FSM - Fortuna Silver Mines Q3 Earnings: A Solid Mid-Tier Gold And Silver Producer

2023-11-09 08:53:58 ET

Summary

• Fortuna Silver Mines has pivoted to gold mining, but still produces 6.5 million oz. of silver.
• The company has five operating mines in five countries and plans to continue building mines.
• Fortuna is currently considered a cheap stock due to the current correction in gold/silver prices, making it a potential opportunity for investors.

Introduction

Fortuna Silver Mines (FSM)(FVI:CA)has been around for a long time and has an experienced team. Moreover, I have followed them for 10+ years and have a good feel for their capabilities. They have not had any significant setbacks and tend to be good executors. I have confidence in their management team and consider it to be a growth stock.

They need to change their name to Fortuna Mining because they have pivoted to gold mining, where they get the majority of their revenue ( 73% gold and 15% silver in Q3 ). Their last two mines were gold mines in West Africa. However, if silver outperforms gold, like I expect, their revenue will be around 55% gold and 35% silver, based on their current mines (I'll do the math below).

This is an aggressive company with five operating mines in five countries. They will likely continue building mines. That seems to be their DNA. They might not get as high a FCF multiple as mid-tier producers in better locations. Their mines could be considered in unsafe jurisdictions (more on that below).

Investors are fortunate for this current correction. Normally, companies of Fortuna's quality are not on sale. If you look at its chart, you will see that it is significantly off its all-time high. I always like to buy quality producers on sale during corrections, because the entry price is everything for big gains. If you buy too high, then you will never get a good return.

During this correction, there are about five stocks that I have been watching, but they are all too pricey. That's actually a tiny number. Most stocks are currently cheap. Fortuna fits in the cheap category, as does nearly every silver producer. Once this correction in gold/silver prices ends, it will become difficult to find quality producers that are cheap.

Note: All gold mining stocks are high-risk and should be considered high-risk speculation investments. Only invest what you can afford to lose.

Company Overview

Fortuna Silver is a mid-tier gold and silver producer in Mexico, Peru, Argentina, and West Africa (Burkina Faso, Cote d'Ivoire). They acquired Roxgold in 2021, which will give them an additional 120,000 oz of gold production from Yaramoko, with breakeven costs ((FCF)) of around $1,400 per oz. Plus, the Seguela mine will add another 70,000 oz of production in H1 2023, with breakeven costs ((FCF)) of around $1,100 per oz (AISC of $788 in Q3). Seguela production should average around 130,000 oz in the first 6 years, with low costs. Those two West African projects are high quality and will provide a lot of FCF.

They just released their Q3 results , and they were excellent. They produced 128K oz of AUEQ at an AISC of $1,300 per oz. They had $70M in FCF and paid down $40M of their debt. They now have $118M in cash and $250M in debt.

They are currently producing around 325,000 oz of gold and 6.5 million oz of silver. (about 70% of revenue comes from gold). Nearly all of that silver comes from their San Jose mine in Mexico. It had a potential permit issue in 2022, but that appears to be resolved. It is currently a high-cost mine, with breakeven costs ((FCF)) of around $22 per oz (AISC of $18 per oz in Q3). While this mine is not generating very little or no FCF today, it is highly leveraged for higher silver prices (as you will see below on the future valuation).

Their other silver mine (Caylloma) is in Peru and also has high costs, with an AISC of around $20 and breakeven costs ((FCF)) of around $22 per oz. It only produces about 1 million oz a year.

Their other gold mine (Lindero) is in Argentina, a location where investors are not excited due to currency controls and high inflation. Note that Fortuna's Lindero mine is exempt from currency controls. Lindero produces about 100,000 oz annually and is a long-life mine. Lindero has high costs, with an AISC of $1,600 in Q3, and breakeven costs ((FCF)) of around $1,800 per oz.

They have about $250 million in debt. Historically, they don't like debt and will attempt to pay it back quickly (last quarter's $40M paydown of debt is an indicator of their plans). Their red flags are some high-cost mines, plus location risk in Argentina, Peru, and Africa. So, location issues could prevent a high multiple.

The key for this company will be higher gold/silver prices, exploration success, and perhaps acquisitions. They have many exploration projects. In fact, they have an outstanding pipeline of exploration projects. Their African properties have some early discoveries, and their Mexico, Peru, and Argentina properties all have potential additional mines. This is a growth story.

They currently have a strong FCF ($70M in Q3) and a significant amount of cash ($118M) on their balance sheet. This should allow them to be somewhat aggressive in exploration or acquisitions. Plus, it provides a bit of a safety net for any price volatility, especially in silver, where both of their silver mines are basically breaking even.

They are currently ramping up Seguela, which has excellent margins, with breakeven costs ((FCF)) around $1,100 per oz. We must watch their next two quarters to see how much FCF they are generating. Hopefully, they can pay down their debt quickly. I would like to see them with zero debt and a lot of cash to pay dividends and do buybacks. If that happens, they could get their FCF multiple to a 10 or higher.

Company Info

Cash : $118 million.

Debt: $250 million.

Current Silver Resources: 55 million oz.

Estimated Future Silver Reserves: 50 million oz.

Estimated Future Silver Production: 6.5 million oz.

Estimated Future Silver All-in Costs (breakeven): $24 per oz.

Current Gold Resources: 5 million oz.

Estimated Future Gold Reserves: 5.5 million oz.

Estimated Future Gold Production: 350K oz.

Estimated Future Gold All-in Costs (breakeven): $1,700 per oz.

Estimated Future FCF Multiple: 10.

Scorecard (1 to 10)

Properties/Projects: 8

Costs/Grade/Economics: 7

People/Management: 8

Cash/Debt: 7

Location Risk: 6

Risk-Reward: 7.5

Upside Potential: 7.5

Production Growth Potential/Exploration: 7.5

Overall Rating: 7.5

Strengths/Positives

Significant upside potential.

Significant exploration potential.

Strong management team.

Aggressive management team (they want to grow).

Silver production exposure (these are rare).

Risks/Red Flags

Dependence on higher PM prices (for large returns).

Location risk.

Speculation stock (high risk).

Location risk.

High debt.

Estimated Future Valuation ($75 Silver/$3,000 Gold)

Silver production estimate for the long term: 6.5 million oz.

Silver All-In Costs (break-even): $24 per oz.

6.5M oz. x ($75 - $24) = $331 million annual FCF (free cash flow).

Gold production estimate for the long term: 350K oz.

Gold All-In Costs (break-even): $1,700 per oz.

350K oz. x ($3,000 - $1,700) = $450 million annual FCF (free cash flow).

$800 million x 10 (FCF multiplier) = $8 billion.

Current FD market cap: $933 million.

Upside potential: 750%.

Future Valuation Explained (recurring paragraph)

First of all, this expected upside potential is not for the next 12 months. This is a long-term view in 3-5 years. I don't believe in investing for the short term. I invest for future gold and silver prices at much higher levels.

I used a future PM price of $75 silver and $3,000 gold because I am a long-term investor who plans to wait for higher silver prices. I expect to see this level reached within 3-5 years. In fact, I use $100 silver for valuations on my website since that is my expected future price. I tone it down a bit to $75 on Seeking Alpha, which I think is more reasonable.

I believe that gold drives the silver price and that macroeconomics drives the gold price. The only reason I expect to see $100 in silver is that I expect to see at least $3,000 in gold. Using a GSR (gold-silver ratio) of 30 might seem aggressive, but I think it is realistic. The GSR was 17 in 1980 and 39 in 2011.

My estimated return (750%) will only occur if all assumptions are correct. A more likely outcome will be something less than this amount, although it is not crazy talk to expect silver to exceed $75 or gold to exceed $3000 in 3 to 5 years.

One key assumption is that costs will not explode higher. I have padded the current costs, but it's possible that I did not pad them enough. We do not know what the future costs will be.

I'm using an FCF multiple of 10 for my future valuation, and they are currently valued at an FCF multiple of 9. Using a 10 is conservative, and I expect them to reach 15 or higher (from much higher margins and an expected clean balance sheet).

My future All-In Costs are the expected costs that will generate FCF. This is essentially a break-even cost per oz.

Balance Sheet/Share Dilution

They have $250 million in debt, which is high and adds risk. They do have $118 million in cash and are generating FCF (last quarter FCF was $70M). At this time, I am not concerned with their debt level. However, if they have any problems at one of their mines and begin burning cash, it could become a problem.

A weak balance sheet always adds risk. Investing in PM mining stock is always speculating. You can never expect a PM miner to do well. The risk level is too high.

I do not expect them to require any more share dilution.

Risk/Reward

This risk/reward looks good, but it does have some high-risk issues. The first is the location of their mines. None of them are in what could be called safe jurisdictions. Mexico used to be considered mining-friendly, but it isn't anymore. In fact, they recently had permit issues at their large San Jose silver mine in Mexico, but thankfully it was resolved.

You need to be risk-averse to own Fortuna because of its location risk. It's much safer to own a mid-tier producer in Australia or Canada. I don't mind the risk because I think it is a growth stock and has 10-bagger potential. But for me to get that return, I am speculating.

The returns for this stock should be solid if the PM prices soar and they don't have any issues at their mines. Plus, I would expect them to find a way to grow production beyond my targets. That's in their DNA.

Investment Thesis

I see Fortuna as a solid mid-tier producer. Their costs are a bit high, but I'm more interested in their potential FCF at much higher PM prices. As long as they survive the current downturn in prices, then they should be around for the next run in PM prices that I am expecting. I think they can reach more than $500M in FCF, and potentially double that amount. If they hit these numbers and get a good FCF multiple, then the returns will be good.

I recognize that this isn't a slam dunk and is a speculation bet. I like to bet on many mid-tier producers (I own a lot of them), and then wait to see which ones are the winners. I don't believe you can pick PM winners, and it is foolish to do so. Instead, I try to pick potential winners and then let the winners appear.

I keep my allocations low and never make big bets. Refer to the link below for my investment strategy.

Strategy to Manage Risk

Link to My Investing Strategy

For further details see: