Capstone Mining Corp (TSX: CS) is a company that mines, explores, and develops mineral properties in the Americas. Specifically, the group has operating mines in the US, Mexico, and Canada, and development projects in Chile and Canada. Capstone's main focus is copper, but the company also produces zinc, lead, molybdenum, silver, and gold. 

Investment Rationale

• Robust Q2 2021 performance: The company reported solid performance in the Q2 2021, with revenue surged by 100% to USD 209.4 million, against USD 104.7 million on a YoY basis and net income rose hugely to USD 49.4 million compared to USD 4.3 million in the previous corresponding period. The healthy performance was driven by improved average commodity prices and increase in % recoveries under copper.

• Sequentially growing Revenue and Earnings from mining operations: Given the strength of the business over the past number of quarters, the company maintained its pace and witnessed the spirited performance across its revenue and earnings from mining operations. The Company is continuously working to grow its profile and higher average realization cost of the metal has also supported, which is appreciable. 

• Realized Copper Prices above LME Average: The realized copper price in Q2 2021 of USD 4.78 per pound was higher than the LME average of USD 4.40 per pound due to 53.3 million pounds of copper priced at an average of USD 3.99 per pound at March 31, 2021 which final settled or were second provisional invoiced at higher prices during Q2 2021, and partially lowered by 53.1 million pounds of copper provisionally priced at an average of USD 4.25 per pound at June 30, 2021, which was lower than Q2 2021 average prices. In addition, the timing of sales during Q2 2021 were more heavily weighted towards the middle of the quarter when prices were higher.

• Record operating cash flow: Due to excellent operational performance, the business generated record Cash flow from operations before changes in working capital during the report period, which increased by USD 116.4 million to USD 140.4 million. Operating cash flow before changes in working capital, excluding the USD 30 million payment from Wheaton stood at USD 110.4 million was the highest in Capstone’s history, driven by production growth and record high copper prices.

Source: Company

• Improvement in net cash position: During the second quarter of 2021, net cash increased by USD 126.7 million to USD 171.5 million, including USD 30 million received from Wheaton Precious Metals Corp. as part of the Santo Domingo precious metals purchase agreement (the "Gold Stream Agreement"). During Q2 2021, the financial sheet was also considerably boosted by strong operating performance and cash flow.

• Industry beating margins: Despite the turmoiled period due to Covid-19 Pandemic, the company maintained its pace and witnessed spirited performance across its margin matrix. In addition, the management’s solid determination helped them leap the industry median margins on many fronts in Q2 2021, which exhibits the competitive advantage of the company within the industry. The chart below gives a glimpse of this. 

• Robust 2021 Guidance: The management is bullish on the commodity outlook and announced a healthy production profile. In 2021, the company expects to produce between 175 and 190 million pounds of copper at C1 cash costs of between USD 1.75 and USD 1.90 per pound payable copper produced.

• Completed Cozamin Mine underground expansion: The company successfully commissioned its Cozamin Mine underground expansion with record quarterly copper production of 13.8 million pounds and attained targeted new run rate of 3,780 tonnes per day (“tpd”). Q2 2021 production was 66% higher than in Q2 2020 following commissioning of the Calicanto one-way ramp that increased underground mining rates by 41% from Q2 2020. The corresponding previous quarter results were impacted by a temporary reduction in mining activities as a result of the government mandated decree in response to the COVID19 pandemic.

• Commenced a brownfield exploration at Santo Domingo: The company began a brownfield exploratory drilling campaign at the Santo Domingo project to extend the copper/iron ore deposit resource and provide geometallurgical samples for cobalt feasibility studies. Furthermore, negotiations towards a collaboration in Santo Domingo are progressing well, with an announcement likely in Q3 2021.

• Bullish technical indicators: On the daily chart, CS stock prices are moving in a rising horizontal channel pattern and sustaining above the lower band of the pattern. Additionally, the stock is trading above its the key support levels of the 100-day and 50-day SMAs, indicating a bullish trend. The leading indicator RSI (14-Period) is at ~54.92 level trading in a healthy zone, further supporting a positive stance for the stock. Moreover, the stock is sustaining above the rising trendline. Hence, we expect from the CS stock to continue its bullish movement.

Technical Price Chart (as on August 12, 2021). Source: REFINITIV, Analysis by Kalkine Group

• Risks associated with investment: The company's business is significantly exposed to the volatility in copper prices. Further inherent risks associated with mining and mineral processing such as the company's mines may not perform as planned; uncertainty with the company's ability to secure additional capital to execute its business plans; the speculative nature of mineral exploration and development, including the risks of obtaining and maintaining necessary licenses and permits, including the necessary licenses, permits, authorizations and/or approvals from the appropriate regulatory authorities.
  

Financial overview of Q2 2021 (In thousands of USD)

Source: Company

• The company produced 43.3 million pounds of copper at C1 cash costs of USD 1.91 per payable pound of copper produced in Q2 2021, compared with 38.5 million pounds at C1 cash costs of USD 1.87 per payable pound of copper produced in Q2 2020. The production in the reported period was 12% higher than Q2 2020 mainly as a result of maximizing mill throughput at Cozamin due to successful one-way ramp utilization.
• In Q2 2021, the company posted revenue of USD 209.4 million, increased by 100% against USD 104.7 million in the previous corresponding period. The increase in the revenue was mainly due to higher realized copper prices at USD 4.78 per pound v/s USD 2.72 per pound in Q2 2020 and higher copper volumes sold 43.1 million pounds v/s 37.9 million pounds in Q2 2020, on higher production.
• The company reported higher production cost at USD 82.6 million against USD 68.5 million in pcp, however, the depletion and amortization cost also increased to USD 21.7 million against USD 19.14 million in pcp. The rise in both cost structure was mainly due to higher mining and mill rates along an increase in copper volumes sold.
• Earnings from mining operations rose enormously to USD 102.8 million in the reported period compared to USD 16.3 million in pcp.
• The company reported record adjusted EBITDA of USD 128.0 million in Q2 2021. This record performance is reflective of the company’s strong operational performance and financial leverage in a robust copper price environment.
• The higher G&A expenses and higher share-based compensation expense had partially offset the income from operation, which stood at USD 78.7 million against USD 8.6 million in pcp.
• On the back of above discussed rationales, the net income in Q2 2021 increased to USD 49.4 million compared to USD 4.3 million in the previous corresponding period.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 46.02% of the total shareholding. GRM Investments, Ltd. and Kores Canada Corporation hold the company's maximum interests at 24.45% and 9.76%, respectively. The company's institutional ownership stood at 15.54%, and ownership of the strategic entities stood at 36.68%.

Valuation Methodology (Illustrative): EV to Sales 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 Q2 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 recent rally in the commodity prices is moving well for the company, and we can see a significant impact of this movement in the precious and industrial metal mining company’s balance sheet. As the prices go up, it increases averages realization prices for the miners, which lead to a higher margin profile, higher free cash flow generation and deleveraging of the balance sheet. We believe that the company is well placed to capitalize on the increasing prices of the underlying commodity and exit FY2021 on strong financial health. Furthermore, the company is managing to realize Copper Prices above LME Average, which is a key positive.

The company has successfully commissioned its Cozamin Mine underground expansion with record quarterly copper production of 13.8 million pounds and attained targeted new run rate of 3,780 tonnes per day and announced a healthy production profile. In 2021, the company expects to produce between 175 and 190 million pounds of copper at C1 cash costs1 of between USD1.75 and USD1.90 per pound payable copper produced. 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 5.51 on August 12, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

One-Year Price Chart (as on August 12, 2021). Source: REFINITIV, Analysis by Kalkine Group

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

*Recommendation is valid at August 13, 2021 price as well.

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