In November 2021, I wrote a bullish SA article on Sierra Metals (NYSE:SMTS) in which I said that its results and market valuation were under pressure due to challenges stemming from the COVID-19 pandemic. It’s been over 7 months since then and the company is still suffering from COVID-related issues. In Q1 2022, mill throughput declined by 24% while EBITDA slumped by 43% to $16 million. However, the situation is likely to improve in the coming months and Sierra Metals is valued at just $113.7 million. In my view, the company is cheap and is still profitable despite the issues and this is why I’m bullish. Let’s review.
Overview of the recent developments
In case you haven’t read my previous article on Sierra Metals, here is a quick description of its business. The company’s portfolio includes the Bolivar copper mine in Mexico, the Cusi silver mine in Mexico and the Yauricocha polymetallic mine in Peru. For the year ended March 2022, copper accounted for over a third of revenues and much of the remainder came from silver and zinc.
These three mines have a combined mill throughput capacity of 9,800 tonnes per day and Sierra Metals plans to boost this to 15,500 tonnes per day over the coming years. Mill throughput is set to increase to 10,000 tonnes per day at Bolivar in 2024 and to 5,500 tonnes per day at Yauricocha in 2025.
According to the latest preliminary economic assessments, the expanded Bolivar and Yauricocha mines have a net present value (NPV) of $361 million and $273 million, respectively. The capex required to increase throughput at Bolivar is forecast to be $67.5 million while the upgrade to the concentrator plant at Yauricocha is expected to cost $47.4 million.
What I don’t like about the NPVs of these projects is that that the one for Bolivar is based on a long-term copper price of $3.05 per pound while the one for Yauricocha is based on copper, zinc, and silver prices of $3.39 per pound, $1.10 per pound, and $21.02 per ounce, respectively. The reason for this is that copper prices have been in freefall lately and are down to $3.30 per pound from $4.80 per pound in April 2022.
Turning our attention to the Q1 production and financial results of Sierra Metals, the company produced a total of 15.9 million pounds of copper equivalent and generated revenues of $57.2 million. The adjusted EBITDA came in at $16 million while the net income was $0.4 million. I find the production figures disappointing as Sierra Metals could struggle to meet its 2022 guidance.
So, what happened? Well, Sierra Metals CEO Luis Marchese revealed during the Q1 2022 earnings call that COVID-19 continued to cause issues and that there was a further significant reduction in mining and service personnel at Yauricocha which resulted in delays in mine development. Production at Bolivar slumped because mining transitioned to a new zone but at least there was a significant improvement in production at Cusi. Silver equivalent production there soared by 57% year on year to 458,000 ounces thanks to a 15% improvement in mill throughput and higher grades. Cusi processed an average of 964 tonnes per day in Q1 2022 and is back in the black, with a net income of $1.6 million.
Looking at what to expect for the remainder of 2022, Sierra Metals thinks that it will be able to make up for the lower production over the coming months as it starts operating at maximum capacity at Yauricocha. The company has also found a new high-grade zone there which should help drive up revenues over the coming months.
At Bolivar, output should improve over the coming months too as mining will be focused on the Bolivar North West zone over the next few quarters. At Cusi, I expect mill throughput to continue to improve and reach 1,000 tonnes per day by the end of 2022. Overall, there should be a significant increase in the production of Sierra Metals over the next few months and I think it’s still possible for the company to meet its production guidance. With output and financial results expected to improve in the second part of 2022, I think this could be a good time to open a small position here. Sure, Sierra Metals has encountered serious operational issues due to COVID-19 restrictions but Bolivar, Yauricocha, and Cusi are good mines that have a combined NPV of $715 million if production is expanded as planned. Considering Sierra Metals is valued at $113.7 million as of the time of writing, its shares seem undervalued and there is a good margin of safety.
Turning our attention to the risks for the bull case, I think there are two major ones. First, a return of COVID-19 restrictions across Mexico and Peru could result in another slump in production which is likely to drive down the share price. Second, it’s crucial that metal prices stop falling as the CAPEX guidance for this year is $69 million. In my view, Sierra Metals is in a tight spot from a financial point of view as it had $81.1 million in debt and $19.5 million in cash as of March 2022.
Sierra Metals posted weak production results for Q1 2022 due to issues at Yauricocha and Bolivar and its share price has also been under pressure due to falling base metals prices. In my view, this opens a good window of opportunity to open a position as the company still thinks it can meet its 2022 production guidance and copper and zinc are starting to look oversold. Considering the combined NPV of the projects of Sierra Metals is $715 million, I think that a quarter or two of good production results could lead to a doubling of the share price.
However, it’s possible that COVID-19 returns in Latin America or that the prices of base metals continue to slide, and therefore I rate Sierra Metals as a speculative buy. It could be best for risk-averse investors to avoid this stock.