Company Profile

Sierra Metals Inc (TSX: SMT) is a precious and base metals producer in Latin America. The company acquires, explores, extracts, and produces mineral concentrates consisting of silver, copper, lead, zinc and gold in Mexico and Peru. Its activity includes the operation of the Yauricocha Mine in Peru and the Bolivar and Cusi Mines in Mexico. Yauricocha is an underground polymetallic mine using the sublevel block caving and cut-and-fill mining methods. Bolivar is a copper-silver-zinc-gold underground mine using the room-and-pillar mining method. The majority of the revenue is earned by selling the mineral concentrates to its customers in Peru.

Investment Rationale

• Strong production profile to lead growth as operations begin to normalize: The group expects strong growth in the rest of 2020 as the COVID pandemic effects begin to ease and operations begin to normalize. At Bolivar, the company continue to ramp-up production to 5000 tonnes per day level, which is ~38% increase over 2019. Furthermore, the recent Bolivar Mineral Resource Update provided for a significant increase in mineral resources and has demonstrated that further expansion potential exists beyond 5000 tonnes per day level, which will be evaluated through an updated Preliminary Economic Assessment. Further, the company has large land packages with many high-value targets, exploration and development, which can provide lower-cost organic growth for many years ahead.
• Diversified Revenue Mix: Given the diversified revenue stream of the company, its revenue improved by 13% in the first quarter of FY20 despite challenging market conditions emerged because of CVOVID-19 pandemic. The company derives the majority of its revenue via Copper sales which contributed ~40% to the total revenue in 1QFY20. The other metals mix as a percentage of revenue stood as follow, zinc and silver each at 20%, followed by lead at 10%, and gold at 9%. Going forward, copper is likely to contribute to the majority of the revenue following the expansion at the Bolivar Mine. Further, higher gold prices are likely to have a positive impact on its gold revenue and consolidated revenue as well.
• Lower Cash conversion Cycle: The group's cash conversion cycle stood at 48 days, which is lower than the industry average cash cycle of 54 days. The shorter the cash conversion cycle is, the better it is. Lower cash conversion cycle means that the company's working capital is not tied up for long, and business has greater liquidity. Further, the company's current ratio stood at 2.15x, which is slightly lower than the industry average of 2.36, though it reflects that the company has enough liquidity and can easily pay off its current liabilities using its current assets.
• Bullish Price Trend: At the last traded price of CAD 2.15 (July 21, 2020, after the market close), its shares traded well above the crucial long-term and short-term support level of 200-day, 100-day, and 50-day daily moving averages, which reflects a bullish price trend in the stock. Price to 200-day DMA ratio stood at 1.32, which implies that the stock is trading approximately 32% above its 200-day DMA. The higher positive spread between price and 200-day DMA suggest a strong momentum. Also, the moving average convergence divergence (MACD) is rising, with the difference between 12-day and the 26-day exponential moving average is positive, which is another positive trend.
• Risk Associated to Investment: As the company deals in a pool of commodities, therefore, the company is also exposed to the volatility in the commodities prices. Also, gold prices have run a lot over the past six months in the wake of market anomalies hovering over the global financial markets, which has emerged due to the COVID-19 led pandemic. Any sharp correction in the gold prices would have a weigh on the group's performance as Copper and Lead already trading at a discounted price on a YoY basis.

2QFY20 Production update

Despite the impact of COVID-19 pandemic impact, the group reported a decent production number in 2QFY20. The group's gold production soared by 9% on a YoY basis to 2,762 ounces, while copper production stood at 9.7 million pounds, broadly in line with the Q2FY19. However, silver production decreased by 32% to 0.6 million ounces, lead production decreased by 21% to 6.4 million pounds, and zinc production declined 17% to 13.7 million pounds on a YoY basis. Consolidated silver production dropped since there was no production at Cusi during the quarter as the mine remained under care and maintenance, while gold production increased largely due to higher gold grades from the Bolivar Mine.

At Bolivar, higher grades and recoveries were partially offset by the 5% decrease in throughput, resulting in a 24% increase in copper equivalent pounds produced during Q2 2020 compared to Q2 2019. A mere 5% decrease in throughput, despite the COVID-19 related shutdown, resulted from the increased plant capacity attributable to the expansion completed at the end of 2019.

The company mentioned that quarterly throughput from the Yauricocha and Bolivar Mines was negatively impacted by the shutdowns announced by the Peruvian and the Mexican Governments to contain the advancement of the COVID-19 pandemic. Also, amid this challenging time, the company has renewed process at each mine site, targeting improving efficiencies and identifying optimized exploration sequencing to add to reserves and resources.

Financial Highlights: Q1FY20 (period ended on 31st March 2020)

During the period under consideration, the group's revenue increased by 13% to US$ 55.6 million, driven by higher mill throughput and grades at all sites as compared to the corresponding previous financial year. However, revenue was partially impacted by a lower realized base-metal prices. The group recorded a 92% increase in the treatment and refining charges along with higher sustaining capital cost during the quarter. Adjusted EBITDA increased by 34% to US$ 16.1 million, driven by higher revenue and lower operating costs per tonne at the Yauricocha and Bolivar mine. Adjusted net income attributable to shareholders stood at US$ 1.21 million as compared to US$ 0.886 million reported in the corresponding previous financial year; however, the Net loss attributable to the shareholders stood at US$ 1.86 million as compared to a loss of US$ 1.72 million reported in the previous corresponding financial period.

Further, cash flow from operating activities before changes in the working capital stood at US$ 15.7 million, surged by 33% on a YoY basis, driven by higher consolidated revenues generated and higher gross margins realized at Bolivar.

Operational Highlights

In the first quarter of the financial year 2020, the company's Consolidated mill throughput was 740,698 tonnes, increased 30% against the same quarter of the previous financial year. Further, the company has achieved a record quarterly throughput of approximately 4,315 tpd from its Bolivar Mine. At Yauricocha, despite the loss of 15 days production due to COVID pandemic, had 22% higher throughput thanks in part to running the mill at higher throughput levels.

Throughput surged by 43% at Bolivar with higher grades for all metals and higher recoveries, with the exception of gold recoveries, resulted in an 80% increase in copper equivalent pounds produced during the quarter under consideration. At Cusi, a 9% increase in throughput combined with higher grades and recoveries resulted in a 28% increase in silver equivalent ounces produced.

Consolidated copper production surged by 43% to 31.2 million pounds, as the company achieved higher production for all metals against the same period of the corresponding previous financial year, despite the impact of COVID-19 pandemic in the second half of March 2020.

Stock Performance

At the last traded price (July 21, 2020, after the market close), SMT shares traded approximately 16.85% higher at CAD 2.15. In a year-over period, its shares have tested a 52w high of CAD 3.67 on June 22, 2020, and a 52w low of CAD 0.89 on March 19, 2020. At the last traded price, its shares have traded approximately 141% above its 52w low price level and approximately 41% below its 52W high price level, which reflect that the stock has had strong run-up after March 19, 2020 bottom price level. 

1-Year Price Performance (as on July 21^st, 2020, after the market close). Source: Thomson Reuters.

On a YoY basis, its shares are featuring a decent price return of 26.47% amid heightened market anomalies. Further, in the last 3-Months, 1-Month and 5-day, its shares increased by 102.83%, 53.57% and 28.4%, respectively. However, on a YTD basis, the stock is featuring marginal negative price return of 1.38%.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, together hold around 64.57% stake in the company. Arias Resource Capital Management LP and BlackRock Investment Management (UK) Ltd. hold the maximum interests in the company at 52.85% and 7.83%, respectively. Further, three out of top-10 shareholders have increased their stake in the company since December 31, 2019, with ETF Managers Group, LLC  and Gonzales are among the top investors that have increased the stakes by 0.21 million and 0.19  million, respectively. The institutional ownership in the SMT stood at 64.15%, and ownership of the strategic entities stood at 1.33%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV/EBITDA Based Valuation Metrics

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

Stock Recommendation: All the mines have continued the productivity increases in the first quarter of 2020. In Mexico, ore processed at Bolivar and Cusi during the quarter was 8% and 27% higher than the last quarter of 2019. The Yauricocha mine in Peru processed at the rate of 3,260 tpd during the quarter, despite the impact of COVID-19 related state of emergency imposed by the government. Further, the company is implementing proactive and reactive mitigation measures to minimize any potential impacts of COVID-19 on its operations, supply chain, and finances.

Sierra remains confident on the longer-term outlook for its major commodities, however global economic uncertainty and COVID-19 have had a significant negative effect on the metal prices (Copper and Lead), which poses a challenge in the near term.

Going forward, the demand for copper is likely to increase as the governments across the geographies are easing the restrictions and allowing the industrial activities to resume. Further, China (one of the largest consumers of copper) has opened its economy, which would support the demand. A recovery in demand is likely to support copper prices. The group is likely to benefit from the elevated gold prices as it derives a certain portion of its revenue from gold sales.

Further, its shares are trading in a bullish cycle, as at the last traded price of CAD 2.15 (as on July 21, 2020, after the market close), its shares traded well above the crucial long-term and short-term support level of 200-day, 100-day, and 50-day daily moving averages.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Speculative Buy” recommendation at the closing price of CAD 2.15 (as on July 21, 2020, after the market close), with lower double-digit upside potential, based on the NTM Peer's Average EV/EBITDA multiple of 4.4x on the FY20E EBITDA. We have considered Major Drilling Group International Inc (TSX: MDI), Forage Orbit Garant Inc (TSX: OGD) and Largo Resources Ltd (TSX: LGO) etc., as a peer group for the comparison purpose.

*Recommendation is valid at July 22, 2020 price as well.

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.