Revenue Mix

Business Segments                                                   Geographic Segment                                                                                              

Investment Rationale

• Strong Balance Sheet: The company is consistently deleveraging its balance sheet, with a significant decrease in Debt to Adj. EBITDA, which reflects management execution on organic growth strategy and alignment in creating shareholder value. Moreover, the company has recorded continued growth in Adjusted EBITDA since 2017; Adjusted EBIDTA has bolstered from USD 37.3 million in 2017 to USD 192.6 million in 2020 (annualised).

Source: Company Presentation

• Industry Leading ROIC: The company has reported industry leading ROIC, driven by deepening extension project from concept to engineered project, which bolstered the company’s ROIC. Also, the company is focusing on growing production at lower cash costs.

Source: Refinitiv (Thomson Reuters)

• Bolstered Liquidity Positions: The Company bolstered its liquidity position at the onset of the pandemic, by drawing down its existing USD and BRL denominated credit facilities. At September 30, 2020, the Company has drawn down USD 14.0 million and RUSD 57.0 million (USD 10.1 million) under various credit facilities as a protective measure. Further, the Company ended the period with a robust cash position of USD 54.3 million – a quarter-on-quarter improvement of USD 2.7 million and a USD 10 million improvement since Q1 2020. Further, the company reported record cash flows from operations. Q3 2020 cash flows from operations stood at USD 44.4 million, an increase of USD 14.9 million from USD 29.5 million in Q3 2019. 

• Strong Third Quarter Performance: In the third quarter of 2020, revenues from the Company’s copper operations at MCSA increased by 39.1% from USD 54.3 million in Q3 2019 to USD 75.6 million. The increase in revenue was primarily attributed to higher average realized copper prices over the comparative period. Revenues from the Company’s gold operations at NX Gold increased 197.9% from USD 6.3 million in Q3 2019 to USD 18.8 million in Q3 2020. The increase in revenue was a result of increased sales volume and increased gold prices over the comparative period. Further mine gross profit from the Company’s copper operations at MCSA totaled USD 46.3 million in Q3 2020 compared to USD 21.0 million in Q3 2019. The increase in mine gross profit was primarily driven by a decrease in cash costs over the comparative period because of a significant weakening of the BRL versus the USD. The Company also recognized mine gross profit of USD 13.3 million in Q3 2020 compared to USD 0.3 million in Q3 2019 from its gold operations at NX Gold. 

• Reaffirming 2020 Guidance: The Company has reaffirmed its 2020 production guidance for the Curaçá Valley operations of 41,000 to 43,000 tonnes of copper in concentrate. At the Curaçá Valley operations, the Company is maintaining its previously revised C1 cash costs guidance range of USD 0.70 to USD 0.85 per pound of copper produced but expects C1 cash costs for the full year to be near or slightly below the low-end of the range. Non-exploration capital expenditure guidance of USD 56 to USD 68 million is maintained at the Curaçá Valley operations, and the Company expects full year capital to be near the high-end of the range as the Company prepares for a meaningful extension of the Company’s life-of-mine operating plan. Further, the company is lowering its 2020 production guidance for the NX Gold Mine to 36,000 to 37,000 ounces of gold but is maintaining its previously revised C1 cash costs guidance range of USD 425 to USD 525 per ounce of gold produced. Capital expenditure guidance has been increased by a modest USD 2 million to between USD 9 and USD 11 million for NX Gold as a result of the initiation of several growth projects, including the installation of a modular paste-fill plant.

• Risk Associated with Investment:As majority of the company's revenue comes from the copper segment, the business is significantly exposed to the volatility in the copper prices. Also, the company is exposed to the next wave of COVID-19 outbreak, as it would lead to a reduction in Copper demand and production hindrance as well. 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.

Q3FY20 Financial Highlights

Source: Company Filing

• During the quarter under consideration, the company recorded strong operational performance at MCSA Operations – tracking full-year copper production guidance with 32,796 tonnes of copper produced YTD.
• In the quarter, 553,148 tonnes processed grading 2.18% copper producing 10,961 tonnes of copper in concentrate after metallurgical recoveries that averaged 90.8.
• The company recorded quarter-on-quarter increase in processed copper grades driven by higher grade ore mined at the Vermelhos mine, where 227,963 tonnes were mined grading 3.76% copper during the period, a 15% improvement in copper grades mined as compared to the second quarter of 2020. Another record quarterly C1 cash cost of USD 0.63 per pound of copper produced during Q3 2020, a quarter on-quarter improvement of USD 0.02 per pound of copper produced (see Non-IFRS Measures).
• During the quarter Revenues from the Company’s copper operations at MCSA increased by 39.1% from USD 54.3 million in Q3 2019 to USD 75.6 million in Q3 2020. The increase in revenue was primarily attributed to higher average realized copper prices over the comparative period. Revenues from the Company’s gold operations at NX Gold increased 197.9% from USD 6.3 million in Q3 2019 to USD 18.8 million in Q3 2020. The increase was a result of increased sales volume and increased gold prices over the comparative period
• Mine gross profit from the Company’s copper operations at MCSA totaled USD 46.3 million in Q3 2020 compared to USD 21.0 million in Q3 2019. The increase in mine gross profit was primarily driven by a decrease in cash costs over the comparative period as a result of a significant weakening of the BRL versus the USD. The Company also recognized mine gross profit of USD 13.3 million in Q3 2020 compared to USD 0.3 million in Q3 2019 from its gold operations at NX Gold.
• During the third quarter of 2020, the company reported record cash flows from operations at USD 44.4 million, an increase of USD 14.9 million from USD 29.5 million in Q3 2019.
• The Company recognized net income of USD 31.4 million in Q3 2020 compared to a net income of USD 16.3 million in Q3 2019. The increase in net income was primarily attributable to an increase in revenues from higher sales volume and a decrease in cash costs over the comparative period from the significant weakening of the BRL versus the USD.
• As at September 30, 2020, the Company held cash and cash equivalents of USD 54.3 million.

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 are 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” stood at 44.7%, and ownership of the strategic entities stood at 16.48%.

Source: Refinitiv (Thomson Reuters)

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

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

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation:

The Company 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 the first quarter of 2020 at the onset of the pandemic have continued through Q3 2020. Further, the third quarter, the company bolstered its liquidity position at the onset of the pandemic, by drawing down its existing USD and BRL denominated credit facilities. Further, the company reported strong operational performance at MCSA Operations – tracking full-year copper production guidance with 32,796 tonnes of copper produced YTD 2020. Also, the company’s exploration of the Santo Antonio Vein at the NX Gold Mine continues to demonstrate continuity of mineralization in advance of updated life-of-mine plan. The company has delivered a strong 3QFY20 result and outperformed the industry on various parameters.

Source: Refinitiv (Thomson Reuters)

Further, the company has maintained a decent margin profile and recorded a continuous improvement in its margin over the past several quarters.

Source: Refinitiv (Thomson Reuters)

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 the company’s performance in the coming quarters, and we believe a further expansion in revenue, margin and profitability in the Q3FY20.  We expect the copper demand to continue to improve as most of the countries have allowed the industrial activities to resume.

Therefore, based on the above rationale and valuation, we have given a “Buy” recommendation at the closing price of CAD 18.79 on December 10, 2020.

1-Year Price Chart (as on December 10, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at December 11, 2020 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.