- Sierra Metals reported its Q4 results highlighted by strong profitability benefiting from higher output and metals pricing despite COVID-19 challenges.
- Expectation for significant production growth in the coming years supports a positive long-term outlook.
- We are bullish on the stock and see upside with exposure to copper and silver translating to higher cash flows and solid profitability.
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Sierra Metals (SMTS) is a Canada-based industrial and precious metals mining company with operations across Mexico and Peru. Despite disruptions last year due to the pandemic, 2020 was a breakout year for the company which benefited from a surge in metals prices and steady production growth. Indeed, shares of SMTS are up over 115% in just the past six months with the market recognizing the company's impressive financial trends and long-term outlook. Sierra Metals just reported its latest quarterly results highlighted by record revenues and positive guidance from management for the year ahead. We're bullish on the stock given its unique diversified exposure to copper as its primary metal in addition to growing silver output which we believe can perform well in 2021. This is a solid company with overall strong fundamentals.
SMTS Earnings Recap
Sierra Metals reported its fiscal 2020 Q4 earnings on March 18 with GAAP EPS of $0.14 which beat expectations by $0.07. Revenue in the quarter at $76.2 million climbed 17.9% year-over-year reflecting both higher market pricing and a 6.4% y/y increase in total ore processed during the quarter.
(Source: company IR/ annotation by BOOX Research)
In Q4, Sierra produced 922k ounces of silver, up 5.6% year-over-year balancing a 6% decline in copper output. Management explains that the weaker copper production was driven by lower grades and some quarterly volatility in recovery rates at the company's Yauricocha mine in Peru. A ramp-up in throughput at the company's "Cusi" mine in Mexico has supported higher silver totals along with an increase in gold recoveries over the past year.
For the full year 2020, revenues reached $247 million, up 7.9% y/y with increased production across all core metals. Total ore processed in 2020 increased 5.9% including a 13.8% increase in copper production and 18.4% higher gold production compared to 2019. For context, approximately 39% of 2020 revenues were based on copper followed by silver at 23%, zinc at 20%, while gold and lead each contributed about 9%.
(source: company IR)
The results for the year are particularly impressive considering operations in Mexico and Peru faced disruptions in Q2 based on government restrictions to deal with the COVID-19 pandemic during that period. The timing of the restart through Q3 coincided with a ramp-up period from the Cusi mine operations that had undergone an expansion upgrade into a new high-grade zone.
(source: company IR/ annotation by BOOX Research)
Silver pricing also has supported the financial results as the commodity price climbed over 50% between Q2 and Q3 and a 26% higher average realized price for the full year. Strength in copper pricing has also been a major theme for the company in recent months. Adjusted net income in 2020 reached $29.6 million, up 113% y/y. Adjusted EBITDA at $97 million was also positive, increasing 49% y/y.
A key metric for the company is its all-in sustaining costs "AISC" for copper equivalent pound sold at $2.12 in 2020, which was 8% lower compared to 2019. Cash costs were down at all mines, attributable to the higher production volumes against some lower operating costs realized when the mining operations were suspended earlier in 2020.
Sierra Metals ended the year with $71.4 million in cash and equivalents, against a reported debt position of $101.1 million. Considering adjusted EBITDA of $97 million for 2020, we calculate a net-debt to EBITDA leverage ratio of 0.3x which we believe represents strength in the company's investment profile. A financial current ratio of 2.0x also highlights solid balance sheet liquidity.
2021 Guidance and Consensus Expectations
Management is reiterating its 2021 guidance issued in January as it relates to production targets and an EBITDA forecast between $155 million and $170 million. Considering copper prices are about 16% over the period, the outlook is trending toward the higher end of the estimate. Sierra expects to produce between 130.0 to 141.0 million copper equivalent pounds vs. 118.2 million pounds in 2020. In terms of silver equivalent output, the company production forecast at the midpoint of 16.8 million ounces if confirmed would be 4.4% higher compared to 2020.
(source: Company IR)
For 2021 there's an expectation for throughput at the Yauricocha mine to increase 20% with a final technical permit expected by Q2. Longer term, the plan is to double output from the Bolivar and Cusi mine from current levels by 2026 based on preliminary economic assessments and pre-feasibility studies.
(source: Company IR)
According to consensus expectations, Sierra Metals is forecast to reach $327 million in revenue this year, up 33% over 2020. The outlook here reflects the elevated metals pricing level which should represent a tailwind in the average realized sales price. The estimate for EPS at $0.48 is 145% higher compared to $0.18 in 2020.
Analysis and Forward-Looking Commentary
There's a lot to like about Sierra Metals and we are particularly encouraged by the positive guidance in terms of production growth. Beyond the exposure to higher commodity pricing, we believe the stock can perform well based on firming financials like the ongoing deleveraging and attractively low AISC across the mining operations.
We are bullish on both copper and silver pricing this year which benefits from the broader macro recovery as the two metals trade-off of industrial demand dynamics. We expect that as the pandemic ends with rising vaccination rates globally, sectors like trade and infrastructure investment in both the U.S. and globally can be positive for metals prices.
We view Sierra Metals with a market cap of around $510 million as a high-quality small-cap player in this segment with a compelling valuation compared to larger peers. In terms of valuation, we highlight that SMTS trading at a forward P/E ratio of around 7x consensus 2021 EPS estimate, represents a deep discount compared to Freeport-McMoRan Inc (FCX) at 14x and Southern Copper Corp (SCCO) at 22x for reference. SMTS also trades a low 3x forward EV to EBITDA multiple.
One explanation for the spread comes back to its smaller relative size and concentration among just three mines, although we view the diversification between copper, silver, lead, zinc, and gold as a strength that can support a higher premium. SMTS can capture the upside regardless of which segment of metals outperforms going forward.
We are bullish on shares of SMTS and rate the stock as a buy with a year-end price target of $4.00 representing a 9x forward P/E multiple and 25% upside from the current level. Our price target assumes a constant pricing environment for copper and silver at current levels, which are the two most important commodities for the company. A leg higher in metals possibility driven by a stronger than expected global macro environment could drive shares even higher with accelerating momentum.
The main risk to watch would be a deterioration of the macro outlook. Weaker than expected economic activity in the U.S. or China could pressure global trade levels and force a reassessment of the company's long-term earnings outlook. Monitoring points over the coming quarters include production levels and the company's cash flow generation. It will be important for management to deliver on its targets for the Yauricocha to drive growth.
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This article was written by
Dan Victor, CFA is a market professional with more than 15 years of investment management experience across major financial institutions in research, strategy, and trading roles. Dan is the president of Posto Asset Management - a startup investment advisory firm based in Miami Beach, Florida.Dan leads the investing group Learn more
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SMTS over the next 72 hours. 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.
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