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 Rationales

• Healthy production numbers: The corporation recently released its 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 Filing

• Robust financial performance: Revenue increased by USD 79.2 to USD 162.6 million in Q3 2021. An increase in sales was primarily due to gold sales from the Yaramoko mine of USD 49.0 million and Lindero mine of USD 41.8 million, while adjusted EBITDA increased by 78% to USD 75.3 million and adjusted net income increased to USD 22.5 million, all on a year-over-year basis. The improved outcomes were fueled by higher output.

Source: Company Filing

• 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 Filing

• Elevated free cash flow: Due to strong operational performance, the company produced considerable cash flow from operating operations during the report period, which increased by USD 7 million to USD 39.4 million. While the free cash flow also increased to USD 33.8 million against USD 30.1 million in Q3 2020. The gain was mostly attributable to higher EBITDA, which was fueled by a higher output and Lindero and Yaramoko contributions.
  

• Trading at discounted valuations: The company’s shares are available at an NTM EV/Sales multiple of 1.1x compared to the industry (Basic Material) median of 1.5x. while on NTM EV/EBITDA multiple the stock is trading at 2.1x compared to 4.3x. This implies that the shares are trading at deep discount against the industry. The stock is undervalued on multiple valuation parameters. The table below reflects the picture.

Source: REFINITIV, Analysis by Kalkine Group 

• 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.
  

• 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 Q3 2021 (In 000 of USD)

Source: Company Filing

• Record sales: In Q3 2021, the company reported record sales of USD 162.6 million, increased 95% from the USD 83.4 million reported in the previous corresponding period. An increase in the revenue was mainly due to higher production.
• Rise in cost of sales: Cost of sales stood at USD 115.2 million against USD 41.3 million in the previous corresponding period. The company’s cost of sales stood at 70.8% as a % to sales in Q3 2021, compared to 49.5% as a % to sales in Q3 2020.
• Mines operating income increased to USD 47.3 million against USD 42.0 million in the previous corresponding period.
• Lower operating income: Operating income in Q3 2021 stood at USD 21.7 million, decreased by USD 6.7 million compared to Q3 2020, primarily due to higher expenses, mainly due to acquisition of Roxgold Inc.
• Net profit in the reported period stood much lower at USD 0.2 million compared to USD 13.0 million in pcp. The dented net income was primarily due to lower operating income and USD 10.5 million in transaction costs related to the acquisition of Roxgold Inc.
  

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 BlackRock Institutional Trust Company, N.A. hold the company's maximum interests at 10.86% and 1.68%, respectively. The company's institutional ownership stood at 34.49%.

Source: Refinitiv, Analysis by Kalkine Group

 

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 company's excellent adjusted EBITDA of USD 75.3 million in the third quarter, with margins of 46%, and free cash flow from operations of USD 33.8 million testifies to the business's strength. FVI's record financial results reflect the Lindero mine in Argentina's continued increasing production trend and the Yaramoko mine in Burkina Faso's first quarterly contribution. We believe, as the group ramp up its building activity at the Seguela project in Côte d'Ivoire, would help them in clocking more healthy cash flow, which is a key positive.

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. Therefore, based on the above rationale and valuation, we recommend a "Buy" rating on the stock at the closing price of CAD 4.16 as of December 16, 2021. In addition, we have considered Dundee Precious Metals Inc, Endeavour Silver Corp, Silvercorp Metals Inc, etc., as a peer group for the comparison.

*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 Technical Price Chart (as on December 16, 2021). Source: REFINITIV, Analysis by Kalkine Group

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

Recommendation is valid on December 17, 2021, price as well.

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