Ero Copper Corp (TSX: ERO) is a mining company and is engaged in the production and sale of copper from the Vale do Curaca Property in Brazil, with gold and silver produced and sold as by-products from the same. Ero's business strategy is centered upon aggressively increasing the high-grade mineral reserves, extending mine life and maximizing mill throughput of the operations, leveraging the excess capacity of the installed infrastructure. The company currently mines copper ore from the Pilar and Vermelhos underground mines.

• Strong Financial Performance in the Second Quarter of 2020: During the second quarter of FY20, the company recorded record cash flows from operations of US$42.5 million, reflecting an increase of US$5.2 million from US$37.3 million generated in Q2 2019. Adjusted basic earnings per share also expanded to US$0.22 vs US$0.18 in Q2FY19 and diluted earnings per share expanded to US$0.22 against US$0.17 reported in the corresponding previous financial period. Further, the group recorded C1 cash cost of US$0.65 per pound of copper produced during Q2 2020, reflecting a quarter-on-quarter improvement of US$0.06 per pound of copper produced.

• A recovery in the Copper prices is likely to benefit the company in the near term: Copper prices gained approximately 43% per cent from the year lows of US$4,617.5/tonne to US$6,613.0/tonne as the demand started to pick up. 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 eased 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.

Copper YTD Price, Source: London Metal Exchange

• Reaffirmed production guidance: The Company is maintaining 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 of US$0.70 to US$0.85 per pound of copper produced and capital expenditure guidance of US$56 to US$68 million.

Source: Company Filing

• Positive operational momentum 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. 

• Ample liquidity: The Company bolstered its liquidity position at the onset of the pandemic, by drawing down its existing USD and BRL denominated credit facilities. YTD 2020, the company has drawn down $14.0 million and R$97.6 million ($17.8 million) under various credit facilities as a proactive measure. The company ended the period with a robust liquidity position of $51.6 million in cash and cash equivalents – a quarter-on-quarter improvement of $7.3 million.

• Higher Spread between ROCE and WACC: The company has consistently maintained a higher positive spread between Return on Capital Employed and Weighted Average Cost of Capital. This reflects prudent capital allocation and management efficiency of the company. A higher spread suggests that the company is generating a significant return over its cost of capital.

• 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 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.

2QFY20: Financial Highlights

Revenue: 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. However, Revenues from the company's gold operations at NX Gold increased 20.8% from $11.8 million in Q2 2019 to $14.2 million in Q2 2020. The increase was primarily driven by gold prices, partially offset by decreased production and sales volumes.

Source: Kalkine, Refinitiv (Thomson Reuters)

Gross Profit: 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 30% reduction in the group’s cost of goods sold on a YoY basis and partially offset by decreased copper prices during the period under consideration.

Source: Kalkine, Refinitiv (Thomson Reuters)

Net Income recovered from net loss reported in the previous financial quarter: The Company reported 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 amounting to US$16.3 million vs US$1.6 million in Q2FY19. Source: Kalkine, Refinitiv (Thomson Reuters)

Stock Performance

Over the last three month, Ero Copper shares are moving in the positive zone and featuring a price return of 11.24%, 21% in the last one month and 4.4% over the last five trading sessions. However, shares are still down 17.4% on a YTD basis and 1.12% on a YoY basis. However, due to positive price sentiment around the Ero Copper shares in the last three months, its shares are hovering above the crucial long term as well as short-term moving averages of 200-day, 100-day and 50-day. This typically considered as a positive price momentum in a stock.

1-year Price Chart (as on September 3, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

Over the past 52Week, its shares have tested a peak of CAD 23.93 (on 03rd December 2019) and a bottom of CAD 8.42 (on 16th, March 2020). And at the last closing price of CAD 19.50, its shares traded approximately 18.51% lower its 52W high price level and 132.14% above its 52W low price level, reflecting a sharp recovery.

Top-10 Shareholders

Top-10 shareholders in the company held around 49.11% stake in the company. Fidelity Investments Canada ULC, T. Rowe Price Associates, Inc. and Tembo Capital Management Ltd are among the largest shareholder in the company and carrying an outstanding position of 10.03%, 10.0% and 9.82% respectively. Further, 4 out of top-10 shareholders have increased their stake in the company over the last three months, with T. Rowe Price Associates, Inc. and CIBC Asset Management are among the top investors in the company that have increased their stakes by 6.03 million and 0.19 million, respectively. The institutional ownership in “Ero Copper” stood at 42.80%, and ownership of the strategic entities stood at 16.46%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology: EV to EBITDA based Valuation Metrics 

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 solid cash flow from the operation, improved gross profit, lower cost of goods sold, and improvement in the 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. 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 and extensive mitigation measures implemented during Q1 2020 have continued through the second quarter.

Further, Copper prices have recoded a sharp recovery on the London Metal Exchange, with commodity prices are hovering above the pre-pandemic price level. Improvement the copper price is likely to benefit the company’s performance in the near to medium term.

The group’s shares have recorded a strong relative price strength on the TSX over the last three months, with significant outperformance against the benchmark index and the sector peers. Also, its shares are trading in a bullish zone, as its shares were 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 done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 19.5 (as on September 03, 2020), with a lower double-digit upside potential, based on the NTM Peer’s Average EV/EBITDA multiple of 10.0x on the FY20E EBITDA.

 

*Recommendation is valid at September 4, 2020 price as well.

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