Ero Copper Corp (TSX: ERO) is a Canada-based company that is engaged in copper production from the Vale do Curacao Property 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 Curacao 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 Curacao 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

• Demand for Electric Vehicles to Boost Rally in Copper: Copper has had a spectacular rally since March 2020. Despite the recent short-term price consolidation seen in copper prices from peak levels, we are still quite bullish on copper on the back of the shift towards EVs. It is expected that demand for copper to be five-fold from the current levels by 2025. Further, copper supply has also been shrinking, which has raised expectations of a historic deficit in the metal this year, fuelling prices. Copper inventories are hovering near multi-year lows at LME as well as Shanghai, and the lack of new mine investment over the last few years could intensify the supply shortfall.
  

• Generating Higher Return for its Shareholders: ERO Copper featuring a TTM ROE of 84%, which is gigantically higher. Moreover, over the past few years, the company maintained a decent Return on Equity, which reflects the competitive advantage of Ero Copper against its peers. 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. Also, consistently higher ROE generating companies tend to command a premium in the market.
  

• Reported Record Performance in Q1FY21: The company recorded record quarterly copper production of 12,638 tonnes and recorded quarterly C1 cash costs of USD 0.49 per pound of copper produced driven by strong operational performance, including higher grade versus budget at both Pilar and Vermelhos underground mine. Further, the company reported strong quarterly gold production of 9,451 ounces from the Santo Antonio Vein at the NX Gold mine at C1 cash costs of USD 487 per ounce of gold produced and All-in Sustaining Costs of USD 643 per ounce of gold produce.
  

• Solid Operational Efficiency Achieved in Q1FY21: The company achieved record quarterly operational performance at MCSA Mining Complex and strong performance from the NX Gold Mine during Q1 2021. Approximately 597,594 tonnes processed grading 2.30% copper-producing record quarterly 12,638 tonnes of copper in concentrate after metallurgical recoveries that averaged 92.0% during Q1 2021 at the MCSA Mining Complex.
  

• Consistently 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. Adjusted EBIDTA had bolstered from USD 37.3 million in 2017 to USD 192.6 million in 2020.
  

• Strong Liquidity Position: As a result of continued strong operating and financial performance throughout Q1 2021, the company ended the period with cash and cash equivalents totalling USD 84.6 million, a quarter-on-quarter improvement of USD 22.1 million and a USD 40.3 million improvements since March 31, 2020.
  

• Outlook- Stable: Company’s ongoing exploration programs continue to highlight the excellent potential and inherent optionality of the Curaçá Valley – the discovery of two new mineralized regional systems and the advancement of key targets. Exploration activities during Q1 2021 continued to advance key target zones and two newly identified mineral systems. The company’s ongoing core exploration programs are focused on developing multiple targets in parallel within the company’s exploration portfolio that has the potential to meaningfully augment each phase of the company’s life-of-mine production plans from near to medium-term and over the long-term at both MCSA and NX Gold. For 2021 annual production guidance for the MCSA Mining Complex of 42,000 to 45,000 tonnes of copper in concentrate at C1 cash cost guidance range of USD 0.75 to USD 0.85 per pound of copper produced and 2021 annual production guidance for the NX Gold Mine of 34,500 to 37,500 ounces of gold at C1 cash cost and AISC guidance range of USD 500 to USD 600 and USD 875 to USD 975 per ounce of gold produced, respectively.

• Gaining Technical Strength on Daily Price Chart: After a recent correction in the stock, ERO Copper shares took strong support at the 200-day SMA and bounced back from their crucial long-term support level. Further, after falling out of the lower Bollinger Band©, its shares recovered a now moving towards the 20-day SMA. However, still trading below its SMA of 50-day and 21-day SMA. A range shift can take place if the 14-day RSI moves above 40 and sustains above its.

Source: REFINITIV, Analysis by 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 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.

Financial Highlights: Q1FY21

• Revenues for Q1 2021 from copper sales were USD 104.8 million (Q1 2020 – USD 56.1 million), which included the sale of 12,469 copper tonnes in concentrate as compared to 10,432 copper tonnes for Q1 2020. The increase in revenues was primarily attributed to higher realized prices and partially from higher sales volume.
• Revenues for Q1 2021 from gold sales were USD 17.8 million (Q1 2020 – USD 11.6 million), which included the sale of 10,020 ounces of gold, compared to 7,526 ounces of gold for Q1 2020. The increase in revenues was attributable to both higher sales volume, and higher realized prices than in the comparative quarter.
• Finance expense for Q1 2021 was USD 3.8 million versus Q1 2020 – USD 6.7 million. The overall decrease in finance expense in Q1 2021 as compared to Q1 2020 is primarily attributable to a decrease in loans and borrowings.
• Foreign exchange loss for Q1 2021 was USD 28.6 million against USD 81.9 million in Q1 2020.
• As of March 31, 2021, the Company held cash and cash equivalents of USD 84.6 million as compared to USD 62.5 million in December 2020. Cash and cash equivalents have increased by USD 22.1 million since December 31, 2020.
• Q1 2021 cash flow from operations was a record USD 62.1 million, an increase of USD 24.8 million from USD37.3 million in Q1 2020.
• Q1 2021 net income per share was USD 0.36 and USD 0.34, on a basic and diluted basis, respectively, compared with Q1 2020 net loss per share of USD 0.62 and USD 0.62, on a basic and diluted basis, respectively.

Top-10 Shareholders    
Top-10 shareholders in the company held around 51% 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 15.32%, 10.45% and 6.63% respectively. The institutional ownership in “Ero Copper” stood at 47.57%, and ownership of the strategic entities stood at 16.42%.

Valuation Methodology (Illustrative): EV to EBITDA 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 started the year with considerable momentum, achieving record quarterly copper production and financial performance. Also, it also made significant progress around the ongoing optimization initiatives of the Boa Esperanҫa Project and expected to provide an update on what this opportunity looks like during the third quarter.

Further, a spectacular rally in copper has enthralled Ero Copper stocks as copper prices have been marching ahead almost every month over the past 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 red 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. Also, EVs require a considerable amount of copper, almost five times more than the regular ones.

From the technical standpoint, after a recent correction in the stock, ERO Copper shares took strong support at the 200-day SMA and bounced back from its crucial long-term support level and moving higher.

Therefore, based on the above rationale, we recommend a “Buy” rating at the closing price of CAD 23.84 on July 22, 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 July 22, 2021). Source: Refinitiv, Analysis by Kalkine Group

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

*Recommendation is valid at July 23, 2021 price as well.

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