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. 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

• Solid Third Quarter Performance: The company reported strong financial performance in the third quarter of FY20, with sales, stood at USD 83.4 million, reflecting a jump of 36% from USD 61.3 million reported in the same quarter of the previous financial year as the prices for silver and gold were 44% and 29% higher than the same period in 2019, along with the increased volume of silver and gold ounces sold at the San Jose Mine. This was partially offset by a lower volume of metals sold from the Caylloma Mine as operations were impacted by the 21-day shutdown in July. Adjusted EBITDA margin nudged to 51% with adjusted EBITDA of USD 42.2 million vs 31% reported in the corresponding quarter of the previous financial quarter. Adjusted net income soared gigantically by 747% to USD 16.1 million against USD 1.9 million reported in the same quarter of FY19, primarily led by higher sales as a result of increases in the precious metal prices and higher sales volume, the adjusted net income also reflects the adding back of USD 2.7 million of foreign exchange loss related to the construction of the Lindero Mine compared to the adding back of USD.6 million for the same period in 2019.

Source: Company Presentation

• Record Free Cash Flow: In the third quarter, the company reported a record-breaking free cash flow of USD 30.1 million compared to USD 10.6 million in the same period in 2019, implies a surge of 184% on YoY basis. The increase in free cash flow from ongoing operations was driven by strong operating performance and higher precious metal prices which increased the cash provided by operating activities by USD 27.3 million. This measure is used by the company and investors to measure the cash flow available to fund the company’s growth through investments and capital expenditures. A higher free cash flow also provides a margin of safety to the investors.

Source: Company filing.

• Strong Balance Sheet: At the end of the third quarter of FY20, the company reported a net liquidity position of USD 140.2 million, an increase of USD 1.8 million since the beginning of the year. The increase was due primarily to USD 62.1 million of cash generated from operations and the completion of a bought deal public equity financing for net proceeds of USD 65.7 million. Further, the company’s investment objectives for its cash balances, in order of priority, are to preserve capital, to ensure liquidity and to maximize returns. Further, the company has a lower debt position in the balance sheet, with total debt/equity ratio of 0.22x, with a strong coverage ratio. Company’s Net Debt/EBITDA ratio at the end of September quarter stood at 0.7x, implies negligible balance sheet risk for the company.

Source: Company Presentation

• Increase in Silver and Gold Production: This was primarily driven by Higher Head Grades at San Jose. At San Jose, silver and gold production increased 12% and 4%, respectively, to 1,917,540 ounces and 11,425 ounces, respectively, over the same period in 2019 due primarily to 16% and 9% higher silver and gold head grades, which was partially offset by a lower volume of metals sold from the Caylloma Mine as operations were impacted by the 21-day shutdown in July. Further, at San Jose, operating income for the three months ended September 30, 2020, was USD 31.7 million, an increase of USD 19.4 million from the USD 12.3 million reported in the same period in 2019. The increase was due primarily to a combination of higher silver and gold prices, higher volume of silver and gold ounces sold, and lower cash production costs.
• 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: Q3FY20

Source: Company presentation

• Silver and gold production for the three months ended September 30, 2020 increased 10% and 12% to 2,127,746 ounces and 12,791 ounces, respectively, over the same period in 2019.
• Realized sliver prices jumped by 44% to USD 24.88/oz against USD 17.31/oz in the same quarter of the corresponding financial period.
• Realized gold prices surged by 27% to USD1,925/oz as compared to the USD 1,487/oz in the same quarter of previous financial year.

Source: Company Filing

• Sales for the three months ended September 30, 2020 were USD 83.4 million, a 36% increase from USD 61.3 million reported in the same period in 2019 as the prices for silver and gold were 44% and 29% higher than the same period in 2019.
• Operating income for period under consideration was USD 28.5 million, a USD 29.9 million increase from the USD 1.5 million operating loss reported in the same period of the previous financial year.
• Higher operation income was primarily because of higher precious metal prices as well as higher volume of silver and gold ounces sold from the San Jose Mine were the primary factors for the increased operating income.
• Further, on October 20, 2020, the company reported its first pour of gold at its Lindero Mine of 728 ounces as the project ramps up towards commercial production in the first quarter of 2021.
• As at September 30, 2020, the Company had cash and cash equivalents of USD 85.2 million, an increase of USD 1.2 million since the beginning of the year

Top-10 Shareholders

The top-10 Shareholders in the company holds approximately 23.57% stake in the company, with Van Eck Associates Corporation and Mirae Asset Global Investments (USA) LLC are the top holders with 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% respectively.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: Despite a continued COVID-19 related restriction, the group’s mines in Peru and Mexico met production of objectives in the quarter. Also, the company reported strong financial performance in the quarter and reported the highest financial figures in the company’s history for sales, free cash flow from operations and adjusted EBITDA. Free cash from operations was a strong USD30 million, and the company’s EBITDA margin stood at a robust 51%. The group has USD 85 million in cash at the end of the quarter, and a comfortable liquidity position of USD 140 million, with a total net debt to EBITDA ratio of 0.7x.

Further, At Lindero, the company produced its first gold on October 20. They are pouring gold every week and made tier first sales in November 2020. Also, the company is immersed in the ramp-up activities, with the aim to stabilize production at visibility design parameters by year-end and into the first quarter.

Moreover, Silver production was above budget and the previous year by 7% and 10%, respectively. The increase was driven by improved grades at the company’s San Jose mine. Gold production was above their internal budgets and previous year by 17% and 12%, respectively. The increases were driven by a welcome contribution of approximately 1,400 ounces of gold from the Caylloma mine and higher grades at San Jose mine.

Further, silver could be the metal with the next big surprise on account of rapidly rising demand for silver in industrial applications, especially those driving the green transformation such as photovoltaic cells used in solar panel production. Consequently, silver prices are likely to remain elevated in the foreseeable future. Also, we expect the gold price to remain higher as global economic outlook remain uncertain. Elevated silver and gold price are likely to help the group in delivering robust performance in the coming quarters.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 9.45 on February 04, 2021.

Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at February 5, 2021 price as well.

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