Fortuna Silver Mines Inc. (TSX: FVI) is a Canadian precious metal mining company. 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.

Investment Rationale

• Silver is Well Placed to Capitalize on Long-term Opportunities, Despite Short Term Challenges: Silver has been often overlooked in favor of its lustrous cousin, gold, but the price of silver has jumped over 60% in the last year. We believe the rally is likely to continue as the global economy reopens. Demand for the precious metal has shot up in the past 12 months. Silver was trading around USD 26.14 an ounce on Thursday, a 70% rise from a year ago when the spot price was around USD 15.5 per ounce. In comparison, gold prices have risen 5.5% in a year. From electronics to photography, jewellery and coins, silver is integral to numerous everyday products. Elevated silver price and rise in demand would help the group in delivering robust performance in the coming quarters.

• Solid Q1FY21 Performance: The company reported solid performance in the Q1FY21, with total sales for the three months reported an increase of 148% on a YoY basis. This was primarily driven by Lindero Mine, which recognized sales of USD 36.9 million from 21,297 ounces of gold sold. San Jose sales were USD 58.0 million, an increase of 50% from the USD 38.7 million reported in Q1 2020 due to increases in the prices of silver and gold and a 3% and 5% increase in the volume of silver and gold ounces sold, respectively. Sales from the Caylloma Mine were up 92% on a YoY basis due to higher metal prices and a 22%, 17%, and 21% increase in the volume of silver, zinc, and lead sold, respectively. Further, Operating income was USD 40.4 million, an increase of USD 38.6 million compared to Q1 2020. The increase was due primarily to higher mine operating income on the back of elevated metal price.

• Industry Leading Margin Profile: FVI commands a strong competitive advantage against the industry peer, with an industry-leading margin profile, profitability and balance sheet strength.

• 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.

• Strong FY21 Production Guidance: 2020 production impacted by government mandated industry wide constraints related to COVID-19. However, the company expect a strong 2021 in terms of production profile.

Source: Company Presentation 

• Acquisition of Roxgold to help in Creating a Low-Cost Precious Metal Producers: Recently, the company announced that it would acquire all the issued and outstanding securities of Roxgold. Under the terms of the Transaction, Roxgold shareholders will receive 0.283 common shares of Fortuna and C$0.001 for each Roxgold common share held. Upon completion of the Transaction, existing Fortuna and Roxgold shareholders would own approximately 64.3% and 35.7% of the pro forma company, respectively. The acquisition would help in creating a low-cost platform for gold and silver production growth in the world’s fastest growing precious metals producing regions.
  

• Acquisition to Drive Synergies to FVI: The company anticipated an annual gold-equivalent production profile of approximately 450,000 ounces. The AISC is expected to be approximately USD 950 per gold equivalent ounce with a declining cost profile. Post the acquisition; the company expects a lower cost of capital and a strong balance sheet to fund the construction of the Séguéla gold Project in Côte d’Ivoire. The acquisition would help in the advanced exploration of the Boussoura Gold Project in Burkina Faso, as well as other organic and external growth opportunities.
  

• 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: Q1FY21

Source: Company Filing

• During the quarter under consideration, the company reported sales of USD 117.8 million, an increase of 148% from the USD 47.5 million reported in the same period in 2020 due to higher realized prices and sales volumes for all metals at all mines, most notably sales from the Lindero Mine of USD 36.9 million.
• Mine operating income was USD 51.3 million, an increase of USD43.8 million from the USD7.5 million reported in Q1 2020.
• Silver production stood at 1,913,755 ounces, an increase of 5% over Q1 2020.
• Gold production stood at 34,555 ounces, an increase of 242% over Q1 2020.
• Lead production came in at 8,181,355 pounds, an increase of 6% over Q1 2020.
• Zinc production was 11,968,896 pounds, an increase of 1% over Q1 2020.
• Operating income came in at USD 40.4 million, an increase of USD 38.6 million from the USD 1.8 million reported in Q1 2020.
• Net income reported at USD 26.4 million or USD 0.14 per share, an increase of USD 30.9 million and USD 0.17 per share, from the USD 4.5 million net loss or USD 0.03 loss per share reported in Q1 2020.
• Adjusted net income was USD 27.5 million compared to USD 2.2 million net loss in Q1 2020.
• Adjusted EBITDA of USD 60.8 million compared to USD 15.9 million reported in Q1 2020.
• Free cash flow from ongoing operations of USD 17.4 million compared to USD 14.2 million reported in Q1 2020, the current quarter was impacted by a USD 16.2 million increase in trade receivables due to timing of collections.
• As of March 31, 2021, the Company had cash and cash equivalents of USD 145.7 million an increase of USD 13.8 million from December 31, 2020.

Top-10 Shareholders

The top-10 Shareholders holds approximately 22.48% stake in the company, with Van Eck Associates Corporation and Mirae Asset Global Investments (USA) LLC are the top holders with an outstanding position of 10.57% and 2.22%, respectively.  The institutional ownership in the company stood at 39.84%, and strategic ownership in the company stood at 1.07%.

Valuation Methodology (Illustrative): EV to Sales

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 global health crisis may have contributed to a decline in the demand for silver, but 2021 has reignited optimism, with experts predicting that the demand for the white metal would rise to a multi-year high. Silver would continue being valuable and in demand thanks to the current economic conditions in developed countries and its use in various products.

Further, Fortuna and Roxgold combination is well placed to benefit its shareholders in the mid to long run, as it is bringing together two highly experienced management teams with track records of “Value Creation” in the Americas and in West Africa. Further, the combination would bring a highly complementary and diversified portfolio, expanded diversified production, development, and exploration platform.

Moreover, the company is offering a strong margin of safety to its investors, with a free cash flow yield of approximately 14%, which implies that the company has sufficient availability of free cash flow to fund its operations in near to midterm. Also, the company’s balance sheet is quite strong with solid risk protection metrics.

Therefore, based on the above rationale and valuation, we suggest a “Buy” recommendation on the stock at the closing price of CAD 7.36 on June 17, 2021.   

1-Year Price Chart (as on June 17, 2021)

*Recommendation is valid on June 18, 2021 price as well.

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

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.