Ero Copper Corp (TSX: ERO) is TSX’s 3^rd largest copper company by market cap. 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

• Generating Higher Return for its Shareholders: ERO Copper featuring a TTM ROE of 23%, which is gigantically higher. Moreover, over the past five years, the Company’s average Return on Equity stood at above 15%, which reflects the competitive advantage of Ero Copper against the peers, despite the Company having relatively higher debt in its balance sheet. The return on equity (ROE) measures how profitable is a company, relative to its book value. The ROE tells us how much profit the firm generates for each rupee of equity it owns. In the case of Ero Copper, the firm with an ROE of 23% means that they generate a profit of CAD 23 for every CAD 100 of equity it owns, and over the past 5-years on average, the Company has generates CAD 15 for every CAD 100 of equity it owns. Also, consistently higher ROE generating companies tend to command a premium in the market. 

• Solid Q3FY20 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 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. 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 a 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.

• Strengthened Balance Sheet: The Company has consistently deleveraged its balance sheet, with a significant decrease in Debt / Adj. EBITDA. This 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 as adjusted EBIDTA has bolstered from USD 37.3 million in 2017 to USD 192.6 million in 2020 (annualized).

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 focus on growing production at lower cash costs underpins ROIC strategy.

Source: Refinitiv (Thomson Reuters) 

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

• 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 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 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 2020.
• 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.
• 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.
• 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 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.
• During the third quarter of 2020, the company reported record cash flows from operations: with cash flows from operations was a record 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 (basic net income per share of USD 0.36) in Q3 2020 compared to a net income of USD 16.3 million in Q3 2019 (basic net income per share of USD 0.19). The increase in net income was primarily attributable to an increase in revenues from higher sales volume and decrease in cash costs over the comparative period from the significant weakening of the BRL versus the USD.
• As of September 30, 2020, the Company held cash and cash equivalents of USD 54.3 million. Cash and cash equivalents are primarily comprised of cash held with reputable financial institutions and are invested in highly liquid short-term investments with maturities of three months or less.

Top-10 Shareholders
According to data retrieved from Refinitiv (Thomson Reuters), top-10 shareholders in the company held around 54.69% stake in the company. T. Rowe Price Associates, Inc., Tembo Capital Management Ltd and Fidelity Investments Canada ULC among the largest shareholder in the company and carrying an outstanding position of 12.36%, 9.62% and 9.31%, respectively. The institutional ownership in the company stood at 51.97%, and ownership of the strategic entities stood at 16.85%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): Price to Cash Flow based Valuation Metrics

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

Peer Comparison 

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: A spectacular rally in copper has enthralled Ero Copper stocks as copper prices have been marching north almost every month over the past one year, and copper within the commodity space remain very hot and tested a 10-Year high recently. Copper, the economic barometer, is portraying an affirmative picture as the global economy is stabilizing. Apart from the dramatic increase in liquidity and low-interest rate regime strengthening prices, the demand for the metal is primarily led by the strong demand from China as its economy has managed to absorb the pandemic shock, and the manufacturing sector is back on track.

Further, Ero Copper is generating a higher return for its shareholders with a TTM ROE of 23% and 5-year Average ROE of above 15%. Also, the company has consistently deleveraged its balance sheet, with a significant decrease in Debt / Adj. EBITDA reflects management execution on organic growth strategy and alignment in creating shareholder value.

Therefore, based on the above rationale and valuation, we recommend a “Buy” rating at the closing price of CAD 20.28 on March 04, 2021.  

1-Year Price Chart (as on March 04, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at March 5, 2021 price as well.

Disclaimer

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