Fortuna Silver Mines Inc (TSX: FVI) is a Canada-based precious metals producer. 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. 

Investment Rationale

• Healthy production: Despite the fact that the Company is managing the required country-by-country limitations connected to the prevention of COVID19 spread, the second quarter of 2021 was a watershed moment, with increased production numbers in every commodity. Silver output grew by 49% to 1.9 million ounces (moz) compared to 1.3 million ounces in the previous similar period, while gold production increased by 337% to 31 Koz compared to just 7.1 Koz in pcp. Other commodities followed a similar upward trend.

Source: Company

• Robust financial performance: The company reported decent performance in the Q2 2021, with revenue surged by 171% to USD 120.5 million, against USD 44.5 million on a YoY basis, while the adjusted EBITDA elevated enormously by 484% to USD 54.9 million against USD 9.4 million and adjusted net income also rose to USD 21.5 million compared to a loss of USD 5.1 million in the previous corresponding period. Improved average commodity prices and increased output drove the positive results.

Source: Company

• Realizing higher metal prices: The company's financials are improving as a result of increased realised metal prices. During the given period, the average realised price of silver increased to USD 26.85, while the average realised price of gold was USD 1,812. Despite some volatility, we anticipate that the average realised prices of the various metals would remain elevated, which would be providing key benefit to the company.

Source: Company 

• Elevated free cash flow: The firm generated significant Cash flow from operating activities during the report period, which rose by USD 18.3 million to USD 18.5 million, thanks to good operational performance. The rise was mostly due to greater EBITDA, which was driven by a higher net average realised selling price and increased output.
  

• Updated production guidance for FY 2021: The company's management is optimistic about commodity prices and has projected a good production profile. The firm forecasts consolidated silver and gold production of 6.8 to 7.6 million ounces and 194 to 223 thousand ounces, or 283 to 323 thousand gold equivalent ounces, in FY 2021, representing a 90 percent to 116% growth year over year. The business merger with Roxgold Inc. is projected to result in increased production figures.

Source: Company 

• Elevated commodity prices to support future earnings: The recent rally in the commodity prices is moving well for the company, and we can see a significant impact of this movement in the precious and industrial metal mining company’s balance sheet. As the prices go up, it increases averages realization prices for the miners, which lead to a higher margin profile, higher free cash flow generation and deleveraging of the balance sheet. We believe that the company is well placed to capitalize on the increasing prices of the underlying commodity and exit FY2021 on strong financial health.

• Industry beating margins: Despite the second wave of the Covid-19 Pandemic, the Company kept up its momentum and had strong results across the board. Furthermore, the company's strong determination enabled them to outperform the industry median margins on several fronts in Q2 2021; while its net margin was somewhat lower than the industry median by a little fraction, it still demonstrates the company's competitive edge within the industry. This is seen in the graph below.

• Business combination between the company and Roxgold: The previously mentioned corporate merger with Roxgold was just finalised. The producing Yaramoko mine in Burkina Faso, the Séguéla development project in Côte D'Ivoire, and the Boussoura exploration property in Burkina Faso are the company's main assets. The firm purchased all of Roxgold's issued and existing common shares in return for 0.283 common shares of Fortuna and CAD 0.001 in cash each Roxgold Share owned under the terms of the transaction.
  

• Disposed investment in Keon Capital Inc: The business recently entered into agreements with two private purchasers to sell 515,365 common shares of Keon Capital Inc. (previously Prospero Silver Corp.) held by the company at a purchase price of CAD 0.10 per common share, for a total of CAD 51,536.50 in proceeds.
  

• Risks associated with investment: The company's business is significantly exposed to the volatility in gold and silver prices. Further inherent risks associated with mining and mineral processing such as the company's mines may not perform as planned; uncertainty with the company's ability to secure additional capital to execute its business plans; the speculative nature of mineral exploration and development, including the risks of obtaining and maintaining necessary licenses and permits, including the necessary licenses, permits, authorizations and/or approvals from the appropriate regulatory authorities.
  

Financial overview of Q2 2021 (Expressed in thousands of US dollars)

Source: Company

• In Q2 2021, the company reported record sales of USD 120.5 million, an increase of 171% from the USD 44.5 million reported in the previous corresponding period. The increase in the revenue was mainly due to higher gold and silver sales volumes and higher realized prices for all metals.
• In the reported period, the cost of sales came in at USD 72.0 million against USD 30.7 million in the previous corresponding period. The company improved its cost of sales and it stood at 59.8% as a % to sales in Q2 2021, compared to 69.1% as a % to sales in Q2 2020.
• Mines operating income increased to USD 48.4 million against USD 13.7 million in the previous corresponding period.
• The company managed to bring down its total operating expenses in the reported period to USD 12.6 million compared to USD 15.0 million in the previous corresponding period. The general and administrative expenses stood lower at USD 9.1 million V/s 10.3 million in pcp.
• Operating income in Q2 2021 stood at USD 35.8 million, increased by USD 37.2 million compared to Q2 2020. The increase was primarily due to higher mine operating income as realized prices of silver and gold were 58% and 5% higher, respectively, compared to Q2 2020.
• Interest and finance cost increased to USD 2.1 million against USD 0.3 million in pcp. It also reported the transaction cost regarding Roxgold at USD 3.5 million, while the losses made on derivatives in the reported period stood at USD 1.9 million.
• Primarily due the factors discussed above, the income before income tax stood at USD 28.2 million in Q2 2021 against USD 0.5 million in the previous corresponding period.
• Total income tax expenses for the reported period increased to USD 12.0 million against USD 6.0 million in Q2 2020, primarily due to higher mining operating income.
• In the reported period the company transformed its net losses into net income at USD 16.1 million compared to a loss of USD 5.6 million in pcp. This transformation was on the back of higher production, higher revenue and higher mine operating income.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 17.39% of the total shareholding. Van Eck Associates Corporation and Mirae Asset Global Investments (USA) LLC hold the company's maximum interests at 8.60% and 1.49%, respectively. The company's institutional ownership stood at 29.82%, and ownership of the strategic entities stood at 1.01%.

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

Despite COVID-19 related challenges at its Lindero mine, the company’s second quarter results reflected the strength of its business with record sales of USD 20.5 million and consolidated EBITDA margins of above 45%. The company recently combined the business activities of Roxgold and expects this acquisition to contribute to financial performance starting in Q3, with the addition of 62,000 to 66,000 gold ounces of production from the Yaramoko mine forecasted for the second half of 2021 at an AISC below USD 1,150 per ounce, which would be a key positive for the company. The recent rally in the commodity prices is moving well for the company, and we can see a significant impact of this movement in the precious and industrial metal mining company’s balance sheet. As the prices go up, it increases averages realization prices for the miners, which lead to a higher margin profile, higher free cash flow generation and deleveraging of the balance sheet.

Furthermore, the company is expected to achieve healthy revenue growth over the medium term on the back of higher commodity prices and improving business risk profile, higher commodity production, and higher realization prices. In addition, the management's solid determination helped them leap the industry median margins on many fronts in Q2 2021, which exhibits the competitive advantage of the company within the industry.

Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 5.38 on September 16, 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

One-Year Price Chart (as on September 16, 2021). Source: REFINITIV, Analysis by Kalkine Group

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

 

*Recommendation is valid at September 17, 2021 price as well.

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