Sierra Metals Inc (TSX: SMT) is a precious and base metals producer in Peru and Mexico. The company acquires, explores, extracts, and produces mineral concentrates consisting of silver, copper, lead, zinc and gold. Sierra has interests in the Yauricocha Mine in Peru, and the Bolivar and Cusi Mines, Mexico.

Investment highlights

• Staging production Increase: The Company is aggressively drilling to increase and replace resources. It is also ramping up the exploration and infrastructure projects, which were on hold due to COVID-19. From FY2021 – FY2023, the Company expects to achieve a Tonnages Per Day capacity of 9,800 TPD, on the back of healthy performance from all three mines. Recently, it announced regarding receipt of permit allowing for a 20% increase of throughput to 3,600 Tonnes Per Day at its Yauricocha mine in Peru, is a key positive.

Source: Company Presentation

• Robust Cash Flow Generation: The company recorded robust cash flow from operations at USD 62.2 million in 9MFY21, up from USD 47.1 million in the previous corresponding period. An improvement was mainly due to higher revenues clocked by the company. We believe an increase in cash from operations would further improv the working capital.

• Higher institutional ownership: Institutional investors own a large portion of the company's stock, accounting for 44.85% of the total outstanding shares. We believe that when institutional shareholding reaches a larger level, retail investors perceive this as a positive aspect because it increases their trust in the stock.

• Minimizing debt: The company reported a decrease in total borrowings at the end of 9MFY21, which is a significant positive and signals greater financial flexibility. Notably, the company's debts are decreasing on a sequential basis, with a total debt of USD 86.9 million reported.

Source: Company Presentation

• Expected Recovery in Precious Metal Prices: We have seen increased investor interest in defensive asset classes because of the prolonged volatility in the global financial market caused by the reappearance of the COVID-19 virus. Since 2019, precious metals, particularly gold and silver, have seen a massive surge. Rising energy prices put upward pressure on metal prices in the third quarter of 2021. If the aforesaid trend continues, higher metal prices would help the company's top line due to higher realization prices.

• Strong Balance Sheet: The Company continues to have a strong balance sheet, working capital and cash position to support its capital expenditures and growth initiatives. Metals prices have strengthened in 2020, especially for copper and precious metals and are expected to remain strong through 2021. The group reported cash and cash equivalents of USD 58.3 million as on September 30, 2021.

• Trading at discounted valuations: The company’s shares are available at an NTM EV/Sales multiple of 0.4x compared to the industry (Metal & Mining) median of 1.9x. while on NTM EV/EBITDA multiple the stock is trading at 0.8x compared to 2.7x. This implies that the shares are trading at deep discount against an industry. The stock is undervalued on multiple valuation parameters. The table below reflects the picture.

Source: REFINITIV, Analysis by Kalkine Group 

Risks associated with investment: The group’s revenue is directly correlated with the prices of commodities in international market. Any volatility in commodity (Copper, Gold, Zinc, etc) prices could affect the group’s financial performance. 

Financial overview of Q3 2021 (In 000 of USD)

Source: Company Filing

• In the reported period the company’s revenue decreased by 17% to USD 60.7 million, compared to USD 73.2 million in pcp. The decline was primarily due to the lower grades at the Yauricocha and Bolivar mines and operational challenges at the Cusi Mine. Additionally, the realization price of gold and silver declined by 7% and 3% respectively, partially offset by higher average realization of copper, lead and zinc.
• On the back of lower sales, coupled with higher mining costs (USD 37.2 million v/s USD 29.2 million in pcp), the gross profit squeezed to USD 11.0 million, against USD 33.0 million in pcp.
• The period was marked by an increase in general and administrative expenses (USD 6.8 million v/s USD 4.5 million in pcp). In contrast, slightly lower selling expenses (USD 2.2 million v/s USD 2.6 million in Q3FY20) supported the operating profitability.
• The group reported a net loss of USD 3.7 million, compared to a net profit of USD 19.4 million in Q3FY20.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 68.48% of the total shareholding. Arias Resource Capital Management LP and BlackRock Investment Management (UK) Ltd. hold the company's maximum interests at 26.77% and 6.07%, respectively. The company's institutional ownership stood at 44.85%, and ownership of the strategic entities stood at 28.40%.

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

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock recommendation 

The Company had a particularly challenging third quarter due to sequencing challenges at its Mexican facilities. Over the previous year, the Bolivar Mine has faced challenges with mine development, infill drilling, and equipment availability, all of which have had a significant impact on throughput, head grades, and recoveries. For the quarter ended September 30, 2021, the firm reported revenue of USD 60.7 million and adjusted EBITDA of USD 17.4 million, based on throughput of 750,208 tonnes and metal output of 21.9 million copper equivalent pounds. Despite the challenges it has experienced this year, the Company has a strong balance sheet and is focused on improving operations. It is continuing to strive for production growth while optimizing operations at all three mines, with cost reductions a top emphasis.

Inflation has been high and is increasing, which might push gold demand and price considerably higher, which would be a significant plus for the company. On a sequential basis, the corporation is reducing its debt, which is a significant plus. Furthermore, on numerous parameters, the stock of SMT is selling at significantly discounted valuations. Institutional investors also possess a significant percentage of the company's stock, accounting for 44.85% of all outstanding shares. This, we believe, boosts retail investors' confidence. Therefore, based on the above rationale and valuation, we recommend a "Speculative Buy" rating on the stock at the current market price of CAD 1.44 at 9:55 am Toronto time on January 26, 2022. We have considered Largo Inc, Amerigo Resources Ltd and Trevali Mining Corp etc., as a peer group for comparison purpose.

One-Year Technical Price Chart (as on January 26, 2022). Source: REFINITIV, Analysis by Kalkine Group 

Technical Analysis Summary

Technical Indicators Defined: -

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest. 

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest. 

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices 

Note 1: The reference data in this report has been partly sourced from REFINITIV. 

Note 2: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

---

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.