CA - Ero Copper: The Returns Could Be Staggering If Gold Soars (Rating Upgrade)

2023-11-11 05:37:17 ET

Summary

• Ero Copper Corp. receives a "Buy" rating which is an upgrade from the previous "Hold" rating.
• The company is well-positioned for future growth in copper and gold markets.
• The stock is currently trading at a cheap price compared to its growth opportunities.

Ero Copper Corp. Earns a Buy Rating for Now

This analysis recommends a “Buy” rating on Ero Copper Corp. ( ERO ) ( ERO:CA ) shares and upgrades the previous analysis’ “Hold” rating.

In the previous article, the stock was viewed as affordable given the excellent growth prospects for copper as a key component in the energy transition program and given the rise in gold prices amid headwinds from the expected downturn in the US economy, which economists predict as early as 2024.

Ero Copper Corp. is very consistent with the future growth of the metals in question, as the company has almost reached the peak of its project to expand its copper ore processing capacity while mining gold from recently discovered high-grade/low-cost gold veins. The expansion of copper operations and the discovery of more profitable gold veins are improving the production profile of its mineral operations in Brazil.

The previous article assumed that stock market concerns about the economic impact of the Fed's interest rate hike policy would initially lead to a decline in Ero Copper's stock price, as demand for copper – Ero’s main source of income – normally is not supported by high financing costs, rather the opposite. Given the described scenario, the previous article recommended waiting for the formation of lower prices in order to strengthen the position in anticipation of the bright future for copper in the energy transition and to take advantage of the next rise in gold prices. And indeed, that was the case; Now prices have become incredibly cheap.

It is now projected that, as will be discussed later in the course of this analysis, Ero Copper shares will rise rapidly in the market, similar to a trend that took place in the second half of 2019, in the wake of a likely bullish sentiment surrounding gold.

Compared to the upcoming growth scenario, for which the stock's rating of "Buy" is taken into account in this analysis, the shares currently appear very cheap.

“Buy and Hold” Seems to Offer Satisfying, but How Staggering the Returns Are with Soaring Gold Prices

In essence, the facts, i.e., the returns, are this: With the shares of Ero Copper Corp., both in the US market under the symbol ERO and in the Canadian market under the symbol ERO: CA, the investment has generated satisfactory return margins with the “Buy and Hold” strategy and is at the same time great asset in gold price cycles.

A “Buy-and-Hold” strategy has proven successful for Ero Copper shares over the last five market years when comparing the performance of the two stocks on the North American markets with the performance of the entire stock market.

Supported by gains in copper +35.8% and gold +39.8%, shares of ERO - a company that explores, develops, and produces both copper and gold deposits in mining districts in Brazil - returned +56% if held in the portfolio continuously for five years.

The stock does not pay a dividend and therefore the return margin comes only from the increase in the stock's market value, which, when compared to the return of the S&P 500 Index ( SPX ) - the benchmark for the entire North American stock market - shows that ERO shareholders were able to benefit from a capital increase in line with the average trend among North American listed shares.

Even on the TSX stock exchange in Toronto, Canada, Ero Copper shares (blue line) significantly outperformed the metals it has in production and exploration and even outperformed most companies listed on the US market.

Of course, these comparisons do not mean that a “buy and hold” approach strategy is completely successful, as the performance of Ero Copper shares is also subject to cyclical fluctuations in line with the performance of the metals it produces. This means that investments in Ero Copper have increased over the past five years but have also been subject to both ups and downs. This exposes the retail investor to the risk of loss if he has to regain possession of the invested funds to cover unexpected costs after a sharp drop in the market value of the shares due to a significant decline in the price of the metals.

But it is also true that the stock has outperformed many other US stocks despite three major declines: the first after the outbreak of the COVID-19 virus pandemic in March 2020, the second due to restrictive monetary policy in the summer of 2022, and the ongoing downturn which is being caused by fears about consumption and investment against a backdrop of high-interest rates and high core inflation.

Therefore, a generally positive trend in Ero Copper shares will pay off in the long term if the retail investor proves to be psychologically strong and does not give in to fears that could lead him to behave irrationally.

Copper and Gold in the Long Run

This resilience of Ero Copper stock's medium/long-term returns to market volatility means that this stock is well-positioned to benefit from the growth outlook for copper and gold, which currently looks very positive.

Gold and copper have developed in a very solid way over the past decade, albeit with cyclical fluctuations, and this is unlikely to be different in the coming years: copper is the key element in the transition to clean forms of energy. This will imply the electrification of economic activities, starting with heavy industry.

Gold prices will benefit from the need to increasingly integrate portfolio strategies with investments in the precious metal to strengthen resilience in what is going to be a particularly challenging future.

Ero Copper Corp has a portfolio that appears to be very well connected to copper and gold growth, and the operational and financial trends identified in Q3 2023 are very encouraging in this regard.

Ero Copper Corp in Q3 2023 and its Promising Growth Prospects

Ero Copper ended the Q3 of 2023 with non-GAAP EPS of $0.18 (up 350% year over year), on a 22.5% year-over-year revenue growth to $105.2 million.

The adjusted EBITDA margin profitability index also improved year-on-year to 40.8% in the third quarter of 2023 (versus 33.9% in the third quarter of 2022), while it was slightly lower compared to 43.7% in the previous quarter.

In addition to a year-over-year increase in metal prices (on average, copper rose 8.2% to $3.79/pound and gold rose 11.9% to $1,935.42/ounce), the result reflects the strong improvement in operations and finances at the Xavantina operation in Mato Grosso state, where initial exploitation of the new “Matinha” lode vein resulted in a significant increase in gold production and grades but a reduction in operating costs per metal unit.

Ero Copper is currently engaged in the Xavantina regional exploration program to increase the chances of unlocking further potential from this gold production, which, as the table above clearly shows, is now characterized by significantly higher gold grades and low operating costs.

Following the valuable discovery of the Matinha vein, exploration activities are now focused on additional existing discoveries and potential new discoveries that could provide a further significant boost to gold production. Ahead of the Matinha Vein, Ero Copper's on-time and on-budget development of the Santo Antônio mine, which has enabled the transition to specific underground mining methods to benefit from higher yields, increases the chances of success in targeted discoveries.

The mine currently has an estimated life of 6 years or more and could achieve an annual production of 60,000 ounces of gold during that time.

Xavantina's exploration activities and possible expansion of the facility's capacity to accept additional ore are currently aimed at developing a potential of approximately 24,000 ounces of gold per year.

For Xavantina, the company expects a strong finish to 2023 as it has increased the guidance range to 55,000-59,000 ounces from the original 50,000-53,000 ounces. While costs are believed to continue to decline: the full-year C1 cash cost forecast is now $375 to $475 per ounce, down from the initial range of $475 and $575 per ounce, and the full-year AISC was decreased to $900 to $1,000 per ounce from the initial range of $1,000 to $1,100 per ounce.

Xavantina made it possible to partially offset the negative effects generally caused on costs by the strengthening of the Brazilian real against the US dollar and to offset the headwinds from Eros Copper’s 99.6% interest in the Caraíba copper operations, located in the Curaçá Valley, northeastern Bahia state, as this deposit produced less copper than usual.

Caraíba copper operations performed less well in terms of production (pounds of copper produced) than in some other quarters, primarily due to lower ore grades due to mine sequencing. Instead, in terms of metallurgical recovery rates, they were approximately at the level of the average for the first 9 months of 2023 and slightly below the average for the first 9 months of 2023. Furthermore, the volume of copper ore processed was only lower compared to the previous quarter but exceeded the results of the previous period.

As the main issue affecting production was the low grade of copper ore being processed, the mine's performance is now on track to improve with the project to increase the mill's processing capacity from 3 million to 4.2 million tonnes of copper ore per year, as it involves the use of higher-than-average grade material from Pilar mine's upper levels.

The plant expansion is scheduled to take place by the end of 2023, after which the company should be able to increase its annual copper production by up to 18,000 tons.

Looking ahead to full-year 2023, the company expects the final quarter of 2023 to be better than previous quarters as it reiterated full-year guidance of 44,000 to 47,000 tons of copper concentrate, or approximately 97 to 103.6 million pounds of copper, a result of an improvement in the Copper ore grade.

To counter the headwinds created by the strengthening of the Brazilian real against the US dollar, which even Xavantina's significant improvement could not fully neutralize, Ero Copper has implemented an expansion of its foreign exchange hedging program, which it believes will cover a significant portion of the operating costs and capital expenditure expected to be incurred over the next 12 months.

Additionally, Ero Copper's growth project portfolio includes a 99.6% interest in the Tucumã project in the southeastern state of Pará. Here the company plans to produce copper from an open-pit mine at an average rate of 62 million pounds of copper per year, or a total of 690 million pounds over an entire life of operations of approximately twelve years. Costs are projected to be low compared to the benchmark of Caraíba copper operations in the first five years of production, as shown in the chart below.

The Tucumã Project was 70% complete as of the third quarter of 2023, up from 45% at the end of the second quarter of 2023, and the first copper should be poured sometime in the second half of 2024.

Ero Copper supports all of these growth projects with a balance sheet that appears to be moderately strong. As of September 30, 2023, the company had available liquidity of $237.6 million, of which 18.8% was in cash and cash equivalents, 18% was in short-term securities and 63.2% was in undrawn revolving credit facilities. This cash balance was offset by a total debt of $419.42 million, of which 2.8% was short-term while the remainder was long-term debt.

The economic recession, as predicted by a group of economists who recently welcomed the voice of Luke Tilley , chief economist at Wilmington Trust, will affect copper prices by dampening demand for the metal and this could raise concerns about Ero Copper's budget, as the revenue depends on more than 70% on the red metal.

In fact, analysts expect copper prices to decline as their 12-month price target of $3.41 compares to the current copper price of $3.58 per pound.

For the trailing 12 months ended September 30, 2023, operating income of $98 million exceeded interest expense of $16.6 million due on the outstanding debt when the price of copper was at $3.8510 per pound above analysts' forecasts. However, it must also be said that the stock gave excellent evidence of its resilience when the copper price fell well below $3 a pound, and even if the commodity were to suffer a dizzying decline below analysts' forecasts, the following factors will provide a soft-landing pad for Ero Copper's balance sheet.

These are falling gold production costs, increasing gold and copper volumes, the implementation of ad hoc heading strategies to offset headwinds if the local currency appreciates too much against the US dollar, and the excellent price appreciation that the gold price seems to be able to bring.

In fact, the economic recession does not bode well for the price of copper, but on the other hand, it will trigger a bull market in gold, as the precious metal will most likely be in high demand due to its safe-haven properties.

Get Exposure to Gold Price Changes Ahead of the Potential Bull Market

The risk of an economic recession increases over time as core inflation remains high despite the Federal Reserve’s “higher for longer” interest rates. This could even cause the banking system to further tighten credit conditions, and in the meantime, inflation will continue to hurt consumption (the main component of the US gross domestic product) by reducing the spending capacity of the budgets of the US households.

In fact, analysts recently raised their 12-month price target for gold bullion from $2,023.71 per ounce on October 22, 2023, to the current $2,083.39 per ounce .

The following charts show a positive correlation between the price of gold - the benchmark of which is gold futures (GCZ2023) - and the share price of Ero Copper stock under the symbol ERO on the NYSE market and the symbol ERO:CA on the TSX market. The positive correlation can be seen in the lower part of the two diagrams, where the yellow area is significantly more represented in the positive part of the diagram than in the negative one.

Positive correlation between GCZ2023 and ERO in the NYSE market:

Positive correlation between GCZ2023 and ERO:CA in the TSX market:

However, the stock is also positively correlated with the price of copper (red area in the two charts), which contrasts with the positive impact of safe-haven gold on the stock when copper is under negative pressure due to the expected recession. In this context, the graphs show a very interesting trend that emerged at the end of 2019: when the price of copper fell and the price of gold recovered, Ero Copper's share price was characterized by a temporary negative correlation coefficient with the price of copper while with the gold price, the correlation coefficient stayed positive.

Based on this past trend, Ero Copper shares should receive a strong boost from safe-haven gold during the economic downturn, although the headwinds of the deteriorating economic cycle will create an environment that is certainly not favorable for copper prices.

The risk for the retail investor here is that the future may unfold differently than the strategy predicts, meaning that Ero Copper stock will follow the trail of the falling copper price that analysts expect while waiting in vain for positive winds from the bull market in gold prices.

This analysis assumes that the risk is not very high since the next year 2024 could have something in common with the second half of 2019, which proved to be crucial for the increase in the price of gold and also shares of Ero Copper: This is the rate cut that bodes well for the price of gold because it lowers the opportunity cost of owning more gold, which investment does not generate income based on a fixed rate, compared to fixed-rate securities like US Treasuries.

Nearly all of the 2018 rate hikes were reversed in 2019 to address the risk to the U.S. economy posed by uncertainty from the Sino-U.S. trade war and slowing global growth. After three Fed rate cuts through October 30, 2019, the gold price soared, reaching record highs that still hold today. Shares of Ero Copper followed suit.

Similar to the second part of 2019, the same positive effects for gold and the shares of the Canadian copper/gold mining company may occur as early as 2024 as next year to prevent too many negative effects from the aggressive hawkish stance on consumption and corporate investment, as anticipated the Fed will switch to an interest rate cutting policy.

The Stock Valuation

This analysis suggests that shares are trading surprisingly cheaply compared to the growth opportunities that can be captured by adding to the position as part of a “Buy-and-Hold” strategy or preparing for the forecasted rise in gold prices.

As of this writing, shares were trading at $11.72 apiece, giving it a market cap of $1.19 billion.

Shares were well below the longer trend 200-day simple moving average of $18.12 and the 50-day simple moving average of $15.91. The stock price is well below the midpoint of $17.69 in the 52-week range of $11 to $24.38.

The 14-day relative strength indicator gives a reading of 20.33.

Stock prices have exceeded oversold levels. Downside pressure from the Fed's “Higher for Longer” stance could still try to influence the market price of Ero copper shares, but beyond these extremely low levels, Ero stock will be little affected.

The same considerations apply to shares of the stock in Ero Copper Corp. traded on the Canadian market.

On the Toronto Stock Exchange, under the ((ERO:CA)) symbol, shares were trading at CA$16.18 per unit as of this writing for a market cap of CA$1.65 billion. Shares are trading far below the 200-day simple moving average of CA$ 24.43 and the 50-day simple moving average of CA$ 21.82.

Shares are also significantly below the middle point of CA$ 23.48 in the 52-week range of CA$ 14.84 to CA$ 32.12.

Additionally, the 14-day RSI trend of 21.01 suggests that shares have crossed oversold levels but are unlikely to be able to create more attractive entry points than the current ones for a Buy recommendation even in this high-interest rate environment.

Conclusion

Ero Copper Corp. is a copper and gold producer in Brazil and its growth plans make its stock a very attractive investment vehicle to participate in the copper and gold markets through a “Buy-and-Hold” approach.

Copper has good prospects as a key element in the transition to less polluting human activities and cleaner energy sources, and Ero Copper is on track to deliver more tonnes of copper from higher-grade mineral material with its plant expansion project in Brazil.

Ero Copper is also poised to benefit from a rally in gold prices, likely triggered by an economic recession that economists predict will occur as early as 2024. Investors will flock to safe-haven gold in search of protection from negative winds for their portfolios from the downturn in the US economic cycle.

The stock was affordable at the time of the previous analysis and is now cheap for a Buy recommendation.

For further details see:

Ero Copper: The Returns Could Be Staggering If Gold Soars (Rating Upgrade)