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Value Play - Fortuna Silver

 -- Published: Thursday, 7 November 2019 | Print  | Disqus 

 - Dave Kranzler


Value Play - Fortuna Silver - (FSM, FVI.TO - US$3.07) - Most of the stocks I follow are micro-cap junior "venture capital" plays.  However, I'll invest in a larger cap producing mining company if I believe the stock has been sold down irrationally to a price that offers superior upside risk/return potential.

FSM.png (1261×344)

Click chart to enlarge.

Fortuna was founded in 2005 with a focus on acquiring precious metals projects in Latin America ("Fortuna" was Greek goddess of fortune). One of the co-founders and the current CEO, Jorge Ganoza, is from a Peruvian mining family.  FSM currently has two low-cost mines in Peru and Mexico.  In 2016 it acquired the Lindero gold project in Argentina, a large open pit, heap-leach gold project that should achieve commercial production in early 2020.


San Jose Mine - The 100% owned San Jose Mine, located in Oaxaca, Mexico, began production in July 2011.  The mine produces silver and gold from a 3,000 tonne per day underground operation. In 2018 the mine produced 8 million ozs of silver and 53,517 ozs of gold. San Jose currently has a resource of 46 million ozs of silver and 375,000 ozs of gold. Most of the resource consists of proven/probable reserves. 


In addition to the existing resource,  FSM budgeted $4.3 million for 11,500 meters of brownfield and exploration drilling. "Brownfield" exploration encompasses looking for deposits near or adjacent to an operating mine. The property hosts a mineralization zone - the Victoria  zone - that runs "sub-parallel" to one of the main veins (the Trinidad vein) currently being mined.  A drill program from 2H 2017 - 2018 returned several high grade intercepts.


Caylloma Mine - The Caylloma Mine is a 100%-owned underground silver, lead and zinc mine operation in Arequipa, Peru. A small amount of gold is also extracted from the ore, the value of which is used to offset the cash costs of mining. For 2019, the mine is expected to produce around 1mm ozs of silver, 27 million lbs of lead and 40-44 million lbs of zinc.


Fortuna has owned the mine since 2005. On a silver-equivalent (AgEq) basis, the all-in sustaining cost of the Caylloma mine averages about $13/oz.  Caylloma currently has five years left of reserves but the property hosts potential for step-out resource expansion. 


Lindero Gold Project - In July 2016, FSM acquired Goldrock Mines Corp in an all stock transaction valued at $129 million.  This gave FSM 100% ownership of the Lindero open pit, heap leach operation in Argentina's Salta Province.  The mine will process 18,750 ton per day over a 13-year mine life, averaging 100,000 ozs of gold annually at an all-in sustaining cost of about $750/oz. 


Fortuna announced the start of pre-production mining at Lindero in mid-September.  The first gold pour is planned for Q1 2020.  This is an incredibly low-cost operation. Part of the reason for this is that the ore body is high grade with a low "strip ratio." The strip ratio is the amount of waste rock required to be processed in order to extract a tonne of ore. For instance, a 2:1 strip ratio means two tonnes of rock needs to be processed per tonne of mineable ore.  Lindero will have a strip ratio below 1 in the first year of operation.


Once Lindero is up and running efficiently, it will be a literal "cash cow," especially if the price of gold continues to move higher. 


The Company also has a of couple exploration assets. The Arizaro Project is situated in the Lindero land package. It's a gold-copper porphyry project on which preliminary exploration and drilling was conducted by the previous owners and which was followed-up by Fortuna with a surface core drill program of 2,178 meters over 12 holes down to 200 meters.  The results encountered near-surface gold-copper porphyry mineralization.


FSM also acquired a 24.2% in Medgold Resources, which owns the Tlamino Project, a high grade gold-silver project in Serbia.  FSM has an option to earn a 51% interest in Tlamino by spending $3 million in development by March 2020. It can earn an additional 19%, or 70% of the project economics, by spending an additional $5 million and completing a preliminary economic assessment by March 2023.


Why FSM dropped in price - In the frenzy of the first 6 months of 2016, FSM traded as as high as US$9.50. Since then the stock has trended down to as low as $2.40 in early May 2019. Most of the decline, I believe, can be attributed to the general downtrend in the price of gold and silver from July 2016 through May 2019.  In addition, the price of lead fell as much as 30% and zinc has dropped as much as 37% since early 2018.


In addition, Fortuna issued a $40 million convertible bond on September 10th which bears an interest rate of 4.65% and converts into 8 million shares at $5/share, or about 5% "dilution" upon conversion. The proceeds will be used to fund working capital requirements for the start-up of Lindero and for general corporate purposes. In a sense, the Company sold shares at $5/share to help fund the completion of Lindero but, as is almost always the case when a mining company raises money via an equity or convertible deal, the stock market reacted negatively.


Finally, the stock has been under pressure from the potential political risk that may result from Argentina's 2019 Presidential elections.  The incumbent, pro-business Mauricio Macri, lost to Alberto Fernandez, who ran on a "populist" platform.  The stock market is unhappy with the fact that his V.P. running mate is ex-President Cristina Fernandez de Kirchner, who imposed heavy trade and currency controls during her term as President. Marci rolled back her economic impositions when he took office in 2015.


While de Kirchner's presence does raise some concern, Fernandez is positioning himself as a middle of the road candidate. No one knows for sure what type of business and social policies he'll ultimately implement. To be sure, Argentina can not afford tax and economic policies which discourage business investment or capital flow into the country.


I asked Carlos Baca, FSM's investor relations manager, about the Company's view of the political situation. Carlos said its impossible to know if Fernandez will try to reimplement some of de Kirchner's economic policies. He did point out that Lindero is in a highly pro-mining province where authorities are actively engaged in supporting the mining industry.


Bottom line - Once Lindero is up and running, Fortuna will be producing annually between 7.5 and 8 million ozs of silver and 293k to 324k gold-equivalent ozs. FSM will have a total resource of 84.5 millon ozs of silver and 2.6 million gold-equivalent ozs. Of that, 45.6 million ozs of silver and 1.9 million ozs of Au-Eq represent proven/probable reserves. 


Converting the silver into gold-equivalent ozs, FSM will be producing roughly 400,000 ozs of gold-equivalent annually. The Company currently has 160 million shares outstanding, which is remarkably low for a Company with 2 operational precious metals mines and one starting up. Fully-diluted, assuming the latest convertible bond converts, FSM will have 172 million shares.


FSM's current market cap is US$492 million. On a relative comparison basis, Alacer Gold will produce approximately 400k ozs of gold in 2019.  While not a perfect comparable for various reasons, Alacer has a market cap of $1.14 billion.  Relative to Alacer, in my view, FSM is undervalued.


I believe the stock market, in the context of the last 6 weeks in which the precious metals market has been in a price correction/pullback, has over-penalized FSM for issuing a convertible bond, for Q2 numbers which were down relative Q2 2018 and for the potential - or lack thereof - political risk associated with Argentina's upcoming Presidential elections.


Keep in mind that FSM's stock was trading around $4.30 before it reported its Q2.  Because of the big price rally in silver in September, I expect Fortuna to beat easily its 2018 Q3 numbers when it reports its earnings on November 14th.  Finally, I also think, because of the overstated fear of political risk in Argentina, the market is not attributing enough value to the cash flow potential of Lindero, especially once gold resumes its uptrend.


Fortuna's shares have sold down to a level at which I believe the potential upside outweighs the risks connected to FSM's operations. I'm not looking for a home run move in the stock. But, if gold and silver continue to move higher over the next twelve months, I believe FSM is an easy double. In addition, it's the type of stock that balances out the high-risk of a mining stock portfolio that is primarily junior exploration shares.


This analysis is reproduced from Investement Research Dynamic's Mining Stock Journal. For more information on this mining stock newsletter:  Mining Stock Journal



Disclaimer:  IRD is not responsible for any loss arising from any investment based on any recommendations, forecast or other information contained here-in.  The contents of this publication should not be construed as an express or implied guaranteed, promise or implication by IRD or David Kranzler that the reader will profit from the strategies herein or that losses in connection therewith can or will be limited.  Any recommendations is derived from objective fundamental macro economic and company-specific calculations and subjective analytic assessment.  I may or may not have personal stock positions at any given time in the company presented.  I always fully disclose whether or not I'm long or short at the time of publication.

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