Capstone Mining Corp. (TSX: CS) is a Canada-based mining company. The company is engaged in the production of and exploration for base metals in the United States, Mexico, Canada and Chile, with a focus on copper. The company's segments include individual mining operations of Pinto Valley (the United States), Cozamin (Mexico), Minto (Canada), Santo Domingo development project (Chile) and others.

Investment Rationale

• Deleveraged Balance Sheet: The company has turned virtually debt-free at the end of March 31, 2021, with the Debt/Equity ratio came down to 0.02x at the end of March 2021, from 0.25x at the end of December 2020. This implies a sharp reduction in debt position driven by solid growth in free cash from the operation on the back of strong underlying commodity prices. Further, the long-term debt to total capital ratio stood at 1.4% at the end of the quarter from 17.7% at the end of December 2020, with robust debt protection metrics, i.e., Net Debt to EBITDA ratio of 0.61x. This improved significantly from 2.53x at the end of December 2020 and well below John Kerry's standard ratio of 5x. This implies that the company has a robust balance sheet.

• Copper Standing Firm: Despite recent correction on the concerns over slowing demand from top consumer China and a stronger US dollar, copper has bounced back and again trading above US$ 4.2/pound. Further, on a YTD basis, Copper prices are still up approximately 21.2%, which implies that the bull run in the copper has not ended yet. And, growing demand for the metal, especially in the electric vehicle market, would further keep the metal hot and firm in the mid-term to long-term.

• Q1FY21 Recorded a Strong Production: In Q1FY1, 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 US$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. Comin 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.

• Robust Performance in Q1FY21: The Company recorded a net income of US$127.0 million for the three months ended March 31, 2021, compared with a net loss of US$21.9 million in Q1 2020. This was primarily driven by a 190% increase in revenue from operations driven by higher realized copper prices (Q1 2021 - US$4.12 per pound, Q1 2020 - US$2.29 per pound) and higher copper volumes sold (Q1 2021 – 49.2 million pounds, Q1 2020 – 30.4 million pounds) on 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.
  

• Industry Leading Margin Profile: The group reported a solid performance and outperformed the industry median on various financial parameters, which is noteworthy.

• Strong Liquidity: Capstone reports record operating cash flow before changes in working capital, with zero long-term debt and in 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 (“RCF”) balance of US$184.9 million on December 31, 2020, and was in a net cash position of US$44.8 million on March 31, 2021. During the quarter, the Company received US$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 US$4 per pound copper price environment.

• Shares Hovering in a Strong Bullish Territory: From the technical standpoint, CS shares are hovering in a strong bullish trend with stock traded well above the crucial long-term as well as short-term support level of 50-day and 200-day SMA. Also, most recent price consolidation in the wake of weakening underlying commodity prices, the stocks bounced back on the back of firm underlying commodity prices. Moreover, the 14-day RSI is hovering in a neutral zone with a bullish bias at 65. Further, the leading moment indicator, Moving Average Convergence Divergence, is rising, and the MACD line could potentially cross the 9-day SMA signal line in the next few trading sessions, another bullish technical indicator.

Technical Price Chart (as on June 30, 2021). Analysis by Kalkine Group  

• Risk Associated to Investment: The company is exposed to volatility in the copper 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 (US$204.1 million versus US$70.4 million in Q1 2020) primarily due to a higher realized copper price (US$4.12 per pound versus US$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 US$26/ounce (“oz”) versus average US$17/oz in Q1 2020) and higher ounces sold (395k oz versus 347k oz in Q1 2020)
• The realized copper price in Q1 2021 of US$4.12 per pound was higher than the LME average of US$3.86 per pound due to 24.9 million pounds of copper priced at an average of US$3.52 per pound on December 31, 2020, which final settled or were second provisional invoiced at higher prices during Q1 2021, and 53.3 million pounds of copper provisionally priced at an average of US$3.99 per pound at March 31, 2021, which was higher than Q1 2021 average prices.
• First-quarter 2021 net income was US$127.0 million, or US$0.25 per share and adjusted net income stood at US$64.4 million or US$0.16 per share.
• Capstone reported record operating cash flow before changes in working capital, with zero long-term debt and a net cash position as of March 31, 2021.
• The company delivered a record Adjusted EBITDA for Q1 2021 of US$118.7 million. Q1 2021 adjusted EBITDA is reflective of Capstone’s strong operational performance and financial leverage of the Company’s EBITDA in a robust copper price environment, as well as lower C1 cash costs. Q1 2021 adjusted EBITDA of US$118.7 million is almost comparable to the annual 2020 adjusted EBITDA of US$139.2 million and higher than the 2019 annual adjusted EBITDA of US$96.4 million. This further demonstrates the growth in production at Capstone as a result of our 2020 capital investments.
• The company recorded a strong Q1 2021 copper production of 47.8 million pounds at C1 cash costs of US$1.70 per payable pound of copper produced.
• During the three months ended March 31, 2021, the company fully repaid its revolving credit facility (“RCF”) balance of US$184.9 million on December 31, 2020, and was in a net cash position of US$44.8 million on March 31, 2021.

Top-10 Shareholders

Top-10 Shareholders together hold around 43.63% stake in the company, with GRM Investments, Ltd. and Kores Canada Corporation are major shareholders in the company holding approximately 24.55% and 9.8%, respectively.  Moreover, seven out of the top-10 shareholders have increased their stake in the company, and two remain unchanged. Institutional ownership in the company stood at 15.31%, whereas Strategic Ownership in the company stood at 36.80%. 

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

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 US$1.70 per pound surpassed the company's expectation, and the group was particularly pleased to see cash costs below the US$1.75 per pound low end of annual guidance.

Copper enjoying a recent price boost thanks to increasing demand as national economies reopen, copper's recovery has been especially strong due to the increased urgency with which nations are shifting toward greener technologies and energy sources.

Also, copper is a "new oil" with highly conductive, naturally corrosion-resistant metal is already a staple resource in the manufacturing of most electronics. As economies worldwide drive up demand for more electric vehicles, the need for the large quantities of copper used to build them would grow right along with it. Therefore, the growing demand for e-vehicles would keep red metal firm and strong. And copper miners would continue to benefit from it in the wake of higher realization prices.

Also, the company has a robust balance sheet with a virtual debt-free position and generating a strong cash flow from the business.

Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 5.38 on June 30, 2021.

1-Year Price Chart (as on June 30, 2021). Source: Analysis by Kalkine Group

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

*Recommendation is valid on July 02, 2021 price as well.

Disclaimer

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