Canada-based Ero Copper (TSX: ERO) is 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

• Demand for Electric Vehicles to Boost Rally in Copper: Copper have had a spectacular rally since March 2020, however despite the recent short-term price consolidation seen in copper prices from peak levels, we are quite bullish on the copper on the back of shift towards the EVs. It is expected that demand for copper to be fivefold 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.
• Copper Prices Likely to Remain Firm: Demand in the US is widely seen on an upward trajectory in coming years with the massive infrastructure spending plans that are expected to be more copper intensive than most. Concerns about the potentially negative impact of monetary tightening remain, but the consumption picture generally remains positive this year. Further, despite being a seasonally quieter period for demand, we expect demand to remain reasonably strong on a year-on-year comparison basis. As a result, copper prices are likely to remain elevated, and the company is likely to benefit from the elevated copper price.
• Generating Higher Return for its Shareholders: ERO Copper is featuring a TTM ROE of 94.28%, which is gigantically higher and reflects the competitive advantage of Ero Copper against its peers. The return on equity (ROE) measures how profitable a company is relative to its book value. Also, consistently higher ROE generating companies tend to command a premium in the market.
• Consistently Deleveraging Balance Sheet: On the back of a solid surge in the Copper prices and Gold prices over the past year, the company generated significantly higher free cash flow, which led to significant debt reduction and balance sheet bolstered significantly. The company's Debt/Equity ratio has significantly reduced to 0.46x at the end of the June quarter of 2021 compared to 1.95x at the end of the June quarter of 2020. A lower debt position would lead to margin expansion and an increase in profitability in the coming years.
• Robust Financial Risk Protection Metrics: Despite a solid reduction in debt outstanding, the D/E ratio of the Ero Copper is still higher compared to the industry median of 0.20x at the end of the June quarter. However, despite a relatively higher debt availability in the balance sheet, the company has industry-leading debt protection metrics with an interest coverage ratio of 43.6x and Net Debt/EBITDA ratio of 0.63x, which implies that the company has no balance sheet risk and indeed could take debt to amplify its profitability.
• Industry Leading Margin Profile: Ero Copper is having a strong competitive advantage against the peer group as the company consistently reported an industry-leading margin profile. In the latest quarter, gross margin came in at 69.3% in Q2FY21 vs Industry Median of 49.2%, EBITDA margin stood at 67.6% vs Industry median of 40.1%, the Operating margin was ~60% vs industry median of 25.1%, and the Net margin was ~ 70% vs industry median of 15.7%.
• Reported Record Cash Flow: During 2QFY21, the company reported record quarterly cash flow from operations of USD 85.1 million, driven by strong performance across the company's operations as well as elevated copper and gold prices.
• Reaffirming Full Year Production and Operation Guidance: 2021 copper production guidance has been reaffirmed with the Company well-positioned to achieve the high-end of the range. 2021 annual production guidance for the MCSA Mining Complex is 42,000 to 45,000 tonnes of copper in concentrate at C1 cash cost guidance range is USD 0.75 to USD 0.85 per pound of copper produced; and annual production guidance for the NX Gold Mine is 34,500 to 37,500 ounces of gold at C1 cash cost and AISC guidance range is USD 500 to USD 600 and USD 875 to USD 975 per ounce of gold produced, respectively.
• 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 foreign exchange risks as a vast majority of the group's earnings come from abroad, primarily from Brazil.

Financial Highlights: Q2FY21

Source: Company Filings

• During the quarter under consideration, revenues from the Company’s copper operations at MCSA increased by 82.1% from USD 56.5 million in Q2 2020 to USD 103.0 million in Q2 2021. 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 24.7% from USD 14.2 million in Q2 2020 to USD 17.7 million in Q2 2021. The increase was primarily a result of increased sales volume over the comparative period.
• Mine gross profit from the Company’s copper operations at MCSA totaled USD 73.1 million in Q2 2021 compared to USD 29.8 million in Q2 2020. The increase in mine gross profit was primarily driven by an increase in revenues attributed to higher average realized copper prices.
• The Company also recognized mine gross profit of USD 10.6 million in Q2 2021 compared to USD 9.7 million in Q2 2020 from its gold operations at NX Gold.
• The Company recognized net income of USD 84.0 million (basic net income per share of USD 0.95) in Q2 2021 compared to USD 7.7 million in Q2 2020 (basic net income per share of USD 0.09). The increase in net income was primarily attributable to an increase in revenues from higher average realized copper prices and higher gold sales volume over the comparative period.
• Q2FY21 cash flow from operations was a record USD 85.1 million, an increase of USD 42.6 million from USD 42.5 million in Q2 2020.
• Cost performance during the quarter continued to track ahead of full-year guidance with C1 cash costs of USD 0.72 per pound of copper produced at the MCSA Mining Complex, bringing H1 2021 C1 cash costs to USD 0.60 per pound of copper produced; at the NX Gold Mine, C1 cash costs and AISC during the quarter were USD 499 and USD 660, respectively, per ounce of gold produced, resulting in H1 2021 C1 cash costs and AISC of USD 494 and USD 652, respectively, per ounce of gold produced

Top-10 Shareholders    
Top-10 shareholders in the company held around 50.50% stake. T. Rowe Price Associates, Inc., Fidelity Investments Canada ULC and Strang (David Maxwell) 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 Sales 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 group’s ongoing exploration programs delivered the best intercepts to date at both the Pilar and NX Gold Mines, with aggressive regional exploration drilling underway. Moreover, on the back of higher underlying commodity production, the company generated record cash flows from operations during the quarter of USD 85.1 million. Moreover, strong operating performance and elevated copper and gold prices resulted in total cash and cash equivalents at the quarter end of USD 137.7 million, an increase of USD 53.1 million quarter-on-quarter and USD 75.1 million since the end of 2020.

Moreover, Ero Copper has significantly strengthened its balance sheet led by higher cash flow in the business on the back of higher commodity realization prices, with Net debt position of USD 19 million at the end of the quarter (excluding proceeds from the NX Gold Stream) versus USD 74 million at the end of Q1 2021. The group also maintained robust debt protection metrics.

Further, looking at the margin profile, it seems that Ero Copper is efficient in converting sales into higher profit against the peer group, with industry-leading margin profile.

Hence, based on the aforementioned facts and valuation, we recommend a “Buy” rating on the stock at the closing price of CAD 21.76 on August 19, 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 August 19, 2021). Source: Refinitiv, Analysis by Kalkine Group

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

* Recommendation is valid on August 20, 2021 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.