Ero Copper Corp (TSX: ERO) is the 3^rd largest copper company by market cap on TSX. Canada-based Ero Copper engaged in copper production from the Vale do Curaca Property that is located in Bahia, Brazil. The Company’s primary asset is a Brazilian copper mining company, Mineracao Caraba S.A. (MCSA), owner of the Vale do Curaca Property. The Company mines copper ore from the Pilar underground mine, the Surubim open pit mine and its newly constructed Vermelhos underground mine. In addition to the Vale do Curaca Property, the Company owns the Boa Esperanca development project, an Iron oxide copper gold ore deposits (IOCG)-type copper project located in Para Brazil.

Revenue Mix

                                                                                                              Business Segments                                                   Geographic Segment

Investment Rationale

• Increased Insider Buying: Over the past year, insiders have increased their stake 12 times, which signals that insider are bullish on the future performance of the company and uses the recent correction led by COVID-19 pandemic as buying opportunities and purchased shares multiple times post the stock market crash took place in march. In the below chart, it can be seen that post the crash in March 2020; the insiders have capitalized the opportunity multiple times to increase the stake, which is a positive signal for existing and potential shareholders.

Insider buying over the last 1-Year. Source: Refinitiv (Thomson Reuters) 

• Copper Price are Hovering Above Pre-Pandemic Levels:Copper prices gained approximately 16% over the past one year, as the demand started to pick up after lockdown restriction lifted across the world. China, one of the world's largest consumer of copper, has opened its economy and allowed the economic and industrial activities to resume, which is supporting the copper demand. Further, copper prices are likely to remain stable in the second half of the year as most of the governments across the globe easing the lockdown restrictions which is likely to result in the resumption of the industrial activities. Quick recovery in the copper prices and surge in copper demand is expected to benefit the company in the near-term.

 

• Margin profile outperformed the Industry: Amid challenging business environment emerged by COVID-19 pandemic, a slowdown in general economic activities, record-high unemployment level and uncertainties fog hovering over the global economy, Ero Copper recorded a solid performance, and outperformed the industry in terms of EBITDA margin, operating margin and net margin in the second quarter of FY20. More importantly, the company has consistently reported EBITDA margin above 30% over the past six quarters, operating margin above 15% in the same period and Net margin above 10% over the past five quarters, except 1QFY20.

Source: Kalkine Group, Refinitiv (Thomson Reuters) 

• Positive Spread Between ROCE and WACC: The positive spread between ROCE and WACC indicates the prudent capital management of the company and implies that the company’s operations are financially viable from the stakeholder’s standpoint. Higher the spread greater the return, the company is generating on the employed capital. This is an important measure to gauge the efficiency of the management. In the case of Ero Copper, TTM ROCE stood at 27.12% whereas the Weighted Average Cost of Capital (WACC) stood at 6.3%, which implies a positive spread of 20.82 percentage points. This is indeed higher and reflects the strong competitive advantage of the company.

• Higher Free Cash Flow Yield: The group’s free cash flow yield stood at 4.9%, which implies that the company has adequate free cash flow to weather its obligation and pass through the challenging times. Also, higher free cash flow yield provides a margin of safety to existing and potential investors.

• Positive operational momentum into H2 2020 at MCSA Operations: MCSA operations continued to perform well during the second quarter, with notable quarter-on-quarter increases in tonnes and grades mined from the Pilar and Vermelhos mines when compared to Q1 2020. At the Pilar Mine, 371,794 tonnes of ore were mined grading 1.40% copper during the second quarter (as compared to 347,125 tonnes of ore mined grading 1.39% copper during the first quarter). At the Vermelhos Mine, 253,349 tonnes of ore were mined grading 3.26% copper during the second quarter (as compared to 234,800 tonnes grading 2.26% copper during the first quarter). In total, contributions from both mines during the period resulted in 625,143 tonnes of ore mined grading 2.15% copper. 

• Bullish Technical Indicators: At the last close, ERO’s shares traded above the crucial short-term as well as long-term support levels of 30-day, 50-day, and 200-day SMAs, which implies a bullish price trend in the stock. Also, the moving averages are edging higher, supporting the trend. More importantly, the leading momentum indicator, the MACD is rising and hovering above its 9-day SMA, with the difference between 12-day and 26-ay EMAs is positive, which is another bullish indicator.  

• Strong Relative Strength: Shares of Ero Copper have recorded solid outperformance against the benchmark TSX Composite over the past year, with relative outperformance of 21% in YoY, 10% in the past 3-Months and 4% in the past 5-day trading sessions.

Source: Refinitv (Thomson Reuters), Kalkine Group

• Risk Associated to Investment:As most of the company's revenue comes from the copper segment, therefore the business is significantly exposed to the volatility in the copper prices. Also, the second next wave of COVID-19 might lead to a reduction in Copper demand and production hindrance. Further, the company is exposed to the foreign exchange risks as a vast majority of the group's earnings come from abroad, primarily from Brazil.

Q2FY20 Financial Highlights

Source: Refinitiv (Thomson Reuters)

• In the second quarter of FY20, the group’s revenue improved by ~ 5% to US$ 70.8 million against the preceding quarter of 2020. However, on a YoY basis, the group’s revenue slumped by 7% primarily because the revenues from the Company’s copper operations at MCSA decreased by 12.6% from US$ 64.7 million in Q2 2019 to US$56.5 million in Q2 2020. The decrease in revenue was primarily attributed to lower average copper prices, during the period
• Revenues from the Company’s gold operations at NX Gold increased 20.8% from US$ 11.8 million in Q2 2019 to US$ 14.2 million in Q2 2020. The increase was primarily a result of increased gold prices, partially offset by decreased production and decreased sales volumes.
• The group’s gross profit during the second quarter of FY20 improved by 23% on a YoY basis and 29% on a quarter-on-quarter basis, driven by reduction in the group’s cost of goods sold.
• The Company recognized a net income of US$ 7.7 million during the Q2 2020 as compared to a net income of US$ 15.3 million in Q2 2019. The decrease was primarily attributable to foreign exchange loss of US $16.3 million in Q2FY20 vs US$1.6 million in Q2FY19.
• Further, the company is maintaining its 2020 production guidance for the Curaçá Valley operations of 41,000 to 43,000 tonnes of copper in concentrate and maintaining its 2020 production guidance for the NX Gold Mine of 38,000 to 40,000 ounces of gold at its previously revised cash costs guidance of US$425 to US$525 per ounce of gold produced and capital expenditure guidance of US$7 and US$9 million plus US$2 to US$3 million in exploration expenditures.
• The company stated that it continues to have no disruption to operations, supply chains or sales channels as a result of the COVID-19 pandemic to date, extensive mitigation measures implemented during Q1 2020 have continued through the second quarter

Top-10 Shareholders   

Top-10 shareholders in the company held around 50.73% stake in the company. T. Rowe Price Associates, Inc., Fidelity Investments Canada ULC, and Tembo Capital Management Ltd among the largest shareholder in the company and carrying an outstanding position of 12.62%, 9.99% and 9.82% respectively. The institutional ownership in “Ero Copper” stood at 44.7%, and ownership of the strategic entities stood at 16.48%.

Source: Refinitiv (Thomson Reuters)

Share Price Performance

Source: Refinitiv (Thomson Reuters), Kalkine Group. Chart represents daily closing price 

Valuation Methodology (Illustrative): EV to EBITDA

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Stock Recommendation: The company reported decent performance in the second quarter of FY20, with record-high cash flow from the operation, improved gross profit, lower cost of goods sold, and improvement in the adjusted basic and diluted earnings per share. Also, the MCSA operations continued to perform well during the second quarter, with notable quarter-on-quarter increases in tonnes and grades mined.

Further, Copper prices have recoded a sharp recovery on the London Metal Exchange, with commodity prices are hovering above the pre-pandemic price level. This improvement in the copper prices is going to benefit Ero Mining performance in the coming quarters, and we believe a further expansion in revenue, margin and profitability in the Q3FY20.

The group’s shares have recorded a strong relative price strength on the TSX over the past year, 3-Months and 1-month, and significantly outperformed against the benchmark index. Also, its shares are trading in a bullish zone, as its shares are trading above the crucial long-term as well as short term support levels of 200-day, 100-day and 50-day SMAs.

Therefore, based on the above rationale and valuation, we have given a “Buy” recommendation at the closing price of CAD 19.86 on October 15, 2020.

 

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Disclaimer

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