Sierra Metals (TSX: SMT, NYSE: SMTS) released Q4 results and an update to its Bolivar mine reserves and resources. While the stock has been hit particularly hard by the recent market meltdown, the company is still relatively well-positioned.
Bottom Line
Financial results were largely in line with our expectations, with revenues of $64.6 million and EPS of $0.03 per share. Compared to analyst estimates, the results fell modestly short of the $69.7 million in revenue and $0.035 EPS that were projected.
However, more important is the company’s comments regarding the economic and operational impacts of COVID-19 as it pertains to its 2020 guidance and distribution announcements.
As of March 16th, the company suspended operations at its Yauricocha mine in Peru in accordance with the Peruvian government’s mandate for all non-essential businesses to shut down. Currently, the mine is scheduled to recommence operations on April 12th.
While this is certainly a challenge, last year Sierra lots 24 days of operation at Yauricocha due to an illegal strike and was still able to meet 2019 production guidance due to its operational flexibility.
As of March 30th, the Mexican government declared a state of emergency and on April 1st, they announced all essential businesses, including mining, were to be shut down. While the mines had been operating normally to date, management has now shut down the mines. Shareholders will be updated as information becomes available.
As it relates to production guidance, although originally maintaining guidance based on operational flexibility at Yauricocha and business as normal in Mexico, the company has since suspended guidance. They stated they will provide a more comprehensive update, including financials with updated metals pricing, with the release of Q1 2020 results.
Maintaining production guidance is clearly a positive sign for Sierra Metals, however, with copper prices taking a substantial hit, we believe it’s unlikely 2020 financial guidance will hold.
Further, the company has postponed the return of capital to shareholders until more clarity on the operational and economic outlook becomes available.
With $43 million of cash on the balance sheet, Sierra is well-positioned to weather the negative effects of COVID-19. This decision to postpone the distribution is the prudent option and will provide Sierra with greater financial flexibility.
From a development perspective, the company has announced it will reassess capital projects as appropriate to maintain its healthy financial position. It is also unclear how the COVID-19 mitigation measures will effect permitting timelines.
Until governments start reducing mitigation measures like business and travel restrictions, significant market uncertainty will remain and volatility will be high.
In the meantime, investors should look for companies with a healthy balance sheet that can weather a prolonged storm and who’s business fundamentals remain largely unchanged.
We believe Sierra Metals is one of these companies, and a comparison with peers supports this finding.
Peer Comparables
While Sierra Metals is a polymetallic miner with significant revenue contributions from silver (2nd) and zinc (3rd), it generates over 40% of its revenue from copper. As such, we have selected a basket of mid-tier copper miners for reference.
Looking at recent price performance (since COVID-19 impacts), it’s clear all copper miners have been hit hard due to the drop in copper price from the projected drop in demand.
However, Sierra Metals has suffered the most. While revenue contributions from silver (>20%), should support the stock to a greater extent, it appears the weakening zinc environment are creating a further drag on the stock. Overall, however, we believe the market has oversold Sierra compared to peers.
Normalized 3-Month Share Price
Source: YCharts.com.Looking at margins, Sierra Metals has been outperforming peers, indicating their operations are better positioned to handle reduced metal pricing.
Further, we previously noted that Sierra has made significant investments to improve profitability over the past year. These are expected to be realized largely in 2020, leaving the company with greater flexibility to handle price pressures in key metals.
TTM EBITDA Margins
On a valuation basis, all copper miners saw a significant drop in their EV/EBITDA ratio entering 2020, however, Sierra remained the cheapest among peers. While the ratio for all miners will almost certainly decline due to COVID-19 effects, Sierra is still cheap compared to peers even before considering silver contributions.
Forward EV to EBITDA
Finally, given the current economic uncertainty, we looked at cash balance for the group. While most are well-positioned, Sierra again sits with one of the strongest balance sheets.
Cash and Equivalents (CAD)
Operational Review
In an earlier note, we reviewed Sierra’s Q4 production results, highlighting that the company’s operations have reached a relative steady-state after multiple quarters of investment and production expansion. The financial results support this.
Quarter over quarter revenues remained flat while cost of production increased slightly. This lead to gross margins decreasing 4% from 28.4% to 27.3%.
On a full-year basis, revenues dropped 1% to $229 million despite a significant increase in consolidated production at all three mines. This is due to lower realized metals pricing in 2019 compared to 2018.
Quarter over quarter, adjusted EBITDA increased 2% to $2.2 million despite higher operating expenses and lower margins. On the full year, Sierra generated EBITDA of $63.5 million compared to $89.8 million in 2018 due to lower metals prices and increased operating costs associated with the mine expansions.
Net cash flows from operations and investing for the period were $4.2 million compared to $1.9 million last quarter and negative $2.4 million a year ago. Cash balance increased to $43 million compared to $40.4 million in Q3 based on the positive free cash flow from operations.
Bolivar Reserve and Resource Update
In December of 2019 Sierra Metals released reserve and resource updates for Bolivar and Yauricocha. Today, they provided additional details for the Bolivar mine:
- Reserve tonnage for Bolivar decreased by 5% since 2017, including 2 full years of depletion.
- Total indicated resources increased 68% since the December 2019 update, including a 37% increase in contained metals (copper equivalent).
- Total inferred resources increased 29% since the December 2019 update, including a 7% increase in contained metals (copper equivalent).
The net results indicate they are effectively replacing what they mine.
The main explanation behind the changes can be summarized by:
- The inclusion of lower-grade mineralization in the report (reducing cut-off grades)
- Incorporating new mineralization zones
- Updates associated with new drilling and a refined model
- Commodity pricing changes
- Depletion since the completed report
Post updated on April 1st at 5 pm to include an update regarding the shut-downs of Sierra Metals Bolivar and Cusi mines in Mexico.
Sierra Metals is a market awareness client of Capital 10X.
