USAS - Americas Gold and Silver Q1 Earnings: Weakness In Base Metals Prices Weighs On Margins

2023-05-25 01:55:36 ET

Summary

• Americas Gold and Silver continues to be one of the worst-performing names in the precious metals space, down 23% year-to-date vs. a 1% gain in the Silver Miners Index.
• This underperformance follows a 29% decline last year, and the stock has now found itself over 90% from its 2017 highs compared to a 25% gain in the silver price.
• Unfortunately, with a weak balance sheet and declining base metals prices that are weighing on profitability, the outlook remains negative and underperformance is likely to continue.
• So, while USAS continues to highlight future growth and a cheap relative valuation as a reason to own the stock, I continue to see this as a case of the stock being cheap for several reasons.

Just over four months ago, I wrote on Americas Gold and Silver ( USAS ), noting that while it was positioned to grow silver production year-over-year in 2023, there was no reason to rush into the stock above US$0.65. This was because the company had a track record of disappointing investors by missing its projections, and the most recent disappointment was a massive one. For those unfamiliar, its Relief Canyon Mine that was supposed to quintuple precious metals production was placed on care & maintenance after barely a quarter of operations and instead of 5x production we saw a tripling of the share count and five years of fixed gold deliveries with nothing to show for it. In this update, we'll dig into its other two mines and see whether the stock is finally worth owning after massively underperforming its peer group.

All figures are in United States Dollars unless otherwise noted.

Q1 Production & Sales

Americas Gold and Silver ("AG&S") released its Q1 results earlier this month, reporting a 66% increase in silver production to ~499,700 ounces, tracking just behind the company's FY2023 guidance of 2.4 - 2.6 million ounces when adjusting for the 17-day shut at its Cosala Operations in Mexico. Some investors might have cheered this headline result and hoped for a significant move higher in the stock after what's been a violent downtrend in the share price. However, digging into the results closer, there was little to write home about. This is because it reported yet another net loss of $10.5 million (Q1 2022: $0.3 million); unit costs soared due to lower by-product credits; and the weighted average share count is 19% year-over-year, translating to one of the worst rates of change in the share count among silver producer peers.

Beginning with the company's Cosala Mine in Mexico, the asset produced ~265,100 ounces of silver compared to ~126,800 ounces in the year-ago period, with mining focused on more silver-rich areas, offset by lower throughput in the period. In the company's defense, this pivot away from areas of the mine with higher base metal grades was timely given the downtrend in zinc and lead prices, but the mine paid for it from a unit cost standpoint, all-in sustaining costs [AISC] soaring from negative $42.51/oz to $9.52/oz in Q1 2023 vs. Q1 2022. This was related to lower base metals production and realized prices and the 17-day shutdown for maintenance, with the former resulting in a significant decline in its by-product credits.

Some investors might argue that these AISC are well below the industry average for silver mines, and this is certainly a valid argument. That said, this is a tiny operation with barely 1.0 million ounces of annual silver production, and zinc prices have continued their decline into Q2, plunging over 18% since late March levels as of yesterday's close. This does not inspire any confidence from a unit cost standpoint as we head into Q2, even with the benefit of a full quarter of production (maintenance completed in Q1). Hence, I would expect another quarter of elevated AISC for AG&S, and while the company was guiding for cash costs of $8.50/oz (consolidated) at the mid-point, the company appears to have been too ambitious on base metal price assumptions, with a miss on costs looking likely.

2023 guidance assumed metals prices of $22.00/oz silver, $1.45/lb zinc, $1.00/lb lead, and $3.75/lb copper. Current prices are $23.00/oz silver, $1.10/lb zinc, $0.95/lb for lead, and $3.50/lb for copper.

Moving over to the company's Galena Complex in Idaho, there wasn't anything to write home in regards to the Q1 results, and we unfortunately saw a tragic incident to start Q2 with an underground miner being struck by falling ground resulting in a worker fatality. The company noted that it is working with the Mine Safety and Health Administration to investigate the incident. From an operations standpoint, silver production increased to ~390,900 ounces (Q1 2022: ~289,200 ounces), benefiting from higher grades and throughput. However, cash costs continue to remain elevated at $18.59/oz, resulting in razor-thin margins, and negative margins from an AISC standpoint ($25.18/oz even without including recapitalization costs).

The silver lining is that the company has begun development on the 4300 level which will increase the number of available stopes, boosting production to take advantage of the Galena hoist which is set to be operational by the end of Q2. This is the next project that AG&S believes will be transformational for the company with higher throughput and the benefit of economies of scale. However, with this being a relatively small asset on a relative basis to Lucky Friday from a production standpoint with lower silver-equivalent grades, I'm less optimistic that the company will be able to push all-in sustaining costs below $18.00/oz consistently, which is what's needed for this asset to generate any meaningful free cash flow and put an end to the consistent share dilution we've seen over the past several years.

Costs & Margins

Looking at costs and margins, AG&S reported all-in sustaining costs of $16.87/oz in Q1 2023, a significant increase from negative $2.67/oz in the year-ago period. This was related to inflationary pressures on some consumables, significantly lower by-product credits at its operations, and what continue to be elevated costs at Galena, with AISC remaining above $31.00/oz with recapitalization costs despite the higher sales volume in the period. If we compare these margins to an average realized silver price of $22.56/oz, AISC margins plunged from $26.57/oz to $5.69/oz, and margins could compress even further in the upcoming quarter with lower by-product credits and a similar average realized silver price.

From a financial standpoint, AG&S reported Q1 sales of $22.1 million (Q1 2022: $26.4 million), impacted by lower average realized metals prices in the period and lower zinc/lead production at Cosala. Combined with higher operating costs and increased finance costs, this resulted in a net loss of $10.5 million for the period, and a trailing-twelve month net loss of $55.4 million. Unfortunately, this left AG&S in a negative working capital position to finish the quarter, suggesting a high likelihood of further share dilution over the next twelve months when combined with its weak balance sheet and cash outflows at current metals prices. In fact, we already saw share dilution in April, with partial exercises of the retraction option by RoyCap settled through ~1.06 million shares being issued.

And if the picture wasn't ugly enough already, AG&S noted in its filings that it entered into a $4.0 million net smelter return royalty agreement with Sandstorm ( SAND ) consisting of a 2.50% royalty on attributable production from Cosala and Galena. This royalty will reduce to 0.20% on attributable production after $4.0 million has been repaid, but will impact its exposure from Galena even further, with AG&S already giving away 40% of Galena when silver traded below $20.00/oz. And like Cosala, the asset is suffering from lower by-product credits due to the sharp pullback we've seen in base metals with it being a silver/lead mine. Fortunately, Cosala is 100% owned with only a 0.50% environmental royalty, but we could see a weaker multiple for USAS going forward, with a downgrade in sentiment for Mexican mining operations following mining law reforms passed in April.

Valuation

Based on ~245 million fully diluted shares (including RoyCap convertible debentures) and a share price of US$0.45, Americas Gold and Silver trades at a market cap of $110 million, which might appear to be a cheap valuation for a company with two silver miners that benefit from base metals credits. However, while AG&S may produce ~2.5 million ounces of silver per annum with a goal to push production above 4.0 million ounces per annum, it continues to have some of the highest costs sector-wide, consistently dilutes shareholders, and is operating at a loss. Worse, there's no light at the end of the tunnel regarding the end of this share dilution with a weak balance sheet despite regular ATM share sales, private placements, and convertible debentures. AG&S' balance sheet is shown below, and shouldn't inspire any confidence, nor should the negative working capital position ($19.7 million).

AG&S consistently emphasizes that this as a growth story, but the only important metric for growth is production growth per share and cash flow per share, and it is preferable that growth in output is achieved at the same or better margins. In AG&S' case, the company has failed miserably from a production growth standpoint, and it's not even close. To illustrate this point, AG&S produced ~2.65 million ounces of silver in 2015 and had ~37 million fully diluted shares heading into 2016. Even if AG&S meets its FY2023 guidance midpoint of 2.5 million ounces of silver, production will be down 5% while the share count will have risen by over 500% to ~230 million fully diluted shares. Hence, if you bought AG&S hoping to get silver price leverage, this leverage worked in the opposite direction, with six times as many shares required to obtain the same amount of silver production.

Summary

While several silver producers continue to look expensive (especially if one uses more conservative silver price assumptions of $22.00/oz) AG&S stands out as looking cheap, and may certainly tempt some investors given that it's fallen 90% from its 2017 highs and may appear to have limited downside. And while I would often consider a stock with sentiment in the gutter that's down 90% from its highs, this is one stock I continue to see as an Avoid with a high probability of future share dilution and a track record that is abysmal, highlighted by the major failure at Relief Canyon. So, while it may be tempting to buy the sector-wide dip and there are some attractive opportunities sprouting up, Americas Gold and Silver is not one of them.

To summarize, if I were long USAS, I would be using any sharp rallies as profit-taking opportunities to re-deploy into better-run names that are returning capital to shareholders vs. a company diluting regularly with a spotty track record of creating any value for shareholders.

For further details see: