As Hochschild Mining Plc Slides On Cash Call, Is Rio Tinto plc A Better Buy?

Peru-based silver miner Hochschild Mining (LSE: HOC) plans to raise £64.8m through a rights issue. The cash will be used to reduce the firm’s £455m net debt and increase cash reserves.

In total, almost 138m new shares will be offered on a 3-for-8 basis. This means that Hochschild shareholders can subscribe for three new shares for every eight shares they currently own. The new shares will be sold at 47p each, representing a 47.6% discount to yesterday’s closing price of 89.8p.

As always with a rights issue, shareholders are not required to take up their rights. Anyone who doesn’t want to participate should be able to sell their rights through their broker.

I estimate that the value of these nil-paid rights will be around 31p for each new share. So investors who don’t participate in the rights issue could receive 93p for every eight shares they own.

The big money is in

Hochschild’s controlling shareholder, Eduardo Hochschild, has committed to take his full allocation of almost 69m shares and has undertaken not to sell any Hochschild shares for at least 180 days after the rights issue is completed.

My view is that the rights issue is a logical step. The firm’s net debt was $455m at the end of June. The position may have got slightly worse since then, as Hochschild said today that its cash balance has fallen from $84m to $75m over the last three months.

However, Hochschild does have serious turnaround potential.

The bull case for Hochschild

The reason Hochschild has so much debt is that it has just completed the development of the Inmaculada mine, which cost $455m to construct. This mine is both large and low cost and could prove to be a game-changer for the firm. The average all-in sustaining cost of mining silver at Inmaculada is expected to be less than $10 per ounce.

The mine’s scale means it could double Hochschild’s production. Over the last three months, the firm’s production rose to 7.6m silver equivalent ounces, thanks to a 3.1m ounce contribution from Inmaculada. Even at today’s silver price of $16 per ounce, Inmaculada should be pretty profitable.

The only problem is that most of the firm’s other mines have higher costs. The group’s average all-in sustaining cost per silver equivalent ounce is expected to be $13-14 this year. That doesn’t leave much room for profit.

Another consideration is that Hochschild has $97m of loan and interest payments due before the end of 2015. If silver and gold don’t stage a recovery soon, cash flow could remain very tight indeed.

A better choice?

In my view, investors wanting mining exposure need to consider whether heavily-indebted smaller firms such as Hochschild are simply too risky.

I believe that Rio Tinto (LSE: RIO) is a much safer alternative. The Australian miner’s low-cost iron ore business and modest net debt mean that its future is far more secure.

Rio shares have bounced back strongly from September’s low, pushing the firm’s prospective yield down to about 5.9%. This means this high yield has now dropped below the 6% danger level, above which many investors believe a cut is likely.

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Roland Head owns shares of Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.