Fortuna Silver Mines Inc. is a Canadian precious metals mining company with operations in Peru, Mexico and Argentina. Its business operations comprised of mining and related activities in Latin America, including exploration, extraction, and processing of silver- lead, zinc, and silver-gold and the sale of these products. The company operates the Caylloma silver, lead, and zinc mine in southern Peru and the San Jose silver, gold mine in southern Mexico, and is developing the Lindero gold Project in northern Argentina. Its operating segment includes Bateas; Cuzcatlan and Mansfield. The company generates maximum revenue from the Cuzcatlan segment.

Investment Rationale

• Solid Financial Performance in FY20 Driven by Strong Metal Prices: Sales were USD 279.0 million, an increase of 8% from USD 257.2 million reported in the year ended December 31, 2019. Mine operating income was USD 110.2 million, an increase of 30% from USD 84.6 million reported in 2019. Operating income was USD 57.2 million, an increase of 67% from USD 34.2 million reported in 2019.

Source: Company Presentation

• Solid Financial Position to Support Growth Strategy: The Company had cash and cash equivalents of USD 131.9 million on December 31, 2020, an increase of USD 48.5 million since the beginning of the year. The increase was due primarily to USD 93.4 million of net cash generated from operations, which was a net of USD 21.8 million of preproduction costs to produce ore stockpile and supplies inventory that was spent during the construction of the Lindero Mine. The Company also received USD 65.6 million of net proceeds from a bought deal equity financing in the second quarter and drew the remaining USD 10.0 million from the Credit Facility. Further, the Company has a lower debt contribution in the balance sheet, which implies low balance sheet risk. Given the strong cash position and balance sheet strength, Company is well placed to capitalize on future opportunities.

Source: Company Presentation

• Strong Growth in Free Cash Flow: Free cash flow from ongoing operations for the year ended December 31, 2020, was USD 78.9 million compared to USD 34.5 million, an increase of 129% on a YoY basis. The increase was driven by higher precious metal prices, which contributed to increased cash flow from operations. This financial metric is very crucial and used by the company and investors to measure the cash flow available to fund the company’s growth through investments and capital expenditures.  

Source: Company Presentation 

• Brownfields Exploration- Potential for discovery and expansion: Consolidated Brownfields exploration expenditures in 2020 were USD 3.8 million. The Company is expanding its exploration budget and initiatives in 2021 as the capital-intensive phase of the Lindero construction has ended. Fortuna´s consolidated Brownfield’s exploration budget for 2021 for all three mines totals USD 15.9 million, which includes 53,800 meters of diamond drilling and 2,170 meters of underground development.

Source: Company Filing, Kalkine Group.

• Strong FY21 Production Guidance: 2020 production impacted by government mandated industry wide constraints related to COVID-19. For FY21, the company is positive and provided strong production guidance.

Source: Company Presentation

• Improved Margin Profile on YoY basis: Despite a challenging operating environment, the company expanded its margin profile in FY20, which is encouraging.

Source: Kalkine Group, Refinitiv (Thomson Reuters) 

• Risk Associated to Investment: The Company derives its revenue from the sale of silver, gold, lead and zinc. The company’s sales are directly dependent on metal prices, and metal prices have historically shown significant volatility that is beyond the Company’s control. Further, the functional and reporting currency for all entities within the consolidated group is the US dollar. Therefore, the company is exposed to fluctuations in foreign exchange rates as a portion of their expenses are incurred in Canadian dollars, Peruvian Soles, Argentine Peso and Mexican Peso.

Financial Highlights: FY20

Source: Company Filing

• Consolidated sales for the twelve months ended December 31, 2020, increased 8% to USD 279.0 million compared to USD 257.2 million for the same period in 2019. The increased sales were due primarily to USD 20.3 million of gold sales from the sale of 10,935 ounces of gold at the Lindero Mine.
• Sales at San Jose for the twelve months ended December 31, 2020, increased 4% to USD 191.0 million as silver and gold prices increased 41% and 26%, respectively, which were partially offset by a 21% decrease in the volume of silver and gold ounces sold. The lower metal production was due mainly to lower head grades and the lost production from a 54-day government-mandated temporary suspension of mining operations during the second quarter to mitigate the spread of the COVID-19 pandemic.
• Sales at Caylloma decreased 7% to USD 67.6 million due primarily to a decrease in the prices of lead and zinc of 9% and 10%, respectively. The company also recognized USD 20.3 million of gold sales from commissioning activities at the Lindero Mine.
• Operating income for the year ended December 31, 2020, was USD 57.2 million, an increase of USD 23.0 million over 2019.
• General and administrative expenses for the year ended December 31, 2020, increased 17% to USD 35.1 million compared to USD 29.8 million reported in 2019. The increase was due primarily to a 107% increase in share-based payments impacted by a 98% year-over-year increase in the company’s share price, which was partially offset by a USD 1.7 million decrease in mine and corporate personnel and administration costs.
• The all-in sustaining cash cost of payable silver equivalent for the full year 2020 increased 24% to USD 12.15 per ounce due primarily to lower production resulting from the COVID-19 related temporary suspension, higher sustaining capital expenditures, and higher royalty and mining taxes associated with higher metal prices.
• Free cash flow from ongoing operations for the year ended December 31, 2020, was USD 78.9 million compared to USD 34.5 million. The increase was driven by higher precious metal prices, which contributed to increased cash flow from operations.
• As of December 31, 2020, the company had cash and cash equivalents of USD 131.9 million (December 31, 2019 – USD 83.4 million), an increase of USD 48.5 million since the beginning of the year.

Top-10 Shareholders

The top-10 Shareholders in the company holds approximately 23.57% stake, with Van Eck Associates Corporation and Mirae Asset Global Investments (USA) LLC are the top holders with an outstanding position of 10.98% and 2.12%, respectively.  The institutional ownership in the company stood at 39.84%, and strategic ownership in the company stood at 1.07%.

Source: Refinitiv (Thomson Reuters)

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 recorded solid financial performance for the year ended December 31, 2020, led by a rally in the underlying commodity prices. Strong metal prices and higher realized prices have gigantically improved the financial performance and margin profile of the company in FY20. For the full-year FY20, Silver realization prices improved by 31% to USD 21.18/oz as compared to USD 16.20/oz reported in a year over period. Gold realization prices also improved over 30% in the same period.

Adjusted EBITDA for FY20 was USD 112.6 million compared to USD 95.4 million reported in FY18. As explained above, the increase was due primarily to the increases in the prices of silver and gold as well as the impact to mine operating income from the early adoption of amendments to IAS 16, Property, Plant and Equipment – Proceeds before Intended Use.

Going forward, we expect demand for silver to remain healthy as silver has the highest electrical and thermal conductivity of all metals, making it an important metal in the transition to a low carbon economy. Moreover, silver is used in photovoltaics (construction of solar panels) and electrical applications, including electric vehicles. Also, silver is an important component in the buildout of 5G networks, which is the next major evolution in communication technology. The group is likely to be benefited from the rising demand for silver. Further, the group has raised its gold production guidance significantly, which is likely to bolster the performance.

Therefore, based on the above rationale and valuation, we suggest a “Buy” recommendation at the closing price of CAD 9.38 on April 08, 2021. 

1-Year Price Chart (as on April 08, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at April 9, 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.