.57 8,224.16 8,306.40

Total Liabilities 28,517.4 27,016.0 37,618.5 42,509.9 46,866.1 58,582.58 60,047.14 61,548.32 62,163.80 63,717.90 64,355.08

Common Stock 2,191.2 2,191.2 2,191.2 2,191.2 2,191.2 2,191.21 2,191.21 2,191.21 2,191.21 2,191.21 2,191.21

Retained Earnings 36,551.9 38,567.7 39,155.1 39,365.0 37,915.2 45,281.48 49,809.63 54,790.59 57,530.12 61,844.88 64,937.12

Treasury Stock (30.5) (30.5) (30.5) (30.5) (30.5) (30.50) (30.50) (30.50) (30.50) (30.50) (30.50)

Comprehensive Inc. and Other

2,664.7 838.8 772.8 4,895.4 12,333.2 15,448.75 17,209.70 19,146.74 20,212.11 21,890.08 23,092.62

Total Common Equity 41,377.4 41,567.3 42,088.5 46,421.1 52,409.1 62,890.94 69,180.04 76,098.04 79,902.94 85,895.66 90,190.45

Minority Interest 10,836.0 12,431.0 13,320.7 9,521.6 11,584.1 13,321.76 13,454.98 13,589.52 13,725.42 13,862.67 14,001.30

Total Equity 52,213.3 53,998.2 55,409.3 55,942.7 63,993.3 76,212.70 82,635.01 89,687.57 93,628.36 99,758.34 104,191.75

Total Liabilities and Equity

80,730.7 81,014.3 93,027.8 98,452.6 110,859.3 134,795.28 142,682.15 151,235.88 155,792.17 163,476.24 168,546.82

*Net Working Capital 14,920.8 17,367.7 15,550.7 16,687.3 19,517.4 28,282.74 28,131.37 35,848.62 41,568.11 37,756.54 38,828.37

*Change in working capital

2,446.95 (1,816.97) 1,136.55 2,830.08 8,765.36 (151.37) 7,717.25 5,719.49 (3,811.57) 1,071.83


Appendix A3: Industrias Peñoles’ Cash Flow Statement Historical & Expected Values

Historical Cash Flow Statement Projected Cash Flow Statement


Net Income 12,754.9 10,031.4 4,760.7 1,199.1 (866.1) 4,729.15 8,488.70 10,100.19 11,949.73 13,101.18 14,728.07

Depreciation & Amort. 4,141.4 5,573.0 5,494.9 6,537.9 8,296.1 9,454.61 10,872.80 11,688.26 12,564.88 13,193.12 13,852.78

Amort. of Goodwill and Intangibles

31.4 - - - - - - - - - -

Impair. of Oil, Gas & Mineral Prop.

- - 774.2 202.7 299.0 - - - - - -

Depreciation & Amort., Total

4,172.7 5,573.0 6,269.2 6,740.5 8,595.1 9,454.61 10,872.80 11,688.26 12,564.88 13,193.12 13,852.78

(Gain) Loss from Sale of Assets

84.1 70.6 71.8 335.8 513.0 - - - - - -

(Gain) Loss on Sale of Invest.

- - 26.1 29.6 40.2 - - - - -

12

Asset Writedown & Restructuring Costs

- - 34.4 97.7 121.8 - - - - - -

(Income) Loss on Equity Invest.

19.8 (152.8) (102.2) (23.1) (38.5) - - - - - -

Other Operating Activities 16,787.2 11,541.1 5,838.7 2,485.0 5,957.0 6,289.76 11,289.97 13,433.25 15,893.14 17,424.57 19,588.34

Change in Acc. Receivable

(2,779.0) (6,522.5) 1,366.8 (1,051.9) (1,748.1) - - - - - -

Change in Inventories (4,936.8) 2,502.2 1,785.8 110.4 (1,235.9) - - - - - -

Change in Acc. Payable (43.2) 32.0 (410.8) 633.3 (173.0) - - - - - -

Change in Inc. Taxes (6,165.4) (5,764.2) (5,432.2) - - - - - - - -

Change in Other Net Operating Assets

(795.7) (1,209.5) (1,348.6) (9.5) (407.0) - - - - - -

Cash from Ops. 19,098.5 16,101.3 12,859.8 10,546.9 10,758.6 6,289.76 11,289.97 13,433.25 15,893.14 17,424.57 19,588.34

Capital Expenditure (9,614.8) (11,406.5) (10,905.4) (9,084.9) (11,489.8) (13,787.8) (17,579.4) (14,063.5) (10,899.2) (13,624.0) (16,348.8)

Sale of Property, Plant, and Equipment

121.6 506.4 90.2 52.7 43.3 - - - - - -

Cash Acquisitions - - - - (10.0) - - - - - -

Divestitures - - - - 637.8 - - - - - -

Sale (Purchase) of Intangible assets

(31.3) (19.2) (34.1) (5.5) (3.6) - - - - - -

Invest. in Marketable & Equity Securt.

(32.3) (285.3) (168.6) (4,268.1) 1,877.5 - - - - - -

Net (Inc.) Dec. in Loans Originated/Sold

(42.4) 48.8 284.0 77.7 49.1 - - - - - -

Other Investing Activities 177.9 171.2 399.0 265.3 129.2 - - - - - -

Cash from Investing (9,421.3) (10,984.7) (10,334.9) (12,962.8) (8,766.5) (13,787.8) (17,579.4) (14,063.5) (10,899.2) (13,624.0) (16,348.8)

Long-Term Debt Issued 17,631.2 7,105.7 15,336.3 - - - - 15,000.0 - - -

Total Debt Issued 17,631.2 7,105.7 15,336.3 - - - - 15,000.0 - - -

Short Term Debt Repaid - - - - - - - - - - -

Long-Term Debt Repaid (18,420.8) (4,591.3) (4,779.6) - (2,101.5) - - (2,000.0) (2,000.0) (4,000.0) (4,000.0)

Total Debt Repaid (18,420.8) (4,591.3) (4,779.6) - (2,101.5) - - (2,000.0) (2,000.0) (4,000.0) (4,000.0)

Issuance of Common Stock

- - - - 23.3 - - - - - -

Repurchase of Common Stock

- - - - - - - - - - -

Common Dividends Paid (3,395.0) (7,967.8) (6,596.1) (753.8) (599.2) (1,891.66) (3,819.91) (5,050.10) (5,974.86) (7,205.65) (8,100.44)

Total Dividends Paid (3,395.0) (7,967.8) (6,596.1) (753.8) (599.2) (1,891.66) (3,819.91) (5,050.10) (5,974.86) (7,205.65) (8,100.44)

Special Dividend Paid - - - - - - - - - - -

Other Financing Activities (3,662.1) (2,922.5) 1,604.6 (7,573.5) (1,573.3) - - - - - -

Cash from Financing (7,846.7) (8,375.9) 5,565.2 (8,327.3) (4,250.7) (1,891.66) (3,819.91) 7,949.90 (7,974.86) (11,205.65) (12,100.44)

Foreign Exchange Rate Adj.

1,523.5 (1,094.9) 148.0 2,277.9 2,533.1 3,000.0 (500.0) - - - -

Net Change in Cash 3,354.0 (4,354.1) 8,238.1 (8,465.3) 274.5 7,398.11 6,970.05 7,319.64 (2,980.95) (7,405.11) (8,860.94)


Appendix A4: Industrias Peñoles’ Discounted Cash Flow Model

Industrias Peñoles - DCF Valuation (MXN$ millions)

2016E 2017E 2018E 2019E 2020E 2021E Terminal Value

EBITDA 24,858.23 31,997.10 36,527.93 41,489.28 45,453.12 49,840.70 49,840.70

EBITDA Margin % 31.63% 33.25% 35.84% 37.04% 36.42% 37.88% 40.00%

(-) Depreciation 9,454.61 10,872.80 11,688.26 12,564.88 13,193.12 13,852.78 13,852.78

(=) EBIT 15,403.62 21,124.30 24,839.67 28,924.40 32,260.00 35,987.92 35,987.92

(-) Cash Tax 6,312.73 7,246.26 8,625.10 10,142.58 11,359.01 12,706.96 12,706.96

Cash Tax Rate 40.98% 34.30% 34.72% 35.07% 35.21% 35.31% 35.00%

(=) EBIT(1-t) 9,090.89 13,878.04 16,214.57 18,781.82 20,900.98 23,280.96 23,280.96

(+) Depreciation 9,454.61 10,872.80 11,688.26 12,564.88 13,193.12 13,852.78 13,852.78

(-) Capex 13,787.76 17,579.39 14,063.52 10,899.22 13,624.03 16,348.84 16,348.84

(-) Change in Working Capital (8,765.36) 151.37 (7,717.25) (5,719.49) 3,811.57 (1,071.83) (1,071.83)

Free Cash Flow to the Firm (FCFF) 13,523.10 7,020.07 21,556.56 26,166.97 16,658.50 21,856.73 21,856.73

WACC (%) 9.16% 9.16% 9.16% 9.16% 9.16% 9.16% 9.16%

Present Value of Cash Flows 13,523.10 6,430.73 18,089.10 20,114.52 11,730.35 14,098.70 311,173.24

13

(+) Sum of PV of FCF 83,986.50

(+) Present Value of Perpetuity 183,871.63

(=) Present Value of FCFF (EV) 267,858.12

(-) Interest Bearing Debt 32,085.30

(=) Industrias Peñoles Equity Value 235,772.82

# Shares Outstanding 397

Industrias Peñoles Target Price Per Share ($MXN)

593.89


Appendix A5: Industrias Peñoles’ Relative Valuation Model

P/E 2011 2012 2013 2014 2015 2016 E 2017 E 2018 E

SLW US 81.54 21.29 15.61 21.64 23.99 32.7 25.98 24.54

THO US 13.1 16.9 14.3 22.79 18.13 14.61 14.48 12.05

HL US 11.71 11.37 25.81 73.51 68.77 29.63 19.27 19.21

CDE US 384.52 15.96 19.73 31.7 44.8 28.67 17.34 12.9

HOC LN 17.62 15.03 20.26 21.2 23.7 19.69 18.7 13.09

G US 32.23 20.84 14.66 135.38 120.69 50.39 28.7 24.21

PAAS US 254.83 8.41 14.37 65.93 71.1 30.9 23.74 16.51

Median P/E for each year 32.23 15.96 15.61 31.7 44.8 29.63

PE&OLES MM 29.97 18.88 18.3 26.86 83.74 22.67

Historical Dicount/ Premium -7.0% 18.3% 17.2% -15.3% 86.9% -23.5%

Median of historical premium 5.1%

2017E 2018E

P/E peers’ median 19.27 16.51

Premium 5% 5%

Target P/E 20.23 17.34

EPS (MXN) 21.38 25.44

Price from P/E (MXN) 432.59 441.02

Weights for year 50% 50%

Average price (MXN) 436.80

EV/EBITDA 2011 2012 2013 2014 2015 2016 E 2017 E 2018 E

SLW US 39.03 17.61 12.02 16.94 16.66 17.02 14.48 14.17

THO US 13.1 12.9 12.5 12.08 16.33 7.91 7.03 6.03

HL US 184.79 4.99 10.83 26.89 9.67 10.67 8.87 8.39

CDE US 11.65 3.8 3.65 4.1 3.9 9.07 6.18 5.36

HOC LN 6.01 4.14 3.8 5.13 8.85 4.84 4.58 4.12

G US 19.47 11.21 8.93 9.5 8.8 54.12 27.57 20.67

PAAS US 10.76 4.49 4.2 5.1 4.9 8.11 7.76 6.02

Median EV/EBITDA for each year 13.1 4.99 8.93 9.5 8.85 9.07

PE&OLES MM 11.89 7.74 7.56 9.32 8.94 7.07

Historical Discount/ Premium -9.2% 55.1% -15.3% -1.9% 1.0% -22.1%

Median of historical discounts -5.6%

2017E 2018E

EV/EBITDA peer’s median 7.76 6.03

Discount -5% -5%

Target EV/EBITDA 7.37 5.73

EBITDA (MXN millions) 31,749.30 36,262.29

14

EV from EV/EBITDA (MXN millions) 234,055.84 207,728.53

Cash & Equivalents 6,297.80 8,816.06

Interest bearing debt 31,303.04 32,110.42

Preferred & Other 13,454.98 13,598.52

Value of equity (MXN millions) 195,595.62 170,835.65

Shares outstanding (millions) 397.00 397.00

Price from EV/EBITDA (MXN) 492.68 430.32


Average price (MXN) 461.50

EV/ Value of Mining Reserves 2011 2012 2013 2014 2015 2016 E 2017 E 2018 E

SLW US 0.44 0.47 0.34 0.35 0.23 0.33 0.25 0.35

THO US 0.5 0.6 0.5 0.5 0.4 0.5 0.4 0.45

HL US 0.16 0.18 0.21 0.17 0.18 0.2 0.18 0.19

CDE US 0.2 0.2 0.18 0.11 0.11 0.17 0.12 0.14

HOC LN 1.18 1.87 0.72 0.44 0.48 0.9 0.51 0.55

G US 0.21 0.17 0.13 0.15 0.1 0.14 0.11 0.12

PAAS US 0.19 0.23 0.12 0.09 0.07 0.16 0.08 0.09

Median EV/Reserves for each year 0.21 0.23 0.21 0.17 0.18 0.2

PE&OLES MM 0.62 0.71 0.38 0.37 0.23 0.375

Historical Discount/ Premium 195.2% 208.7% 81.0% 117.6% 27.8% 87.5%

Median of historical Premium 102.6%

2017E 2018E

EV/ Reserves Median 0.18 0.19

Premium 1.03 1.03

Target EV/ Reserves 0.37 0.39

Reserves

40,185.31

33,242.36

EV from EV/Reserves (USD millions) 14,683.71

12,821.58

Expected Exchange rate (USD/MXN)

22.15

22.00

EV from EV/Reserves (MXN millions) 325,244.25

282,074.71

Cash & Equivalents

6,297.80

8,816.06

Debt

31,303.04

32,110.42

Preferred & Other

13,454.98

13,598.52

Value of equity (MXN millions)

286,784.03

245,181.83

Shares outstanding (millions)

397.00

397.00

Price per share (MXN)

722.38

617.59


Average price 669.98

Total price average 524.18


Appendix B5: Valuation Summary

Price from Relative Valuation 524.18

Weight of Relative Valuation 40%

Price from Intrinsic Valuation (DCF) 593.89


12-Month Target Price (MXN) 566.0

Price Per Share (January 20, 2017) 488.24

Upside Potential 15.93%


15

Appendix A6: Peer group selection criteria

1) Production criteria:

2) Significant portion of mining operations in Latin America.

c) At least 10 million ounces of

silver produced in the last

reported year.

b) At least 100 thousand ounces

of gold produced in the last

reported year.

c) Gold produced in the last reported

year must not be higher than 10% of

silver production in the same year.

0

10

20

30

40

50

60

Mil

lio

ns

of

ounce

s

Silver production 2015 (Millions of ounces)

Lower limit (10 Million ounces)

0

0.5

1

1.5

2

2.5

3

3.5

Mil

lio

ns

of

ounce

s

Gold production 2015 (Millions of

ounces)Lower limit (0.1 million ounces)

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

Gold/silver production ratio

Upper limit (10%)Source: Bloomberg, Team Estimates

-

2,000.00

4,000.00

6,000.00

8,000.00

10,000.00

12,000.00

14,000.00

16,000.00

PE&OLES SLW THO HL CDE HOC G PAAS

Milli

ons

of

$U

SD

Enterprise Value (Millions of USD) Current/ LTM

Lower limit (1,000 Million USD)

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

140.00%

160.00%

PE&OLES SLW THO HL CDE HOC G PAAS

Last 5 years average CAPEX/ Sales ratio Lower limit (10%)

3) At least 10 million ounces of silver produced

in the last reported year.

4) Five-year Capex/ Sales ratio average of at

least 10%.

Source: Bloomberg, Team Estimates Source: Bloomberg, Team Estimates



16

Appendix A7: Debt Obligations Overview

Rating Agency Credit Rating Scale Outlook

Industrias Peñoles

S&P BBB Global –long term stable

S&P mxAAA Local – long term stable

S&P BBB/mxAAA Issuance of exchange traded bonds stable

Moody’s Baa3 Global, local currency stable

Moody’s Baa3/Aa2.mx Issuance of exchange traded bonds stable

Fresnillo PLC

S&P BBB Global - long term stable

Moody’s Baa2 Global foreign currency stable


Appendix A8: Hedging program

a) Metal price and energy hedging program

As at 30 September 2015, Grupo Peñoles has entered into the following contracts that commit a portion of its

production from 2016 to 2019:

Note: (1) Includes 100% of consolidated hedging.


400

200

800

0

100

200

300

400

500

600

700

800

900

2020 2021 2022 2023

Debt maturity profile US$ million

Silver Gold Zinc Lead Copper Natural Gas

19,802,934 1,238,388 88,629 5,859 8,301 1,290,000

ounces (oz) ounces (oz) tonnes (tn) tonnes (tn) tonnes (tn) mmBtu

Period Oct. '16 - Dec. '17Oct. '16 - Dec. '19 Oct. '16 - Dec. '17 Oct. '16 - Dec. '17 Oct. '16 - Dec. '17 Oct. '16 - Dec. '16

% production 2016* 50% 55% 29% 12% 32% 80%

% production 2017* 21% 45% 23% 3% 12% 0%

% production 2018* 0% 38% 0% 0% 0% 0%

% production 2019* 0% 37% 0% 0% 0% 0%

Price usd/oz usd/oz usd/tn usd/tn usd/tn usd/mmBtu

Min. Forward - - - - - 2.19

Max. Forward - - - - - 2.28

Wgt. Avg. Forward - - - - - 2.23

Min. Put 14.00 1,050 1,765 1,765 4,410 -

Max. Put 17.48 1,250 2,205 1,985 6,063 -

Wgt. Avg. Put 15.13 1,102 1,936 1,840 4,737 -

Min. Call 16.70 1,285 1,980 1,975 5,065 -

Max. Call 26.50 2,622 2,610 2,310 6,700 -

Wgt. Avg. Call 20.34 1,434 2,355 2,124 5,368 -

(1) Includes 100% of consolidated hedging.

* Based on 100% of consolidated production of the residuary period.

Total Hedged Volume (1)

17

b) Foreign currency hedging program

As at 30 September 2015, Grupo Peñoles has established the following derivative transactions that hedge a portion

of future obligations (2016) denominated in Mexican pesos:


Appendix A9: Ratio Analysis

Credit Ratio Analysis FY 2011

FY 2012

FY 2013

FY 2014

FY 2015

Profitability Ratio Analysis

FY 2011

FY 2012

FY 2013

FY 2014

FY 2015

Net Debt/EBITDA -0.24 -0.06 0.01 0.52 0.80

Returns

Net Debt/EBIT -0.28 -0.08 0.01 1.03 2.48

Return on Common Equity

38.24 24.19 11.38 2.71 -1.75

EBITDA to Interest Expense

69.53 51.30 20.81 11.23 10.76

Return on Assets 18.72 12.40 5.47 1.25 -0.83

EBIT to Interest Expense

60.33 40.19 13.20 5.60 3.49

Return on Capital 35.83 23.29 9.20 2.77 -0.79

Common Equity/Total Assets

51.25 51.31 45.24 47.15 47.28

Return on Invested Capital

31.85 20.43 8.42 3.04 -0.71

Long-Term Debt/Equity 15.28 17.96 35.75 36.46 37.30

Margins

Long-Term Debt/Capital 13.19 15.16 26.33 26.07 27.17

Gross Margin 34.54 29.48 27.74 26.11 20.64

Long-Term Debt/Total Assets

9.88 11.97 21.29 20.72 21.53

EBITDA Margin 32.56 26.46 22.58 21.18 18.93

Total Debt/Equity 15.82 18.45 35.75 39.88 37.30

Operating Margin 28.25 20.73 14.32 10.56 6.15

Total Debt/Capital 13.66 15.57 26.33 28.51 27.17

Pretax Margin 27.52 20.69 14.02 7.76 5.50

Total Debt/Total Assets 10.23 12.30 21.29 22.66 21.53

Net Income Margin 13.17 10.32 7.15 1.95 -1.33

Net Debt/Equity -14.69

-2.82 0.16 12.00 15.44

Additional

Net Debt/Capital -17.22

-2.90 0.16 10.72 13.37

Effective Tax Rate 33.37 29.70 36.30 64.17 113.89

Dvd Payout Ratio 60.12 63.28 15.23 48.06 —

Source: Bloomberg

Section B: Industry Overview, Competitive Positioning, and Business Overview

Appendix B1: Gold overview

Table B1.1: Gold supply and demand balance

tonnes

Supply 2012 2013 2014 2015 2016 2017E 2018E 2019E

Mine Production 2,849.8 3,039.5 3,129.0 3,178.1 3,121.9 3,056.3 2,992.1 2,940.5

Scrap 1,700.4 1,302.3 1,157.4 1,166.2 1,288.9 1,429.3 1,524.3 1,612.3

Net Hedging Supply (40.1) (38.8) 107.7 20.9 90.0 (39.0) (18.0) (28.0)

Supply 4,510.1 4,302.9 4,394.2 4,365.1 4,500.8 4,446.6 4,498.4 4,524.8

Demand 2012 2013 2014 2015 2016 2017E 2018E 2019E

Jewellery 2,044.2 2,477.8 2,249.3 2,178.0 1,658.0 1,847.9 1,930.5 1,990.1

Industrial Fabrication 424.9 417.2 399.3 361.5 336.9 308.6 290.2 282.0

...of which Electronics 302.9 296.3 286.1 254.4 235.3 210.2 192.8 175.3

...of which Dental & Medical 38.6 36.3 33.9 31.5 31.0 29.3 26.9 25.1

...of which Other Industrial 83.4 84.7 79.3 75.6 70.5 69.0 70.4 81.6

Net Official Sector 544.1 409.3 465.6 435.7 200.0 200.0 200.0 200.0

Retail Investment 1,357.6 1,791.7 1,103.1 1,105.2 961.5 988.5 1,049. 0 1,146.2

Exchange Rate Mxn/Usd Short Forward Long Forward Options

Hedged Volume (Thousands of USD) - - 113,500

Hedged Volume (Thousands of MXN) - - 1,884,950

Period - - Oct '16 - Dec '16

Wgt. Avg. Put - - 16.6075

Mi. Put - - 16.4400

Max. Put - - 17.2500

Wgt. Avg. Call - - 19.1791

Min. Call - - 18.5000

Max. Call - - 20.3400

Wgt. Avg. Fwd - - -

Min. Fwd - - -

Max. Fwd - - -

18

...of which Bars 1,052.2 1,409.9 851.7 846.4 728.5 761.3 795.8 885.6

...of which Coins 305.5 381.8 251.4 258.8 233.0 227.2 253.2 260.6

Total Physical demand 4,370.8 5,096.1 4,217.2 4,080.4 3,156.3 3,345.1 3,469.6 3,618.3

Physical Surplus/(Deficit) 139.3 (793.1) 176.9 284.8 1,344.5 1,101.5 1,028.7 906.5

ETF Inventory Build 279.2 (880.1) (154.6) (124.5) 800.0 500.0 300.0 ..

Exchange Inventory Build (9.7) (98.0) 0.5 (48.2) 100.0 .. .. ..

Net Balance (130.2) 184.9 331.0 457.5 444.5 601.5 728.8 906.5

Source: Thomson Reuters GFMS, International Copper Study Group, COMEX, Shanghai Futures Exchange, London Metal

Exchange

Table B1.2: Gold prices forecast

Gold (US$/Oz)

2016 2017E 2018E 2019E 2020E 2021E LT

Bear Case 1251 1,095.75 1,087.15 1,129.41 1,136.02 1,171.07 1,144.24

Base Case 1251 1,217.50 1,242.46 1,328.71 1,376.99 1,463.83 1,525.66

Bull Case 1251 1,308.81 1,366.71 1,494.80 1,583.54 1,720.00 1,830.79

Source: Thomson Reuters GFMS, Team Estimates

Appendix B2: Silver overview

Table B2.1: Silver supply and demand balance

millions of ounces

SUPPLY 2012 2013 2014 2015 2016 2017E 2018E 2019E

Mine Production 790.8 823.7 868 893 887.4 868.9 848.9 837.2

Scrap 255.5 192.1 168.3 145.5 145 161 175.4 184.2

Net Hedging Supply -47.1 -34.8 16.8 7.8 -20 -5 -5 5

Total Supply 1006.6 988.9 1053 1046.4 1012.4 1024.8 1019.3 1026.5

DEMAND 2012 2013 2014 2015 2016 2017E 2018E 2019E

Jewellery 185.4 217.8 224 226.2 208.5 212.7 219.5 228.5

Coins & Bars 159.6 241.9 236.5 292.4 222 202 196 190.1

Silverware 43.7 58.8 60.7 62.9 49.1 48.1 47.1 46.2

Industrial Fabrication 615 619.1 611.2 588.9 585.1 572.3 563.4 557.7

...of which Electrical & Electronics 266.7 266 263.4 246.9 242.9 236.9 230.4 224.5 ...of which Brazing Alloys & Solders 60.6 63.2 66.1 61.1 59 58.4 59.1 59.7

...of which Photography 54.2 50.5 48.5 46.7 45.6 44.4 43.5 42.3

...of which Photovoltaic* 62.9 62.5 61.7 75.2 83.3 78.8 75.4 72.1

...of which Ethylene Oxide 4.7 7.7 5 10.2 10.2 6.9 5.5 7.1

...of which Other Industrial Uses 165.8 169.3 166.5 148.9 144.1 146.8 149.4 152

Total physical demand 1003.7 1137.6 1132.4 1170.3 1064.6 1035 1025.9 1022.5

Physical Surplus/(Deficit) 2.9 -148.7 -79.3 -124 -52.2 -10.2 -6.6 4

ETF Inventory Build 55.3 2.5 1.5 -17.7 71.4 40 20 10

Exchange Inventory Build 62.2 8.8 -5.3 12.6 61.9 .. .. ..

Net Balance -114.6 -160 -75.5 -118.9 -185.5 -50.2 -26.6 -6

Source: Thomson Reuters GFMS, International Copper Study Group, COMEX, Shanghai Futures Exchange, London Metal Exchange

19

Table B2.2: Silver prices forecast

Silver (US$/Oz)

2016 2017E 2018E 2019E 2020E 2021E LT

Bear Case 17.11 15.49 15.48 16.48 16.64 16.89 16.37

Base Case 17.11 17.21 17.69 19.39 20.17 21.12 21.82

Bull Case 17.11 18.51 19.46 21.82 23.20 24.81 26.19


Appendix B3: Copper overview

Table B3.1: Copper supply and demand balance

thousands of tonnes

Production 2012 2013 2014 2015 2016 2017E 2018E 2019E

Global Refined Production 19,990 20,685 21,698 22,206 22,668 23,204 23,713 24,141

Consumption 2012 2013 2014 2015 2016 2017E 2018E 2019E

Total Mature Economies 5,896 5,890 6,164 6,212 6,292 6,397 6,505 6,636

...of which EU-28 3,100 3,027 3,137 3,212 3,276 3,338 3,400 3,466

...of which Japan 978 988 1,064 1,015 1,010 1,012 1,019 1,040

...of which United States 1,663 1,715 1,800 1,820 1,838 1,875 1,912 1,953

...of which Canada 155 159 163 165 168 171 174 177

Total BRIC 9,854 10,533 11,033 11,234 11,499 11,827 12,146 12,501

...of which Brazil 426 447 403 370 348 351 357 365

...of which Russia 660 664 630 460 446 450 452 455

...of which India 456 455 440 462 485 510 538 568

...of which China 8,312 8,967 9,560 9,942 10,220 10,516 10,799 11,112

Total ASEAN Economies 798 826 881 916 949 982 1,018 1,056

South Korea 720 714 745 739 737 740 745 754

Taiwan 433 437 465 463 472 485 500 515

Others 2,097 2,240 2,163 2,285 2,345 2,420 2,499 2,581

Global Consumption 19,799 20,640 21,450 21,849 22,294 22,852 23,412 24,043

Market Balance 191 46 248 357 374 352 301 98

Stocks (inventory) 2012 2013 2014 2015 2016 2017E 2018E 2019E

Total Stocks 1,360 1,325 1,339 1,482 1,855 2,208 2,508 2,606

Total as No. of weeks consumption 4 3 3 4 4 5 6 6

Source: Thomson Reuters GFMS, International Copper Study Group, COMEX, Shanghai Futures Exchange, London Metal Exchange

Table B3.2: Copper prices forecast

Copper (US$/ tonne)

2016 2017E 2018E 2019E 2020E 2021E LT

Bear Case 4,870.0 4,800.0 4,800.0 4,850.0 4,950.2 5,052.4 5,050.0

Base Case 4,870.0 5,771.0 5,800.0 6,250.0 6,508.2 6,642.6 6,650.0

Bull Case 4,870.0 6,500.0 5,950.0 6,300.0 6,630.1 6,762.9 6,750.0


Appendix B4: Zinc overview

Table B4.1: Zinc supply and demand balance

million tonnes

Supply 2016 2015 2014 2013 2012 2011

Global Mined Zinc Supply 10,194,231 13,267,720 13,613,675 13,663,137 13,308,783 12,461,778

North America 1,508,886 1,761,038 1,844,003 1,853,086 2,039,462 2,023,459

20

United States 672,300 807,500 832,000 784,000 738,000 769,000

Mexico 574,861 677,018 659,878 642,542 660,349 631,859

South & Central America 1,688,111 2,124,254 2,041,031 2,007,474 1,927,671 1,962,551

Europe 899,110 1,130,093 1,189,417 1,178,919 1,187,886 1,170,644

Asia 4,865,090 6,228,833 6,516,550 6,718,502 6,271,443 5,473,531

China 3,878,605 4,750,000 5,118,400 5,187,700 4,859,100 4,050,000

India 456,609 825,723 728,600 817,025 724,937 733,022

Oceania 835,000 1,600,000 1,560,000 1,523,000 1,507,000 1,516,000

Africa 177,625 229,189 265,396 279,997 304,723 285,345

Production and Demand 2016 2015 2014 2013 2012 2011

Global Zinc Slab Production 11,520,539 13,886,617 13,512,986 13,023,457 12,594,682 13,128,835

Global Zinc Slab Demand 11,458,406 13,786,482 13,801,165 12,970,339 12,107,715 12,571,379

Zinc Slab Net Surplus/-Deficit 62,133 100,135 (288,179) 53,118 486,967 557,456

Inventory and Reserves 2016 2015 2014 2013 2012 2011

LME Zinc Inventory 427,850 464,400 691,600 933,475 1,220,750 821,700

Global Zinc Mine Reserves (rounded) 200,000 230,000 250,000 250,000 250,000

Source: CME Group, Bloomberg, WBMS

Table B4.2: Zinc prices forecast

Zinc ($US/ tonne)

2016 2017E 2018E 2019E 2020E 2021E LT

Bear Case 2,400.0 2,466.0 2,469.4 2,446.8 2,325.9 2,349.2 2,372.7

Base Case 2,400.0 2,740.0 2,822.2 2,878.6 2,907.4 2,936.5 2,965.9

Bull Case 2,400.0 2,877.0 3,033.9 3,166.5 3,198.2 3,230.2 3,262.5


Appendix B5: Lead overview

Table B5.1: Lead supply and demand balance

million tonnes

Supply 2016 2015 2014 2013 2012 2011

Global Mined Lead Supply 3,842,320 4,997,171 5,271,167 5,293,415 5,099,584 4,771,557

North America 495,079 624,669 638,554 616,622 638,267 625,318

United States 291,869 370,526 385,017 342,583 336,061 334,095

Mexico 193,958 253,890 249,920 253,361 238,091 223,717

South & Central America 393,898 474,417 439,641 429,150 408,075 407,530

Europe 408,200 514,159 493,914 467,172 442,580 397,340

Asia 2,060,313 2,612,534 2,860,333 2,966,761 2,872,531 2,626,827

China 1,801,030 2,335,024 2,608,600 2,696,500 2,613,200 2,405,697

India 111,737 138,720 105,100 105,500 115,050 94,055

Oceania 364,000 654,000 728,000 711,000 639,000 621,000

Africa 80,889 90,139 80,385 95,264 100,493 100,595

Production and Demand 2016 2015 2014 2013 2012 2011

Global Refined Lead Production 8,984,145 10,190,618 11,022,943 11,305,623 10,709,074 10,646,647

Global Refined Lead Demand 9,003,445 10,204,971 11,039,546 11,294,322 10,525,762 10,462,772 Refined Lead Net Surplus/-Deficit (19,300) (14,353) (16,603) 11,301 183,312 183,875

Source: CME Group, Bloomberg, WBMS

21

Table B5.2: Lead prices forecast


Appendix B6: Peñoles’ expected revenue breakdown by product

Appendix B7: Porter’s 5 forces

Power of Buyers – Moderate: Given the wide range of

uses that the Peñoles’ products have, there is also a wide

range of consumers. However, it is possible to divide

consumer by product segment. The Precious Metals

products (gold and silver) consumers have a low

bargaining power, since final gold and silver products

are mostly jewelry products. In the other hand, the Base

Metals products consumers are often big companies that

use the base metals to create another final product, so

their bargaining power is moderate. Nonetheless, both

precious and base metals are commodity products, and

their prices change as market conditions change.

Power of Suppliers – Low: The mining industry often

has large amounts of cash to buy their own plants and

equipment. Furthermore, most mining companies

usually acquire the same type of equipment, and there is

an important variety of equipment brands to choose from, hence the equipment providers have low bargaining power and

it is difficult for them to increase their prices significantly because of competitive reasons.

Threat of Substitutes – Low: On the one hand, precious metals such as gold and silver are often consumed as jewelry

products, and even though here are other types of jewelry in the market such as diamonds and gems, gold and silver are

seen by consumers as the most representative jewelry products. Thus, consumers are unlike to substitute gold or silver to

other type of jewelry. On the other hand, base metals products are difficult to substitute as well. Base metals such as Zinc,

have very specific and important industrial functions, so it is difficult to replace them with something else.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2016E 2017E 2018E 2019E 2020E 2021E

Gold (USD) Silver Zinc Copper Lead Other

Lead (US$/tonne)

2016 2017E 2018E 2019E 2020E 2021E LT

Bear Case 1,850.0 2,061.9 2,054.7 2,036.0 1,944.9 1,964.4 1,984.0

Base Case 1,850.0 2,291.0 2,348.3 2,395.2 2,431.2 2,455.5 2,480.0

Bull Case 1,850.0 2,405.6 2,524.4 2,634.8 2,735.1 2,762.4 2,790.0

0

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Power ofBuyers

Power ofSuppliers

Threat ofSubstitutes

Threat of NewEntrants

ExistingRivalries

Figure B7.1: Porter's Five Forces Analysys



22

Threat of New Entrants – Insignificant: The mining industry is a very capital intensive sector, where companies need

to have large amounts of cash to operate properly. Furthermore, companies need to have mining concessions and special

environmental permits to start a mining project. Thus, the threat of new entrants to the mining business is insignificant.

Existing Rivalries – Moderate: Since mining companies can’t do much to change metal commodities prices, the only

place where they can compete is in operating costs. Mines usually compare to each other in how cost efficient they are

(extraction costs, production costs and smelting costs). Companies know at what commodities prices mining would stop

being a profitable business for them, and there are some companies that would stop operations before others because of

their different operating costs (See Appendix #).

Appendix B8: Competitive advantage analysis

1) Mine cash costs analysis

a) Cash cost for primary silver producers 2015 (US$/Oz Silver equivalent):

b) Cash cost for zinc mines 2015 (USc/lb Zn):



23

2) Mines reserve replenishment history

3) Mine production by metal

Mine 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

NAICA 7 8 7 7 8 6 7 5 3 4 5 8 11 11 8 16 19 14 15 5

SABINAS 21 25 23 17 28 30 23 12 15 10 10 11 11 11 11 12 13 11 10 13

BISMARK 9 9 5 6 5 7 3 2 1 2 2 4 5 5 8 10 10 8 7 5

TIZAPA 15 11 8 7 5 5 3 3 3 4 3 12 17 22 19 14 14 14 13 12

MADERO 14 14 11 8 11 11 11 13 15 13 15 18 17 16 14

VELARDEÑA 15 16 17 16

MILPILLAS 19 38 27 22 16 12 10 10 8 8

FRESNILLO 11 10 9 9 10 8 9 9 8 8 7 11 12 12 13 13 13 12 10 8

CIÉNEGA 10 10 8 8 12 15 14 15 18 11 10 11 13 14 11 14 17 12 11 10

SAUCITO 3 11 9 6 5

HERRADURA 15 9 6 5 7 5 8 10 12 11 12 12 10 7 7 4 9 9

SOLEDAD-DIPOLOS 6 4 3

NOCHE BUENA 5 3 4 3

AVERAGE 12 12 11 9 10 11 10 8 8 7 8 13 13 14 12 11 12 11 10 9

0

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Gold

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Silver

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Zinc

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Lead


24

4) Peñoles’ mines and third party mines contribution to refined production

0

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45

2004

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kton

Copper

41%50% 53% 51% 48%

62%

59%50% 47% 49% 52%

38%

11 12 13 14 15 3Q '16

Go

ld

Year

Peñoles Third Parties

45%38%

57%65% 59% 64%

55%62%

43%35% 41% 36%

11 12 13 14 15 3Q '16

Sil

ve

r

Year


41% 42% 48%58% 54% 56%

59% 58% 52%42% 46% 44%

11 12 13 14 15 3Q '16

Le

ad

Year


63% 60%70% 74%

80% 84%

37% 40%30% 26%

20% 16%

11 12 13 14 15 3Q '16

Zin

c

Year




25

5) Mine projects pipeline

Precious metals segment (Fresnillo PLC) projects pipeline:


Base metals segment projects pipeline:

Humos (Sonora): copper, advanced exploration, estimated startup of operations: 2022.

La Industria (Durango): lead, zinc and silver, advanced explorations.

Rey de Plata (Guerrero): polymetallic, under construction, investment US$ 296.0 million, estimated startup of

operations: 2018.

Racaycocha (Peru): copper-molybdenum, estimated startup of operations: 2022.

Chile: gold and copper, continuous exploration.

6) Geographical localization of mines and offices


26

Appendix B9: Industrias Peñoles’ Shareholders (PE&OLES)

Appendix B10: Macroeconomic Overview

Federal Reserve Economic Projections (Dec 14, 2016):

Figure A9.1: Summary of economic projections released by in the FOMC minutes

Source: Federal Reserve

Figure A9.2: FOMC participants’ assessment of appropriate monetary policy

Note: Each dot represents a prediction of the federal funds target rate by a member of the Federal Open Market Committee (FOMC).


HolderCommon Stock

Equivalent Held

% of Total Shares

Outstanding

Market Value

(MXN in mm)*Position Date

González, Alberto Baillères 140,539,312 35.36 53,915.10 Dec-31-2015

Albacor, S.A. De C.V. 132,980,278 33.46 51,015.30 Dec-31-2015

BlackRock, Inc. 12,966,096 3.26 4,974.20 Nov-30-2016

First Eagle Investment Management, LLC 11,111,145 2.8 4,262.60 Sep-30-2016

The Vanguard Group, Inc. 3,843,639 0.97 1,474.50 Aug-31-2016

* Market value is calculated using the closing price 383.63 MXN as of Dec-22-2016.


27

Figure A9.3: Medians, central tendencies, and ranges of economic projections, 2016-19 and over the long run


Appendix B11: U.S. Dollar and Precious Metals’ spot prices

The usual justification behind investing in a commodity is to capture a price movement of a particular raw material, nonetheless it is

principally driven by the underlying supply and demand fundamentals. As stated before, supply and demand encompass economic,

geo-political, social and industrial factors. Additionally, exchange rates and currency parity relations play a major role as global

production and consumption is distributed differently amongst each of the regions.

28

Nevertheless, the U.S. dollar is the currency of international trade. This is remarked for gold, as the “Nixon Shock” allowed a

reordering of the global financing system due to the commitment of the U.S. to back their dollars overseas with gold. Resulting in an

ownership of over half the world’s official gold reserves (574 million ounces at the end of World War II), but also as the Bretton

Woods system fostered expenditure of the rebuilding nations on American cars, steel and machinery. The latter stemmed in an

international system that mainly held reserves in US dollars (Figure 12) to hedge, mainly, against inflation and because of dollar

denominated debt, and for trade purposes xix. The result is a system where, in order to buy a commodity such as gold, you will have

to own dollars; inasmuch as the demand for gold increases the selling positions of US dollar will increase too, decreasing its value.

Hence, the inverse correlation between the two (Figure 13).

Section C: Investment Risks

Appendix C1: Sensitivity Analysis Using Monte Carlo

The team performed a Monte Carlo analysis to understand the impact of changes in variables integrated in our valuation. For instance,

commodities’ prices and volumes of production; which are related to those items stated in the Investment Risks, and their respective

statistical assumptions and likelihood (Including Floods, decrease in ore's grade, yielded regulatory governance, Currency Exposure

and Hedging Positions on Spot Prices, Volatility of Gold & Silver). The assumptions included:

Revenues movements driven by gold & silver prices based in an econometric model (Appendix C2)

Assumptions on probable growth in the production volume based on declared growth projects.

Sensitivities on closing mines due to filed lawsuits or natural disasters, therefore hindering the rate of production.

Decrease in ore’s grade as a detrimental to production rate, based in historical data.

The Monte Carlo used a total of 500,000 iterations to reflect statistical accuracy. The inputs in the modelling were defined to have

effect as continuous variables, including closing mines with a minor likelihood but still considered as to affect total volumes of

production. Because of this, the team decided to use the Normal Distribution using historical standard deviations with implied mean

values for each of the years. The implied means were assessed by a previous fundamental analysis.

Appendix C2: Econometric Modelling

To forecast the prices of gold and silver in the future, we conducted an econometric model, the way this model was constructed in

described here. First, from 15 variables that are connected to Precious Metal Prices: including the VIX, Inflation, Unemployment,

S&P500, and others, we carried out a correlation test with both Spearman and Pearson’s methodologies. This was done in order to

recognize linear and monotonic relationships, in the case of non-linear relationships we ran the scatterplots for each of the variables

assessing the level of correlation through R-squared testing on polynomial and logarithmic equations.

The reason to why all the chosen variables are U.S.-based variables, lies in the fact that the majority of World’s Market Capitalization

comes from the United States (Figure C2.1) and the correlation that other equity markets hold with the U.S. equity market (Fig. C2.2).

Figure C2.1 (left): Shows the market capitalization participation of the U.S. as part of World’s Market Cap. Fig. C2.2 (right): Shows

the correlations of returns in foreign equity markets with U.S. equity markets.

Source: The World Bankxx Sources: Vanguardxxi, Thomson Reuters DataStream and MSCI

Secondly, we ran tests with stepwise regressions using a 95% confidence interval; to ensure that our manual picks were in fact

correlated, and discarded variables that did not hold any relationship to the response variable. In other words, we ensured our picks

with both fundamental and mathematical methods. The final linear predictor included the variables obtained in the first two steps, and

they were: the U.S. Unemployment Rate, the PCE (Personal Consumption Expenditures) inflation, the S&P500 index, the 10Y Bond

Yield and the U.S. Fed Fund Target Rate. Finally, in order to increase the accuracy of the results, we made a consensus between

model estimates and the price of commodities’ futures derivatives contracts, achieving a closer outlook respect to market expectations.

0%

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USA Non-U.S.

Figure C2.1

Figure C2.2

29

Endnotes

i 2015 Annual Information Form. Industrias Peñoles, S.A.B. de C.V. ii 2015 Annual Report. Industrias Peñoles, S.A.B. de C.V. iii Gold Investor. World Gold Council. October, 2016. ivEconomic projections of Federal Reserve Board members and Federal Reserve Bank presidents under

their individual assessments of projected appropriate monetary policy, December 2016. Federal Reserve. December 14,

2016 v “2016 Global Metals & Mining Conference”. Nyrstar. May 12, 2016. vi “Metals Market Update and Outlook”. Thomson Reuters Report, July 2016. vii “China smelters face lowest fees in four years as zinc market tightens”. Burton, Melanie. Reuters Commodities. Aug

18, 2016. viii “METALS-Lead rises to 16-month high on tighter supply, nickel slips”. Serapio, Manolo. Reuters. Sep 29, 2016. ix “Is the Gloom Lifting for Base Metals?” Base Metals Team. Thomson Reuters. October 26, 2016. x Press Release. Board of Governance of the Federal Reserve System. Federal Reserve. December 14, 2016. xi “Ford Cancels Plans for New $1.6 Billion Mexico Plant”. Naughton, Keith. Bloomberg. January 3, 2017. xii “Fiat Chrysler plants in Mexico may close if Trump enacts import tax, CEO says”. Rushe, Dominic. The Guardian.

January 9, 2017. xiii “How General Motors Plans to Create Thousands of U.S. Jobs”. Korosec, Kristen. Fortune. January 17, 2017. xiv Historical Implied Equity Risk Premiums. Damodaran, Aswath. NYU Stern. January, 2017. xv Country Default Spreads and Risk Premiums. Damodaran, Aswath. NYU Stern. January, 2017. xvi “Mexico’s drug cartels make millions robbing multinational corporations”. Grillo, Ioan, Global Post. Los Angeles

Daily News. April 22, 2015. xvii Q3 2016 Report. Industrias Peñoles, S.A.B. de C.V. xviii UPDATE 1-Penoles suspends operations at Naica mine in northern Mexico. Market News. Thomson Reuters.

October 13, 2015. xix “The Nixon Shock”. Lowenstein, R. Bloomberg August 04, 2011. xx Market capitalization of listed domestic companies (current US$). World Federation of Exchanges database. World

Bank. January 2017. xxi Global equities: Balancing home bias and diversification. B. Philips, Christopher, CFA. Vanguard Research.

Vanguard. February 2014.

30

Disclosures: Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.

The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias

the content or publication of this report.

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject

company.

Market making:

The author(s) does not act as a market maker in the subject company’s securities.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the

author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or

completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This

information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report

should not be considered to be a recommendation by any individual affiliated with CFA Mexico, CFA Institute or the CFA Institute

Research Challenge with regard to this company’s stock.

CFA Institute Research Challenge

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