C. Financials and Discussion: In general, I am very impressed with Endeavour Silver, their management, their reserves and properties, their business model, their potential, and their future. All top management are long-term veteran miners, have spent their whole career in the mining industry, and they all love this business. Their head of Mexico's operations is a Mexican who is has life-long experience in mining and knows all the ins and outs of mining in central Mexico. He was instrumental in introducing Endeavour to the Guanacevi project, in helping them to acquire the properties, and later on, in starting production only half a year after the purchase.
In addition to the Guanajuato and Guanacevi projects, Endeavour is also exploring at the Parral area in Chihuahua, currently under feasibility evaluation, and at the Arroyo Seco property located in south-eastern Michoacan, still in the discovery phase. To be conservative, the following analysis does not take into account those two projects which we didn't visit this time.
As I consider all the nice, silver-rich properties they have at their current operating mines and in the nearby high potential exploratory areas in Guanajuato and Guanacevi alone, It won't surprise me if Endeavour reserves increase substantially in the near future, and will add more value and make Endeavour more attractive. I did some number crunching and analysis after coming back from my trip, and the more I do, the better I feel about this Company.
First, let us look at the cash flow this year. Endeavour will spend about $13M on capital expenditure this year, mainly on both the Guanacevi and Guanajuato plants (around $7M to improve the Guanacevi process plant, $3M on underground mining development at Guanacevi, and $3M on the Guanajuato plant and its mining operations). From their 1st quarter report, cash cost is $10 per ounce (with Guanajuato higher, but Guanacevi lower), or $5M cash outflow per quarter, likely going higher at the 4th quarter due to the tripling of production at Guanajuato, but with lower unit cost. Let us say $25M ($5M for Q1 & Q2 each, $7M for Q3 and $8M for Q4) cash cost in 2008, with total operating cash outflow at $38M ($13M capital plus $25M mining operations), excluding exploration and general & administrative.
The expected production for 2008 is about 2.5 million ounces of silver (0.5 million ounces already achieved in the 1st quarter). Endeavour realized $18 per ounce for silver in sales, resulting in $10.7 million revenue in Q1. Using only the average $16 silver for the whole year, 2.5 million ounces means $40M cash inflow, higher than $38M cash outflow. In other words, Endeavour should achieve positive operating cash flow this year by about $2M.
For the cashflow of the whole company, we need to add exploration and general & administrative (both are cash items), which I estimate at $8M for exploration and $5M for general & administrative in 2008, or another $13M. This will put Endeavour at about $11M in the negative cashflow territory. However, if they can realize the same price as Q1 at over $18 in the 2nd half, they should get over $45M revenue in 2008, only $6M from breakeven in total cashflow. This means Endeavor will not need to dip very deeply into their $21M cash reserves, or refinancing by issuing more dilutive shares, except in the case of any major purchase and acquisition.
Secondly, let us look at the earnings this year. Again, the 1st quarter revenue is at $10.7 million, but let us use the same $40M revenue for the whole year with average $16 silver price as discussed above. Cash cost is assumed to be around $10 per ounce (4th quarter should be lower with higher production), 2.5 million ounces will cost $25M, consistent with my cashflow assumption above. We then need to add back depreciation, which I estimate to be around $7M, with total operating cost at $25M + $7M = $32M, less than $40M revenue.
Again, Endeavour should achieve positive operating earnings this year by about $8M. This figure is higher than net operating cashflow due to higher capital expenditure in 2008. For the 2008 earnings, we need to add exploration, general & administrative and stock-based compensation incentives (stock option value based on Black-Scholes model). I estimate them roughly as follows: $8M for exploration, $5M for general & administrative, and $5M for stock- based compensation (non-cash item), totaled to be another $18M.
By adding $18M on top of the $32M operating cost discussed earlier, we have $50M at the total expense line. This will put Endeavour at a loss of about $10M, not far from the $11M net negative cashflow discussed earlier. Again, if they can realize over $18 per oz as they did at Q1, resulting in over $45M revenue, they are only $5M from breakeven this year.
More importantly, let us look forward for the next two years. Endeavour's target is to produce 5 million oz of silver annually, doubling from 2008, by running at full capacity at both plants with improved recovery rate, efficiency and output. I estimate the time frame that they should achieve this goal on an annual basis is from mid-2009 to mid-2010. Again, let us look at cashflow first. Conservatively, I use only $16 per ounce with 5 million ounce production, or $80M on the revenue side.
With production doubled, the target for cash cost by management is around $6-7 per ounce. Let us use $7, or $35M cash cost annually. In next two years, Endeavour will reduce its capital expenditure to around $5M per year, no need to maintain it at this year's $13M level anymore. Thus the total operating cash outflow will be around $40M ($80M - $35M - $5M). This represents a net $40M positive operating cashflow annually and 50% of revenue. For the forward looking cashflow of the whole Company, we need to add exploration (around $6M for 2009, $2M lower than 2008), general & administrative (say $6M for 2009, $1M higher than 2008), resulting net positive total cashflow at $28M ($40M - $12M). This is more than their cash reserves of $21M at the moment.
Now let us see what the forward earning power will be once Endeavour reaches its annual production target of 5 million ounces. We need to include depreciation (estimated around $8M for 2009), but remove capital expenditure to get operating earnings, resulting $37M ($80M - $35M - $8M), not far from the net operating cashflow figure of $40M. Again, it shows great operating earnings power and high gross profit margin of 46%.
For the forward-looking earnings of the whole company, we need to include exploration ($6M), general & administrative ($6M) and stock based incentives (say $6M, $1M higher than 2008, a non-cash item). That is another $18M expenses, plus $43M from above ($35M cash cost and $8M depreciation), which equals $61M at the total expense line. In other words, Endeavour should achieve $80M - $61M = $19M profit with 53 million fully diluted shares, or 36 cents of earning per share, and 52 cents of net cashflow per share ($28M / 53M shares).
The forward-implied P/E ratio is only 9 at current $3.2 price ($3.2 / $0.36). With a company showing the ability to grow its reserves at about 50% per year for last several years and potentially for future years, a P/E ratio twice of 9 at 18 even seems very low once the market realizes its future earning power. At a P/E of 18 with $0.36 earning per share, Endeavour should be at $6 per share, which is my target for the next 12 months, doubling from the current level.
In the above calculations, I ignore other miscellaneous items such as loyalties, foreign exchange impact, investment income, etc., which I feel are not material, sometimes offset each other when combined, and most likely won't change the whole picture that much. I also tried to be conservative in my calculations. In the near future, I see earnings will be lower than cashflow due to: 1) depreciation which will increase due to large capital expenditure the last 2 years but will decreasing next year; 2)stock-based incentives (options) which will increase. Both are non-cash items, especially stock options expenses, which were not even included in and part of anyone's financial statement until a couple of years ago.
During the entire trip, Endeavour Silver was very open and transparent about their financials, and it is a company which is easy to understand and evaluate. It is simple, blue-collar and straight forward. It has tangible assets you can actually see and touch, unlike some hi-tech companies with products that either go up to the sky or fall to Hell, or some non-tangible banking "assets" which become huge liabilities overnight.
Gold and silver correlate closely with each other. I fully expect both gold and silver to do well in the next two years, with silver probably outperforming gold and junior miners entering an explosive phase. If it happens as predicted, with its operating leverage, all estimates here on Endeavour's cashflow and profit could turn out to be quite at the low end. Currently Endeavour receives very little institutional coverage, even at market cap of about $160M.
Once its story of high potential, high growth and high profit becomes broadly publicized, it is expected to draw more institutional interest, coverage and ownership, which will help its stock price. The timing at the moment seems right too, since Endeavour is at the turning point of becoming profitable. Silver production is often a by-product of other minerals, and there are very few stand-alone silver companies around. Once the precious metals and junior miner sector come back to life after the current correction phase, we should see a nice run-up of many juniors including Endeavour, which is on its way to becoming a mid-tier silver exploration and production company.