Update: Fortuna Silver Will Increase Its Throughput By 50%

| About: Fortuna Silver (FSM)
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Fortuna Silver effectively decides to approve the San Jose mill expansion to support a production rate of in excess of 10M silver-equivalent ounces.

This isn’t a surprise as I was already anticipating this move because it makes a lot of sense.

The investment thesis will be positively impacted by this expansion as the amount of free cash flow will definitely increase.

Fortuna Silver (NYSE:FSM) has announced it is effectively going ahead with its expansion plans to increase the throughput of the San Jose processing facility in Mexico from 2,000 to 3,000 tonnes per day. This is a major decision which will result in the San Jose mine producing 9.8-11.7M silver-equivalent ounces (of which 6.7-8.3M ounces will be pure silver with 52-57,000 ounces of gold). The price tag for this expansion is relatively modest at $30M.

The after-tax IRR is 36% with a payback period of approximately 2 years so the investment definitely meets my minimum criteria. More importantly, this expansion will unlock additional benefits from economies of scale and the expected all-in sustaining cost per ounce of silver will be $8-9. So even at a silver price of $15/oz, the San Jose project will very likely generate $40-50M in cash flow. As Fortuna had $80M in working capital as of the end of September, Fortuna can most definitely afford this expansion. I had expected this expansion and this doesn't really come as a big surprise. The company will have to spend $12.6M in 2015 and $17.5M in 2016, so the costs are nicely spread out over two years and this shouldn't have a severe impact on the company's free cash flow profile.

With this decision, Fortuna is one of the very few silver mining companies which actually dares to expand during these difficult times. This also means the company will be in the pole position when the silver market picks up again as it will have a double-digit silver-equivalent production at a single digit cost basis. Fortuna will also change its 'game' plan from slurry tailings to dry stacking tailings which will cost approximately $32M of which the majority will have to be spent in 2014. This will put some pressure on the cash flow numbers but should be seen as a one-time expense.

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