Fortuna Silver Mines: A Large First Quarter From Seguela

It has been a tough stretch for the Gold Juniors Index (GDXJ), with the sector discovering itself down ~31% from its Might highs regardless of a comparatively delicate decline within the gold worth. This efficiency is much more irritating when trying on the 3-year return, with the GDXJ down almost 55% since Q3 2020 in a interval when the gold worth is comparatively flat, which has some buyers scratching their heads. Sadly, it isn’t this easy, and whereas the gold worth has held its floor above $1,800/ozoutside of transient excursions beneath this stage, margins have clobbered, affected by rising labor, gasoline, and consumables prices. The end result? A 35% plus decline in margins sector-wide from peak ranges in Q3 2020, and as much as 75% declines in margins for higher-cost producers.

On the time of the Fortuna Silver Mines Inc. (NYSE:FSM) acquisition of Roxgold in 2021, there was cause to be fairly optimistic concerning the firm’s future, on condition that it was including a sub $850/ozall-in sustaining price [AISC] mine that will assist its consolidated prices, pulling its company-wide AISC again beneath $1,150/oz. Nevertheless, two years of inflationary pressures have thrown a wrench in these plans, and Seguela is now trying like a $1,000/ozAISC mine, on condition that the 2021 AISC projections did not embrace company G&A and we have seen important inflation over the previous two years. And with Seguela being a ~$1,000/ozAISC mine and the remainder of its operations having prices above $1,500/ozon common on a gold-equivalent foundation, the outlook for margins is far weaker.

That stated, for issues that Fortuna can management, it is value commending the corporate for bringing this asset into manufacturing on schedule and price range, and the primary quarter out of Seguela was definitely spectacular, properly exceeding my expectations of 26,000 to 28,000 ounces. And whereas these grades had been properly above the common reserve grades over the mine life and will not final, it was good to see some optimistic grade reconciliation even when a comparatively small pattern of whole tonnes relative to the mine life, and with the higher than anticipated grades partially offset by fewer tonnes.

On this replace, we’ll take a look at the Q3 manufacturing outcomes and whether or not the inventory is lastly providing a margin of security after important outperformance previously few years.

All figures are in United States {Dollars} except in any other case famous.

Q3 Manufacturing & H2 Outlook

Fortuna Silver Mines (“Fortuna”) launched its Q3 outcomes this week, reporting quarterly manufacturing of ~94,800 ounces of gold and ~1.68 million ounces of silver, translating to a 43% and eight% decline from the year-ago interval. The sharp improve in gold manufacturing was helped by one other strong quarter out of Yaramoko, which benefited from above-average head grades within the interval, however the main contributor was Seguela, which got here out of the gate sturdy with ~31,500 ounces of gold produced in its first full quarter.

Sadly, the strong outcomes out of those two mines had been offset by one other gentle quarter at San Jose with lower than ~1.Four million ounces of gold produced, and an extra decline in manufacturing at its Lindero Mine in Argentina, with decrease grades leading to a 30% decline in manufacturing to only ~20,900 ounces. The end result was that regardless of the addition of a brand new mine, gold manufacturing was solely up 15% to ~116,000 gold-equivalent ounces from This autumn 2021, regardless of a ~60% improve within the share rely associated to the Roxgold acquisition.

Gold-equivalent ounce manufacturing comparisons use a relentless 80 to 1 gold/silver ratio.

Digging into the outcomes just a little nearer, we will see that Seguela moved as much as the #2 spot by way of quarterly output, simply behind Yaramoko, which had an abnormally sturdy quarter with its grades coming in ~15% above anticipated life-of-mine grades at 7.73 grams per tonne of gold. In the meantime, Lindero and San Jose have seen a continued decline in quarterly manufacturing, with Lindero’s manufacturing peaking in This autumn 2021 at ~36,000 ounces and set to settle at a decrease stage of ~25,000 ounces per quarter sooner or later. Lastly, Caylloma introduced up the yr with ~300,000 ounces of silver, however this can be a comparatively insignificant asset, particularly with decrease zinc costs than final yr weighing on prices due to decreased by-product credit.

So, what led to the spectacular efficiency at Seguela?

Whereas Seguela is definitely an outstanding asset with above-average open-pit grades, the Q3 efficiency was a lot better than I anticipated, with ~502,000 tonnes mined at 3.48 grams per tonne of gold at a low strip ratio of two.Three to 1.0. These higher than anticipated grades mixed with throughput charges above nameplate capability (plant throughput was 174 tonnes per hour in September, 13% above nameplate capability) helped the asset to ship properly above my estimates of 27,000 ounces of gold in Q3, and Fortuna famous that grades have reconciled properly since mining started, with the 6 p.c dip in anticipated tonnes greater than offset by a 29% improve in grades. As proven beneath, increased grades had been definitely to be anticipated from Antenna Stage 1, with an expectation of ~1.5 million tonnes at 3.Zero grams per tonne of gold from this primary section of the undertaking.

That stated, this can be a important outperformance. Whereas it is encouraging, I would not be banking on this stage of optimistic grade reconciliation sooner or later which bumped up the Q3 output.

That stated, buyers might be excited as a result of the plant is operating at properly above nameplate capability, suggesting this asset can run at nearer to 1.55 to 1.60 million tonnes every year, in step with ranges it anticipated to ramp as much as in 12 months Three in line with its preliminary mine plan. Assuming the asset can function at ~1.50 million tonnes subsequent yr with a mean grade of ~3.40 grams per tonne of gold for its first two years, the asset ought to produce upwards of 155,000 ounces every year, setting it as much as report new quarterly information nearer to 40,000 ounces over the subsequent a number of quarters. Therefore, there’s some upside to the manufacturing we simply witnessed at Seguela, and as famous in previous updates, there’s room to optimize this mine plan by pulling ahead high-grade ounces from Sunbird.

Though that is definitely thrilling, this is only one asset, and the fact is that whereas one of the best years are forward of Seguela, with a mean annual gold manufacturing profile of ~150,000 ounces from 2024 to 2027 at sub $1,050/ozAISC, one of the best years are behind the corporate at three of its different property, which embrace Lindero (previous its peak years of grade), Yaramoko (steadily declining throughput offsetting comparable grades), and San Jose, which continues to see declining grades and is struggling to switch its reserves.

So, whereas it is definitely optimistic to have this spectacular asset on-line and firing on all cylinders, Seguela is not any Fekola, which reworked B2Gold (BTG) in a single day right into a money move machine, so it is solely going to assist a lot from a money move standpoint when balancing this in opposition to declining manufacturing at its different property. And, as I’ve said beforehand, I’m not optimistic about reserve development at San Jose/Yaramoko, with sticky inflationary pressures probably contributing to rising cut-off grades and a better hurdle to including new reserves at these mines.

Lastly, it is value noting that whereas Seguela can have a powerful H2 with elevated grades and a full quarter of upper processing charges (~360,000 tonnes) in This autumn, the corporate is not getting any assist from the gold worth, and positively not from the silver worth. In reality, silver is again to plumbing its year-to-date lows and its margins had been already razor-thin at its silver property in Q2 regardless of a better silver worth. So, whereas there is no query that Fortuna’s gold enterprise can have a greater H2 with the advantage of a 3rd mine in Seguela, the silver phase can have one other tough half yr, particularly if silver cannot discover its footing quickly on condition that the corporate is up in opposition to comparable silver costs, increased consumables inflation, and a stronger Mexican Peso (regardless of the latest rebound) on a year-over-year foundation at its flagship silver mine, San Jose.

Valuation

Based mostly on ~310 million shares and a share worth of $2.84, Fortuna trades at a market cap of ~$880 million and an enterprise worth of ~$1.07 billion. This can be a very affordable valuation for a multi-mine producer that’s diversified throughout the Americas and in West Africa.

Nevertheless, it is essential to notice that two of the corporate’s mines have sub 4-year mine lives and a poor monitor file of reserve alternative, and one of many firm’s mines is comparatively insignificant (Caylloma). Therefore, though the corporate is a five-mine producer, its future appears to be like to be that of a three-mine producer, as San Jose and Yaramoko are prone to head offline by 2027. Which means whereas the corporate will see a big improve in income and money move in 2024 and 2025, these numbers should not run charges that may be relied upon post-2025 when Seguela sees a slight dip in manufacturing, San Jose probably heads offline, and Yaramoko additionally has a a lot much less important manufacturing profile, even when it may add some reserves at 55 Zone extensions.

Given this setup, I do not suppose it is honest to worth the inventory on a worth to money move foundation, and I feel a big weighting ought to be positioned on P/NAV vs. P/CF on condition that the ahead 10-year run charge will look a lot totally different from the elevated years of 2024/2025. Plus, whereas Fortuna is fast to level out that it stays discounted relative to friends on a P/CF and EV/EBITDA foundation in its most up-to-date presentation, these charts can deceive if one would not learn the nice print. And whereas the corporate does commerce at a reduction to its peer group, I might argue that it has conveniently chosen its peer group to incorporate three teams that profit from increased multiples on steadiness, together with:

1. Among the lowest-cost producers sector-wide like Lundin Gold (OTCQX:LUGDF), Alamos Gold (AGI), Dundee PM (OTCPK:DPMLF), and Centerra Gold (CGAU).

2. A number of Tier-1 jurisdiction producers like SSR Mining (SSRM), Wesdome Gold (OTCQX:WDOFF) and OceanaGold (OTCPK:OCANF).

3. The best-margin and solely giant Tier-1 jurisdiction silver producer: Hecla Mining (HL).

And with solely one West African producer within the peer group and Fortuna hardly being a silver producer – with the majority of its income from gold (and fewer silver income than its silver producer friends on steadiness) – it is no shock that this low cost is in place, because the peer group will not be lifelike in comparison with Fortuna’s portfolio.

The second level value making is that whereas there might need been an argument for utilizing a 5% low cost charge for Fortuna beforehand to calculate its web asset worth, it is onerous to justify utilizing this identical low cost charge at present when charges are a lot increased and over 50% of its web asset worth is tied to a Tier-Three ranked jurisdiction: West Africa. And even when we use a 5% low cost charge for its non-West African property and a 7% low cost charge for Seguela, Yaramoko and Diamba Sud, Fortuna’s estimated NPV is available in at ~$1.55 billion, with an estimated web asset worth of ~$1.11 billion after subtracting out estimated company G&A and web debt. If we divide this determine by 310 million totally diluted shares, Fortuna’s honest worth is available in at US$3.60, translating to a 26% upside from present ranges.

To be honest, I feel we should always assign some weighting to P/CF, and use what I consider to be extra conservative multiples of 5.5x ahead money move and 1.0x P/NAV and a 65/35% weighting (P/NAV vs. P/CF), I see a good worth for Fortuna of US$4.05. Nevertheless, I’m on the lookout for a minimal 40% low cost to honest worth to justify proudly owning small-cap producers based mostly primarily in Tier-2/Tier-Three ranked jurisdictions (Mexico, West Africa, Argentina, Peru). And after making use of this low cost, the best purchase zone for the inventory is available in at US$2.43 or decrease, barely decrease than my earlier low-risk purchase zone of US$2.60 which the inventory has rallied 7% from just lately. So, whereas FSM has undoubtedly develop into extra moderately valued, I proceed to see extra engaging bets elsewhere within the sector, and one might argue {that a} 7% low cost charge nonetheless is not low cost sufficient for West African gold mines within the present charge surroundings.

Abstract

Fortuna Silver Mines Inc. had a good manufacturing quarter, and the inventory continues to commerce at a really affordable valuation, particularly if it had been a diversified silver producer within the Americas. Nevertheless, with its silver publicity being a melting ice dice and its gold publicity predominantly coming from a jurisdiction the place low single-digit money move multiples should not uncommon, it is onerous to argue for any excessive undervaluation relative to its extra related friends like Perseus Mining (OTCPK:PMNXF) and Endeavour Mining (OTCQX:EDVMF).

In reality, Fortuna arguably appears to be like costly comparatively, buying and selling at ~3.2x ahead EV/EBITDA vs. Perseus at ~2.5x and Endeavour at ~3.6x regardless of these being bigger and higher-margin producers. That stated, if Fortuna Silver Mines Inc. shares had been to say no beneath US$2.44, it might drop right into a low-risk purchase zone. So, if I had been trying so as to add lengthy publicity and was snug proudly owning what’s develop into primarily a small-cap West African gold producer, FSM appears to be like like a sexy reward/danger wager beneath US$2.44.