Investment Rationale

• Copper Prices are likely to remain elevated: Copper futures climbed above USD 4.60 per pound mark in the last week of May, not far from the record-high of USD 4.84 per pound hit earlier this month. The price rise was underpinned by upbeat US economic data and the threat of strikes in mines in top copper producer in Chile. Recent readings from the United States, including better than expected jobless claims, reinforced a positive narrative of economic strength, while President Biden’s multitrillion-dollar infrastructure plan lend further optimism to the copper bulls. Also, given how crucial copper is in the transition to a carbon-free world, demand is due to outstrip supply this year on account of the lack of investment by large miners.

1 Year Copper Price Chart (as on May 28, 2021).

• Strong production profile: In Q1FY21, the group’s consolidated production reported solid growth of 35% as compared to the same period of the previous financial period. This was primarily driven by PV3 Optimization Phase 1 projects and Cozamin one-way ramp completion. Higher production at both mines was primarily a result of higher throughput, grades and recoveries. The increase in production was the main driver for the USD 0.35 per payable pound decrease in C1 cash costs. Pinto Valley Mine Q1 2021 production increased by 36% compared to the same period last year, underpinned by the investments in PV3 Optimization Phase 1 projects which were completed in 2020. Cozamin Mine Production in Q1 2021 was 31% higher than the same period last year. This was primarily due to the completion of the Calicanto ramp, which increased underground mining rates from 3,052 tpd in Q1 2020 to 3,641 tpd in Q1 2021 and finishing the quarter at the targeted run rate of 3,780 tpd. 

• Record net income generated in Q1 2021: The Company recorded net income of USD 127.0 million for the three months ended March 31, 2021, compared with a net loss of USD 21.9 million in Q1 2020. This was primarily driven by a 190% increase in revenue from operations on account of higher realized copper prices (Q1 2021 – USD 4.12 per pound, Q1 2020 – USD 2.29 per pound) and higher copper volumes sold (Q1 2021 – 49.2 million pounds, Q1 2020 – 30.4 million pounds) on the back of higher production (Q1 2021 – 47.8 million pounds, Q1 2020 – 35.5 million pounds). Q1 2021 realized copper prices benefitted from prior period sales settling at higher prices than anticipated on December 31, 2020.

• Zero debt balance sheet: Capstone reports record operating cash flow before changes in working capital, with zero long-term debt and a net cash position as of March 31, 2021. During the three months ended March 31, 2021, the Company fully repaid its revolving credit facility balance of USD 184.9 million and was a net cash position on March 31, 2021. During the quarter, the Company received USD 150 million in proceeds from the Cozamin 50% Silver Stream Agreement, which was announced in Q4 2020. The balance sheet was further bolstered by strong operating performance during Q1 2021 in a plus USD 4 per pound copper price environment.

Source: Company

• Strong Technical Strength: CS shares are hovering in the bullish zone, with stock traded above the crucial long-term as well as short-term support levels of 200-day SMA and 50-day SMA. Further, the stock has consistently taken strong support near 50-day SMA and consistently traded above it. Moreover, the stock is inching towards the 21-day SMA and a breakout above the 21-day SMA would send prices higher. Further momentum indicator 14-day RSI is recovering and hovering in neutral zone.

Technical Price Chart (as on May 27, 2021). Analysis by Kalkine Group

• Robust improvement in Fundamentals: The company recorded a solid improvement in the various financial metrics since June 2019, which is commendable. The fundamentals are likely to improve further as the demand for copper is likely to remain strong, which would support the copper price and, thereby, the realization price for the company.

Data Source: Company, All Data in USD million

• Risk Associated with Investment: The company is exposed to volatility in the copper and silver prices as a large swing in the underlying commodity prices could have a significant impact on the company financial health. Further, the company is exposed to the forex risk; production led disruption, lower demand offtake for copper and general weakness in the macro-economic activities.

Financial Highlights: Q1FY21

Source: Company Filing

• Revenue increased quarter-on-quarter USD 204.1 million versus USD 70.4 million in Q1 2020) primarily due to a higher realized copper price USD 4.12 per pound versus USD 2.29 per pound in Q1 2020) on 18.8 million pounds higher copper volumes sold (49.2 million pounds versus 30.4 million pounds in Q1 2020).
• The increase in revenue was also affected by higher silver revenue at Cozamin and Pinto Valley due to increased silver prices (average market prices USD 26/ounce (“oz”) versus average USD 17/oz in Q1 2020) and higher ounces sold (395k oz versus 347k oz in Q1 2020)
• First quarter 2021 net income stood at USD 127.0 million, or USD 0.25 per share and Q1 2021 adjusted net income came in at USD 64.4 million or USD 0.16 per share.
• Capstone reports record operating cash flow before changes in working capital, with zero long-term debt and a net cash position as at March 31, 2021.
• The company achieved a record Adjusted EBITDA of USD 118.7 million. Q1 2021 adjusted EBITDA is reflective of Capstone’s strong operational performance and financial leverage in a robust copper price environment. Q1 2021 adjusted EBITDA of USD 118.7 million was almost comparable to annual 2020 adjusted EBITDA of USD 139.2 million and higher than 2019 annual adjusted EBITDA of USD 96.4 million. This further demonstrates the growth in production at Capstone as a result of the 2020 capital investments.
• The company reported strong Q1 2021 copper production of 47.8 million pounds at C1 cash costs of USD 1.70 per payable pound of copper produced.
• During the three months ended March 31, 2021, the Company fully repaid its revolving credit facility balance of USD 184.9 million and was in a net cash position at March 31, 2021.

Top-10 Shareholders

Top-10 Shareholders together hold around 43% stake in the company, with GRM Investments, Ltd. and Kores Canada Corporation are major shareholders in the company holding approximately 22.14% and 9.8% respectively.  Moreover, seven out of top-10 shareholders have increased their stake in the company and two remain unchanged. Institutional ownership in the company stood at 14.88% whereas Strategic Ownership in the company stood at 24.68%.

Valuation Methodology (Illustrative): EV to EBITDA

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks

Stock Recommendation: In Q1 of fiscal 2021, the operating results were terrific as the group benefited from a combination of strong production, lower cost and higher copper prices. The Q1 consolidated production of 47.8 million pounds of copper at a C1 cash cost of USD 1.70 per pound surpassed the company's expectation, and the group was particularly pleased to see cash costs below the USD 1.75 per pound, which was the low end of annual guidance. With 49 million pounds of copper sales at a C1 cost of USD 1.70 per pound and a realized copper price of USD 4.12 per pound fueled record-high performance, and this firmly places Capstone in the mid-cap group of companies.

Further, as the company's production profile moves up another 10% next year and 100% overall in the next three years with Santo Domingo, we believe the company is transforming to the premier mid-cap copper company. The company operates in top mining jurisdictions with district growth optionality and powered by a debt-free balance sheet with even lower cash costs when Santo Domingo is added to the portfolio.

Moreover, the company has outlined the significant EBITDA generation of over USD 400 million in this current USD 4-plus copper price environment, and the assumption is based on the midpoint of the company's guidance for Cozamin and Pinto Valley, respectively. The company has begun the year with ~USD 119 million of adjusted EBITDA.

The company reported an industry-leading margin profile, with an EBITDA margin of 41.7% against the industry median of 39.4%, while the operating margin stood at74% vs the industry median of 22.3%. Further, the company is generating a significantly higher return for the shareholder, with a TTM ROE of ~16%. 

Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 5.63 on May 27, 2021.

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid on May 28, 2021 price as well.

Disclaimer

The advice given by Kalkine Canada Advisory Services Inc. and provided on this website is general information only and it does not take into account your investment objectives, financial situation and the particular needs of any particular person. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. The website www.kalkine.ca is published by Kalkine Canada Advisory Services Inc. The link to our Terms & Conditions has been provided please go through them. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations later.