Endeavour Silver: We've Revised Our Production Estimates Higher

Summary

• We published an article on 2/28/18 naming EXK a top pick for 2018.
• Shares are in rally mode thanks to geopolitical tensions stemming from a possible trade war as well as what we believe was the Street's recognition of value in EXK stock.
• Production numbers showed nearly across the board improvement from a year ago.
• Based on the results we have revised our expectations for 2018 production.
• We are awaiting financial results to assess costs but have reiterated our expectations for declining production costs.

We recently named Endeavour Silver (NYSE:EXK) as one of our top picks for 2018. It is interesting because this was long a name we had recommended avoiding given the market headwinds in the precious metals and mining sector, as well as the company specific woes that were being experienced. We were sour on the name for much of 2017. That said, today we want to check back in on our pick just over a month later to see how the name is performing. In this column, we will specifically hone in on the most recent production numbers and discuss these results in light of our call, especially considering that the stock has appreciated 16% since our call.

Recent price action

Shares have appreciated nicely since we highlighted the stock:

Source: Yahoo Finance, graphics overlaid by Quad 7 Capital and BAD BEAT Investing

We believe this action was driven in part by the realization that shares had fallen a bit too much, attracting value buyers, coupled with positive price action in precious metals stemming from immense volatility in equity markets that was driven by the potential trade war between China and the U.S.

Given the fear that was brewing, metals gained and volatility spiked. The miners of precious metals saw benefits in their share prices as the Street bid up equities in the sector. Still, we cannot solely rely on metal prices, despite the strong correlation between moves in the precious metal commodities and the mining stocks. As such, we need to focus on the fundamentals. With that, we are turning to the production numbers as supportive evidence for our long thesis on the stock.

Production ramped up once again

We believe the just announced production numbers support our bullish stance on the company. Production in Q1 2018 showed nice gains relative to Q1 2017:

Source: Q1 production results, chart made by author in Excel

The year-over-year numbers are impressive. In Q1 2018, silver production was 1,350,840 ounces, rising 25% year-over-year. This result compares with silver production of 1,076,974 ounces in Q1 2017. Gold production came in 13% higher than a year ago at 13,208 ounces, rising from 11,724 ounces in 2017. Using a 75:1 silver-to-gold ratio, silver equivalent production was 2.3 million ounces.

Why production was higher

We have to ask ourselves why production was higher. It is key to remember that back in early 2017 the company was struggling with some lower grades at Bolanitos and El Cubo. However, Guancevi is still reeling from operational issues that developed in mid-2017, resulting in slightly lower production this year.

The issues at Guancevi should be resolved in Q2, according to management’s commentary in the production release. We want to address however that mine output was lower here as the company implemented a productivity optimization program. So, the decline was temporary and for good reason. Despite output being a touch lower, silver and gold grades were both higher due to better dilution control. This led to silver equivalent production in Q1 2018 dipping only slightly lower than Q1 2017. This was good news.

Both Bolanitos and El Cubo saw sharp production increases. At Bolanitos, output was much higher, along with better silver grades. However, gold grades were lower. The lower gold grades stemmed from normal ore variations within one of the mine’s main veins.

Management stated in the release that “grades are expected to return to plan during the year,” most likely when the mine has made it through this variation in the vein. Still, with the output being higher and silver grades being stronger, silver equivalent production rose nicely.

As for El Cubo, we saw across the board improvement on all production metrics, leading to significantly improved production. Below are the production tables for Q1 2017 and Q1 2018.

Source: Q1 2017 production release

Source: Q1 2018 production release

As you can see, production numbers were up across the board, with the exception of Guancevi silver production. We are encouraged by management’s assurance that grades will return to historical norms this year. We also want to point out that the magnitude of the production increases is stark, and is in large part due to the sacrifices made by the company in 2016 and 2017. As such, we believe the production numbers will continue to benefit.

Looking ahead on production

When we last covered the name, we told you that we anticipated that 2018 would be a strong year, even as 2017 saw production rev up every quarter. Based on these results and management’s commentary, we continue to expect an even stronger year in 2018 for production than we saw in 2017. We believe we will see a positive trajectory for the company through 2018.

Based on the present discussion, we are slightly updating our expectations for production on the year. As a whole, we were anticipating a strong 15%-25% increase in silver equivalent production for the year. Considering a 23% increase in production from Q1 2017, as well as improved grading in Guancevi as the year develops, we are now looking for an 18% to 25% increase, up from our initial projections of a 15-25% increase. As such we now are looking for 5.78 to 6.2 million ounces of silver to be produced in 2018. We are also looking for 58,500 ounces to 63,000 ounces of gold production on the year.

We will have to await the full quarterly release to get financial data including costs, but we want to remind readers that the company is looking to reduce production costs by approximately 7-10%, which it will do by controlling input costs and labor. It remains to be seen if we can rely on this forecast range after Q1, but assuming that this range remains doable, we are highly encouraged. We will update out cost projections following earnings, but if our cost data holds, considering that metal prices have gotten a boost lately, and production is rising, it could lead to some significant margin expansion. That said, we will be closely watching costs. We believe cash costs will approximate $6.75-$7.25 in 2018, while we are projecting all-in sustaining costs of $16.00 to $16.75 per ounce. We see both production and costs moving in favorable directions because of higher grades and improved throughput at the company’s properties.

Take home

We called for a buy at $2.30 per share and continue to see upside given that it appears the company is in the midst of a demonstrated turnaround. We cannot be idle or lazy however. We must keep up on the sector, because the story could change quickly if there are mine specific issues or a rapid selloff. However, right now all signs are bullish.

Nearly every key metric of interest we look for in a silver miner are on the rise for Endeavour, and we will get more color in a few weeks when the financial data is released. In addition, the company has acquired more development projects for the long-term, including making great progress at El Compas, which will continue to help the company’s growth longer-term. We continue to like Endeavour Silver in 2018.

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Analyst’s Disclosure: I am/we are long EXK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.