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 focus is copper, but the company also produces zinc, lead, molybdenum, silver, and gold.

Investment Rationale

• Solid Growth Ahead: Pinto Valley's PV3 Optimization, Copper Cathode Expansion and PV4 Expansion study targeted to drive higher NPV, plus the fully permitted copper iron gold Santo Domingo project with cobalt optionally provides transformational growth opportunities.

• Gradual Improvement in Quarterly Margin Profile: The company reported gradual improvement in the quarterly margin profile, with Gross margin expanded to 49.1% at the end of June 30, 2021, from 15.6% at the end of June 20, 2021. The same kind of trend was witnessed in EBITDA margin from 23.6% to 48.6%, Operating margin from 8.3% to 37.6% and Net margin from 4.1% to 23.6%. The margin expansion was mainly driven by a solid surge in the copper and gold prices over the last one and half years.

• Consistent Reduction in Debt Position - Virtually Debt Free Company: Over the past one year, driven by solid cash flow generation, the company has significantly reduced its outstanding debt positions. At the end of June 30, 2021, Capstone is virtually debt-free. The debt/Equity ratio has lowered from 0.34x at the end of June 30, 2020, to 0.02x at the end of June 30, 2021. Long-term debt as a percentage of total sales has reduced to 1.5% at the end of June 30, 2021, from 22.8% at the end of June 30, 2020. 

• Solid Increase in Copper Production: The company reported solid improvement in the copper production, driven by a 66% jump at the Cozamin mines to 13.8 mn pounds and partially offset by a 2.3% reduction at the Pinto Valley mine due to COVID-19 led reduction. Total production in Q2FY21 improved by 12% to 43.3 mn pound from 38.5 mn pound in the same quarter of the previous financial year.

• Significant Jump in the Copper Realization Prices: Copper average realization prices jumped by 76% on a YoY basis, which bolstered the group’s financial heath over the past one year.

• Positive RSI Range Shift: An RSI range shift appeared on the daily price chart as over the last two sessions, the leading momentum indicator was the 14-day RSI shift from selling zone to buying zone. RSI moved above 40, and sustaining at that level implies that bulls are taking control over the bears. Together with the RSI range shift, a bullish engulfing Candlestick on the last trading session confirming that the downtrend in the stock is largely over and stock is carrying the potential to move higher from the current trading levels.

Source: REFINITIV, Analysis by Kalkine Group

• Strengthening Balance Sheet: Backed by a solid rally in the underlying commodity prices along with a significant jump in the underlying commodity average realization prices and improved margin profile, the company has significantly bolstered its balance over the past one year, with zero long-term debt and net cash in the balance sheet at the end of the second quarter.

• Risk Associated to Investment: The company is exposed to a variety of risks ranging from an unprecedented decline in copper prices, a slowdown in the consumption of copper due to macro-economic conditions and resurgence in the COVID-19 cases, higher input costs could take a toll on the margin profile of the company especially gasoline, diesel, and other energy prices. Further, a higher US Dollar against the basket of majors could also weigh on the copper prices. Other risks are forex risks, supply chain-related difficulties, the strike of workers at mines and others. For investors, sharp volatility in the underlying commodity prices would have an impact on the stock price of the company as well.  

Financial Highlights: Q2FY21

Source: Company Filings

• During the quarter under consideration, the company’s revenue jumped by more than 100% to USD 209.4 million versus USD 104.7 million in Q2FY20 primarily due to a higher realized copper price (USD 4.78 per pound versus USD 2.72 per pound in Q2 2020) along with 5.3 million pounds higher copper volumes sold (43.1 million pounds versus 37.9 million pounds in Q2 2020).
• The increase in revenue was also impacted by higher silver revenue at Cozamin due to increased silver prices (average market prices USD 27/ounce (“oz”) versus average USD 16/oz in Q2 2020) and higher volumes sold (410k oz versus 321k oz in Q2 2020).
• Copper sold during the quarter under consideration stood at 43.1 million pounds vs 37.8 million pounds in the same quarter of the previous year.
• The realized copper price in Q2 2021 of USD 4.78 per pound was higher than the LME average of USD 4.40 per, also jumped by 76% on a YoY basis.
• Net cash grew by USD 126.7 million to USD 171.5 million during Q2 2021, inclusive of USD 30 million in proceeds from the Gold Stream Agreement. The balance sheet was significantly enhanced by solid operating performance and cash flow during Q2 2021.
• Record Adjusted EBITDA for Q2 2021 of USD 128.0 million. Q2 2021 adjusted EBITDA is reflective of Capstone’s strong operational performance and financial leverage.
• The net change in cash was USD 126.6 million in Q2 2021 compared to USD 57.0 million in Q2 2020
• The group recently completed the underground expansion at Cozamin with a record quarterly copper production of 13.8 million pounds and attained a targeted new run rate of 3,780 tonnes per day (“tpd”). Q2 2021 production was 66% higher compared to the previous corresponding period, following the commissioning of the Calicanto one-way ramp that increased underground mining rates by 41%. Q2 2020 results were impacted by a temporary reduction in mining activities as a result of the government-mandated decree in response to the COVID-19 pandemic.
• The company reported a net income of USD 49.4 million, or USD 0.12 per share and an adjusted net income of USD 68.7 million or USD 0.17 per share.

Top-10 Shareholders

The top-10 shareholders together hold approximately 44.32% stake in the company, with GRM Investments, Ltd.  and Kores Canada Corporation are among the major shareholders with the outstanding position of 24.45% and 9.76%, respectively. Institutional ownership in the company stood at 14.4% and strategic holding 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: The company reported robust performance in the second quarter of 2021, driven by higher production output and higher commodity realization prices.  Further, the company turned virtually debt-free with net cash reported at the end of Q2FY21 against net debt position at the end of Q2FY20. Moreover, over the past one year, the company reported consistent improvement in the margin profile, which is helping the business to generate a lot of free cash flow, thereby strengthening its balance sheet.

Further, copper prices have remained above USD 4.00 per pound since February, with the substantial recovery in demand, briefly peaking at nearly USD 4.9 per pound in early May before retreating amid the risk of the covid-19 Delta variant which slowed China’s manufacturing activities and therefore its copper imports.

Going forward, copper demand is expected to remain elevated in the wake of rising industrial demand and copper prices are likely to remain high in the mid-term, which would benefit copper miners.

Hence, based on the rationale discussed above and valuation, we recommend a “Buy” rating on the stock at the closing price of CAD 5.15 on September 23, 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

1-Year Price Chart (as on September 23, 2021). Source: REFINITIV, Analysis by Kalkine Group

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

*Recommendation is valid on September 24, 2021, price as well.

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Disclaimer

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