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

• Robust preliminary production numbers: The corporation recently released preliminary third-quarter production statistics from its four active mines in the Americas and West Africa, revealing that it produced 65,425 ounces of gold, up 411% from the previous corresponding period. Although, it witnessed a slight decline in silver at 1,711,881 ounces but the momentum was higher for Zinc and lead.

Source: Company

• Robust financial performance: Revenue increased by ~171% to USD 120.5 million in the second quarter of 2021, while adjusted EBITDA increased by ~484% to USD 54.9 million and adjusted net income increased to USD 21.5 million from the negative number, all on a year-over-year basis. The improved outcomes were fueled by higher average commodity prices and output.

Source: Company

• Realizing higher metal prices: As a result of higher realized metal prices, the company's financials are improving. The average realized price of silver climbed to USD 26.85 throughout the time period, while the average realized price of gold was USD 1,812. Despite some volatility, we expect higher average realized prices for different commodities, which would result in a significant advantage to the company.

Source: Company

• Elevated free cash flow: Due to strong operational performance, the company produced considerable cash flow from operations during the report period, which increased by USD 18.3 million to USD 18.5 million. The gain was mostly attributable to higher EBITDA, which was fueled by a higher net average realized selling price and higher output.
  

• Updated production guidance for FY 2021: The 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% to 116% growth year over year. The business’ merger with Roxgold Inc. is projected to result in increased production figures.

Source: Company 

• Industry beating margins: 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.

• Risks associated with investment: The performance of the company is directly correlated with the gold and other metal prices. Thus, volatility in the commodity price would dampen the company’s income and would take a toll on the overall performance.

Financial overview of Q 2 2021 (Expressed in thousands of US dollars)

Source: Company

• Record sales: In Q2 2021, the company reported record sales of USD 120.5 million, increased 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.
• Improved cost of sales: Cost of sales stood at USD 72.0 million against USD 30.7 million in the previous corresponding period. The cost of sales stood at 59.8% as a % to sales in Q2 2021, compared to 69.1% as a % to sales in Q2 2020.
• Elevated mines operating income: Mine operating income increased to USD 48.4 million against USD 13.7 million in the previous corresponding period.
• Higher operating income: Operating income in Q2 2021 stood at USD 35.8 million, increased by USD 37.2 million compared to Q2 2020, primarily due to higher mine operating income as realized prices of silver and gold were 58% and 5% higher, respectively, compared to Q2 2020. Also, the operating expenses were on the lower side.
• Transformed losses into net profit: 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 20.0% of the total shareholding. Van Eck Associates Corporation and Mirae Asset Global Investments (USA) LLC hold the maximum interests at 10.87% and 1.49%, respectively. The institutional ownership in the company stood at 33.21%, 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

With record revenues of USD 20.5 million and consolidated EBITDA margins of over 45%, the company's second quarter results showed the strength of its business. The company recently merged Roxgold's business activities and expects this acquisition to contribute to financial performance beginning in Q3, with 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. 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 5.93 on October 21, 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 October 21, 2021). Source: REFINITIV, Analysis by Kalkine Group

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

*Recommendation is valid on October 22, 2021 price as well.

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