Thesis

Silvercorp Metals’ (SVM) 12-month share price performance has seen one hell of a roller coaster ride. During this prevailing era of COVID-19, one thing is clearly visible in the price performance of a large number of mining companies; their prices nose-dived from mid-February and continued to fall till mid-March, but have been on a consistent recovery since then. The reason? The share prices broadly follow the trend observed in the prices of metals mined by those companies. Nevertheless, the share price charts also reveal some deviation from the actual performance of metal prices and that’s where I believe the market is incorporating the perceived impact of a miner’s fundamental performance. In the case of SVM, have a look at Figure-1 that presents its 12-month price chart where I have pinpointed the specific catalysts that resulted in a particular behavior in share price.

Figure-1 (Source: Finviz-comments added by author)

In this article, we will take a look at SVM’s FY 2020 performance, and consider the strength of its balance sheet at the end of the year. In my view, a key element of management’s performance is the ability to take the right decision, especially when it comes to investment in a mining project and binding its cash flows in the hope of generating an attractive return. The article will also discuss SVM management’s performance on this criteria. Finally, we will analyze SVM’s growth outlook for FY 2021 amid improving metal prices. Let’s get into the details.

Figure-2 (Source: Kitco)

FY 2020 Performance Review

Income Statement-Management prevented its declining revenues from hurting margins but faces higher production costs, on a YoY basis: During FY 2020 ended on 31st March 2020, SVM reported revenues of $158.8 MM (2019: $170.5 MM), operating income of $59.3 MM (2019: $70.9 MM), net income of $45.2 MM (2019: $52 MM), and basic and diluted EPS of $0.20/share (2019:$0.24/share) and $0.20/share (2019:$0.23/share), respectively. Based on the numbers above, SVM’s operating and net income margins are figured out to be 37.38% (2019: 41.6%) and 28.46% (2019: 30.52%), respectively. Put it another way, the 7% YoY decline in sales resulted in the operating and net margins declining by only 4.22% and 2.06% respectively. In my view, this is a positive indicator that reveals management’s ability to control margins despite the decline in sales. Note that the sales decline was attributable to a 2% YoY reduction in ore mined/milled, as well as the overall negative impact of metal pricing (lead and zinc prices fell sharply by 19% and 32% YoY) on SVM’s FY 2020 revenues. The decline in operating margins was caused by higher YoY cash cost and AISC (read: All-In-Sustaining-Cost) per ounce of silver NOBPC (read: net of by-products credit). On that note, cash costs/oz NOBPC declined from negative $4.29/oz to negative $1.91/oz which is itself an unfavorable development, and AISC/oz NOBPC increased sharply from $3.52/oz to $6.86/oz. Have a look at Figure-3.

Figure-3 (Source: MD&A Year End and Q4, 2020-pg.4)

Balance sheet-fairly strong and apparently safe from the risk of impairment thanks to the prevailing high metal prices: Perhaps the best thing about SVM’s $512.7 MM balance sheet is that >85% of it is equity and <15% of it is liabilities. The FY 2020 balance sheet essentially remains debt free. The $23 MM accounts payable balance, and certain deferred tax liabilities worth ~$36 MM are the only significant components of the liabilities portion. It’s encouraging to know that both these line items are well-covered by the FY 2020 cash & equivalents of ~$65.77 MM. The company maintains a low share count of ~171.7 MM and ~174 MM in basic and diluted shares, respectively. Low share count together with zero debt gives SVM an edge in the mining industry. From what I have seen of various gold/silver miners, either the balance sheet has significant debt, or the debt itself is low but this positive characteristic is largely offset by a high share count (say, close to or above one billion shares) that impacts the miner’s ability to derive bottom line earnings. Having these two positives in tandem is not very common.

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Furthermore, a look at the assets side of the balance sheet (Figure-4) indicates that SVM’s balance sheet is strong on a couple of key line items considered significant in the context of miners. These items include cash & equivalents of $65.77 MM (or ~13% of balance sheet), investment in associates of $44.56 MM (or ~9%), plant and equipment of $66.72 MM (or ~13%), and mineral rights and properties of $224.58 MM (or ~43%). In my view, the prevailing high metal price environment (Figure-5) de-risks SVM’s balance sheet against the risk of impairment since, as per accounting principles, it’s less likely that recoverable amounts will be less than the carrying amounts of those mining properties.

Figure-4 (Source: Financial Statements Year End & Q4 2020-p.4)

Figure-5 (Source: Infomine, multiple pages)

Management

We’ve discussed earlier how SVM’s management protected its operating and net margins in relation to the YoY decline in sales revenues. At this point, the notable YoY upside in ‘cash costs/oz of silver NOBPC’ and ‘AISC/oz of silver NOBPC’ (refer to Figure-3) are the only metrics that reflect negatively on management’s performance. Other than that, I believe SVM’s management has done a fairly good job.

For one, they managed to surpass the production guidance for silver, lead, and zinc by 3%, 3%, and 17% respectively despite the fact that SVM’s Q4 2020 operations in China were suspended for almost 1.5 months (two weeks operational suspension in the wake of the Chinese New Year, and one month additional suspension following the COVID-19 outbreak in China).

Second, management’s capable of appropriately picking investment ventures to increase shareholders’ value. We’ll divide this discussion into decisions taken for undertaking a good investment, and to avoid a not-so-good investment.

New Pacific Metals-A Good Investment: SVM’s ~29% ownership stake in New Pacific Metals (OTCQX:NUPMF) can be termed as a good investment. If we look at the break-up of SVM’s investment profile in NUPMF (Figure-6) during the past two years, we can figure out that SVM’s number of shares held in NUPMF increased from ~39.35 MM at the end of FY 2019 to ~42.5 MM at the end of FY 2020, and the market value of this investment more than doubled YoY (from $69.78 MM to $148.62 MM).

Figure-6 (Source: Financial Statements Year End & Q4 2020-p.26)

Despite the increased investment in its associate, SVM’s proportionate ownership declined from 29.6% (2019) to 28.8% (2020). This is because when SVM exercised its warrants to buy the additional 1.5 MM common shares in May 2019, Pan American Silver (PAAS) also exercised the warrants and acquired 8 MM common shares. Nothing to worry here since SVM’s proportionate ownership in NUPMF is not materially changed. Plus, PAAS is a seasoned silver and gold producer who’d not exercise the warrants if it weren’t for the attraction of NUPMF’s mining profile.

On that note, the April 2020 initial resource estimate of NUPMF’s ‘Silver Sand’ project entails M&I (read: Measured & Indicated) resources worth 155.9 Moz (read: a million ounces) at average grades of 137 g/t of AgEq (read: Silver equivalent), and Inferred resources of 35.6 Moz at average grade of 112 g/t of AgEq. The investment’s return has seen notable upside from last year. At the end of FY 2019, the return worked out at 180.3% (market value of $69.78 MM against investment of $38.7 MM). This spiked to 333.57% (market value of $148.62 MM against investment of $44.55 MM) at the end of FY 2020, which reveals that for an additional investment of $5.85 MM, the investment’s market value increased by ~$78.8 MM during the year. Hence, a very good investment decision by the management of SVM.

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Guyana Goldfields-A prospective not-so-good investment: In April 2020, SVM entered into an agreement to acquire 100% shares of Guyana Goldfields (OTCPK:GUYFF). The proposed deal was initially valued at ~CA$ 105 MM (or CA$ 0.60/share in cash, and/or in kind), whereby SVM aimed to acquire the Aurora gold mine through the intended acquisition of GUYFF. The Aurora mine’s expected to contain more than 2 Moz of AuEq (read: gold equivalent) in reserves and ~2 Moz in resources. In the context of its strategy to diversify its product mix and expand its portfolio of future gold mining assets (including the BYP gold mine currently owned by SVM), this seemed like an ‘in-the-money’ offer. Seeking Alpha contributor Taylor Dart presented a fairly detailed and reasonable analysis on how SVM was moving ahead to acquire the asset at a reasonable price.

However, SVM subsequently upped its offer for Guyana at a total per-share consideration of CA$ 1.30, in an effort to match competing bids for the takeover target from other potential acquirers. This new offer saw Guyana’s total price tag to reach ~CA$ 227 MM (from ~CA$ 105 MM earlier), and also incorporated a CA$ 9 MM termination fee to be paid by Guyana to SVM.

A new twist to the story came when Guyana got another significantly higher takeover offer from Zijin Mining (OTCPK:ZIJMF), a Chinese miner that offered a price tag of CA$ 323 MM (or US$ 238 MM) for Guyana. This time, the offer was not countered by SVM and for good reason. Why? Let’s see.

1. Although SVM’s current balance sheet is robust in view of its existing liquidity needs, however, SVM did not have sufficient cash (only ~$66 MM at the end of FY 2020) nor enough OCFs (read: operating cash flows) (FY 2020 OCF=$ 77 MM) to pay for the acquisition. Given its unlimited authorized share count, limited outstanding shares, and nil debt, SVM’s best bet to secure funds for the acquisition would be through issuance of further shares, or by seeking debt.

2. Considering that Guyana’s Aurora gold mine has a history of operational issues including production hurdles, financing, as well as higher cost production, I believe SVM would have gone all the way to fund the purchase of a distressed miner. All that painstaking effort to add a potential ~2 Moz each in reserves and resources? Does not make sense, in my view. SVM’s mining edge has traditionally lied with silver, lead, and zinc mining, and chasing Guyana’s distressed gold asset would have its impact on SVM’s future operational performance.

I’d give it to the management that they made a good decision by letting go of the proposed Guyana acquisition.

FY 2021 outlook

When considering SVM’s FY 2021 outlook, I would look at the following catalysts:

1. Production and cost guidance: In terms of production, the mid-point of expected ore processing tonnage is ~950,000 tonnes resulting in expected production between 6.2-6.5 Moz of silver, 66.1-68.5 Mlbs (read: a million pound) of lead, and 24.5-26.7 Mlbs of zinc. These numbers represent a 2-7%, 2-5%, and 12-22% YoY increase in production of silver, lead, and zinc respectively. In terms of cost, the consolidated cash cost is expected to lie between $66.6-73.6/ton of ore, and the consolidated AISC to lie between $122.6-135.5/ton of ore. SVM has not provided its cost estimates in terms of the commonly used ‘AISC/oz’ of silver production. By using FY 2020 numbers (AISC/ton of $125.29 that translated into AISC/oz of $6.86 NOBPC) and applying a lineal correlation between the two cost metrics, I calculate that FY 2021’s expected AISC/oz will be ~$7.065/oz based on mid-point values. Here’s my calculation.

[(122.6+135.5)/2 ÷ (125.29/6.86)]=7.065

2. Metal prices, particularly silver: Despite producing significant quantities of lead and zinc, SVM’s production and costs are primarily denoted in terms of silver ounces net of by-products credits. As seen above, the expected AISC/oz of silver NOBPC works out to be a little over $7/oz, therefore I believe the current silver prices of $18/oz+ combined with increased YoY production for all three metals will continue to enhance SVM’s margins and support the upward trajectory in share price.

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3. BYP mine: At this point, investors should not take into consideration the gold production potential of SVM’s BYP mine. Consider it bonus production if and when the BYP license is renewed, and the mine’s production restarts. SVM states in the MD&A for FY 2020 (emphasis added),

The Company is carrying out activities to apply for a new mining license, but the process has taken longer than expected. No guarantee can be given that the new mining licenses for the BYP Mine will be issued, or if they are issued, that they will be issued under reasonable operational and/or financial terms, or in a timely manner, or that the Company will be in a position to comply with all conditions that are imposed.

4. Organic growth of existing assets: SVM’s drilling programs are planned to enhance resource potential at the existing YMD (read: Ying Mining District) and GC mining properties. SVM targets 105,000 meters of in-fill diamond drilling during FY 2021 (YMD=79,300 metres and GC=25,700 metres). A drilling program is already underway at certain mines in the YMD. The strategic importance of YMD is denoted by the fact that it generated superior operating and net margins (of 46% and 35% respectively) compared with those of the GC mine (26% and 25% respectively).

5. Dividends: SVM is not an ideal pick for the dividend seeking investor due to its trivial yield of <1%. Nevertheless, it has paid 5 consecutive semi-annual dividends amounting to $0.0125/share. The dividend payments roughly amount to $4 MM each year, and based on its robust liquidity profile I don’t see any reason why SVM would cut those payments during FY 2021.

Investor Takeaway

In the preceding discussion, we have seen that SVM’s FY 2020 had been flat YoY in terms of operational performance. However, the balance sheet has all the elements of a solid financial standing. Management is capable of steering the company in the right direction even in these times of widespread COVID-19 related uncertainty in the business environments, and has proved its merit to take investment decisions that have so far proved fruitful for the investors.

As we move into FY 2021, SVM’s organic growth opportunities come into the spotlight, further reinforced by increased YoY production guidance, and planned additional drilling programs at SVM’s existing mining assets. SVM’s investment in NUPMF will act as a positive catalyst in the near-to-long term. NUPMF’s Silver Sand project’s PEA (read: Preliminary Economic Assessment) will be released towards the end of FY 2020 and will shed more light on future project development. With all these positive catalysts at play in addition to a favorable silver price environment, SVM’s share price is climbing on the back of the precious metal’s trajectory.

Figure-7 (Source: Finviz)

As shown in Figure-7 above, silver has breached the $18/oz mark and is trading at ~$18.20 (at the time of writing). Therefore, any breakout of silver above its 12-month resistance level of >$18.50/oz would provide profit-taking opportunities for SVM investors. Nevertheless, SVM is equally promising as a long-term investment thanks to its strong fundamental profile.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.



Via SeekingAlpha.com