Sierra Metals (TSX: SMT NYSE: SMTS) announced Q2 2022 earnings; operational restrictions led to delays at Bolivar and a revision in full year guidance. Capital 10X examines the fundamental underlying value of the company.

The Fundamental Value Case for Sierra Metals

Mining will always be the glue that allows society to survive and thrive, but at the end of the day drilling for gold, silver, copper, iron ore and other important materials is not done for charity. Investors who fund the machines, the drilling and the digging expect profits. For good companies with good assets like Sierra Metals, the highs always come. But there have been periods like today, where the lows seem to last longer than they should.

Unfortunately for Sierra Metals, mother nature and remnants of COVID reared their heads once again – to push out what had planned to be a strong recovery by one more quarter.

However disappointing Q2 results may appear, stock investing is a game of expectations not results. Though lower than expected production and the suspension of the dividend are both tough pills to swallow for investors, the future looks especially bright given the severely beaten down value of this company.

The old investment adage, “price is what you pay, value is what you get” has never been more true than when you look at Sierra Metals.

Though the company is dealing with rising costs as COVID continues to snarl supply chains and was hit with flooding in the Bolivar mine this quarter, both issues are fading away as the year progresses. Given that Sierra trades for only 3x this year’s EBITDA and 2x next years (a 67% discount to small/mid copper miners), very little has to go right from here to see upside in the stock.

More importantly, potential buyout catalysts are starting to surface in the copper sector. BHPs recent $5.8B bid for Oz Minerals at a 50% premium, shows that the big players understand the huge amounts of copper that will be needed to supply the world’s move to renewable energy.

Given that Sierra trades at a significant 90% discount to a net asset value of $4.43/share (as per the company’s 2020 PEA), it is ripe for a buyout by a larger producer hungry for cheap copper. Even if we haircut the net asset value due to mining costs that are up 40% so far this year, the company is still worth over $2.00/share, making it one of the most discounted small cap miners.

There is a reason well known investors like Leon Cooperman of Omega family office are circling the company, he owns 6% of the company currently (Source: Bloomberg). They know that a company with high quality assets can’t trade at a discount this big for long.

Recent investors to the story likely missed the fact that the company was entertaining offers for assets within the company back in early 2021, when the stock was 6x higher.

With the operational bar set low after a difficult six months and copper merger activity heating up, we think focusing on difficult results in the past clouds the the clear value opportunity within the stock.

Q2 Results Review

Reviewing Q2 results, average realized metals prices were mixed – copper was down 2%, silver was down 15% and zinc was higher by 34%. Production, EBITDA and cost guidance were revised this quarter, due to lower-than-expected performance at the Bolivar and Cusi mines. This was offset by higher throughput and grades at Sierra’s flagship mine Yauricocha.

For Q2, 48% of the company’s production was copper, 20% zinc and 20% silver. 17.8 million pounds of copper equivalent pounds produced resulting in revenue of $49.9 million and EBITDA of $1.4 million.

Yauricocha

• At the Yauricocha mine the company processed 317K tonnes – inline with Q1, resulting in 12.1 million pounds of copper equivalent produced.
• The company is expecting higher production for the year, raising guidance to 49-53 million copper equivalent pounds. The focus will be on meeting max permitted throughput of 3,600 tonnes per day.

Bolivar

• At the Bolivar mine the company processed 256K tonnes, an increase of 37% vs Q1 – resulting in 4.2 million pounds of copper equivalent produced.
• Operating constraints at the mine led to revised 2022 production guidance of 14-16 million copper equivalent pounds. Management is focused on the continued turnaround and increasing throughput at Bolivar north-west and El Gallo Inferior.

Cusi

• At the Cusi mine the company processed 67K tonnes, 24% lower vs q1 due to unexpected flooding. The mine produced 283K silver equivalent ounces.
• The flooding issues have been now resolved and the the company is proceeding with plan. The focus will be on meeting current throughput of 1,100 tonnes per day.

Revised Guidance

The turnaround in Bolivar is making progress but is taking longer than expected, due to operating restrictions and limited ventilation related to delays on a new raise bore in Bolivar NorthWest. Unexpected underground flooding at Cusi also impacted production results for the first half of 2022.

While these are considered temporary setbacks, management believes that they warrant downward revisions for the production sites for H2 to be conservative.

Copper equivalent production is now expected to fall between 70.0 to 78.0 million pounds (13% lower than previous guidance). Production guidance for silver, lead, zinc and gold have also been revised to factor in the quarter’s impactful events as per the table below.

On a brighter note – Yauricocha’s tonnages and grades are expected to improve (due to mining in Fortuna), resulting in positive adjustments to production for the next half of the year.

Copper guidance for the year at Yauricocha has risen to 49 – 53 million tonnes, from 45 – 49 million tonnes.

Although the company is facing a challenging year, with lagging production there are no uncertainties with expected production and cash generation over the next 12 to 15 months. Sierra Metals is laser-focused on their turnaround plan at Bolivar.

A Note on the Dividend

Sierra Metals decided to suspend the dividend for 2022 to both make sure adequate cash was available for the turnaround program at Bolivar, and so they are well positioned to manage through any further weakness in commodity prices over the next 12 months. Any dividend cut hurts investors, but we would rather see a management team realistic about capital needs during a commodity price selloff, than one pretending everything is great right up until capital is permanently impairing for stockholders.

By suspending the dividend payout, Sierra is saving close to $5 million a year which will pay for 14% of remaining CAPEX needs this year. With remaining CAPEX of $37 million and cashflow generation of at least $20 million for the remainder of the year as production improves, the company should have adequate cash to fund operations.

Q2 Exploration Update

Yauricocha

• 6,258 meters of drilling was completed in Aoeba, Adrico South, Fortuna and Fortuna North zones.

Bolivar

• 17,227 meters were drilled in Bolivar West, Bolivar North-West, La Montura and El Gallo Superior.
• Additional infill drilling of 6,975 meters was completed in Bolivar West, El Gallo Inferior and Bolivar North-West.

Cusi

• 4,111 meters of infill drilling was completed to support the development of the Santa Rosa de Lima vein and NE Trend.

Sierra Metals is a market awareness client of Capital 10X.