Tuesday, April 12, 2016

Endeavour Silver - Production Cuts Overshadowing This Excellent Company In The Short - Term

Endeavour Silver is a silver / gold producer, operating three mines in Mexico. 
It is quite a different company from its peers. Due to a very experienced management, Endeavour Silver runs its business without caring too much about the size of the company's mineral reserves. Let me explain this phenomenon - the chart below shows historical reserves and mine life, calculated for the Bolanitos Mine:

Mine life is calculated as reserves divided by production reported next year. For example, at the end of 2013 Bolanitos was holding 2,335 thousand ounces of silver, classified as mineral reserves. In 2014 the mine delivered 2,397 thousand ounces of silver so the mine life, calculated at the end of 2013 was 2,335 / 2,397 = 0.97 years. 

What am I trying to say? Well, the company's philosophy is to explore its current operating mines to be at least one year ahead with its production. It is totally different strategy than that applied by the others. However, it works. 

Since 2004 Endeavour has been increasing its production in an impressive way:

                source: the company's presentation (slide 11)

Summarizing - you will not find a technical reports showing the standardized mine plans. In other words, it is rather impossible to build a reliable production forecast, based on technical reports, feasibility studies etc. 

Therefore I may say that Endeavour Silver is built on its management team reputation so anybody interested in investing in the company's shares has to have strong trust in this team. 
In my opinion, this trust is well deserved. The chart above confirms this thesis (consistent production growth).

Another thing - as a rule, Endeavour Silver's management is focused on acquiring the old and depleted mines. Then, thanks to its excellent exploration and development skills, the company is able to discover new, economically viable deposits and start profitable production. The first two mines, Guanacevi and Bolanitos, were acquired applying this philosophy. The third mine, El Cubo, was an exception - it was purchased as an ongoing operation.

The economics of operating mines

The chart below shows the 2015 production breakdown: 

As the chart shows, the largest mine in the company's portfolio, in terms of the scale of production, is El Cubo, acquired in 2012 (in 2015 this mine delivered 4,3 million ounces of silver equivalent). However, El Cubo is still ramping up its production so financial results, delivered in 2015, were lower than those reported by Guanacevi and Bolanitos.

For example, operating margins, delivered by El Cubo, were lower than those reported by the other two mines:

Of three operating mines, the best one has been the Bolanitos Mine. Although the ore grades reported at this operation are substantially lower than those reported at Guanacevi (in 2015 the silver grades were standing at 118 grams per ton of ore at Bolanitos while Guanacevi reported the average grade of 295 grams per ton), the Bolanitos operating margin has been generally higher than that delivered by Guanacevi (with one exception in 2015):

source: Simple Digressions

Note: operating margin is defined as revenue less operating cash cost

2016 Guidance

The picture below shows the 2016 production guidance:

source: the company's presentation (slide 7)

As the picture shows, Endeavour Silver plans to produce much less silver and gold than in 2015. The company explains (page 30):

"The projected decrease in production, compared to 2015, is due to the Company’s efforts to focus on minimizing all-in sustaining costs and improving after-tax free cash flow rather than maintaining metal output"

Well, it is quite ironical that Endeavour Silver's management wants to cut its production when gold and silver prices have just started their big rally. 

However, the question is whether the management is going to change its mind and, if this rally is developing further, the 2016 mine plan is to be verified. I do not know but I think that it would be ridiculous if the company's management were not to verify this plan in such circumstances. 

Anyway, a few days ago the company announced its 1Q 2016 operating results

As the picture above shows, in 1Q 2016 Endeavour Silver cut its production, as expected. Having these figures, I have prepared my estimates of 1Q 2016 financial results. Here are my assumptions:

  • gold price realized: $1,184 per ounce (the average gold price in 1Q 2016)
  • silver price realized: $14.90 per ounce (the average gold price in 1Q 2016)
  • gold sales: $18,062 thousand
  • silver sales: $22,519 thousand
  • production costs (direct production costs + royalties + share-based compensation + depreciation and amortization + exploration + administrative expenses): $16.4 per ounce of silver equivalent sold (no change, compared to 4Q 2015)

If my assumptions are correct, in 1Q 2016 the company should incur operating loss of $4,100 thousand (in 4Q 2015 the company lost $4,143 thousand). 
Note that despite lower production, 1Q 2016 financial results should be similar to 4Q 2015 results - it is a result of higher gold and silver prices in 1Q 2016.

The EBITDA should stand at $6,574 thousand, which means that at the current share price of $3.03 a piece, the company would be valued at a multiple of enterprise value / EBITDA standing at 17.4. In my opinion, it is quite an elevated reading. The chart below shows current valuations, calculated for the biggest silver miners:

As the chart shows, Endeavour is overvalued against its peers (the average multiple is standing at 14.3 - black, horizontal line). 

On the other hand, using the EV / EBITDA metric, two companies, namely Klondex and Hochschild, are currently undervalued against other silver miners.

Note: Hochschild has hedged a substantial part of its production against lower silver and gold prices - if the rally in precious metals continues, these hedges are going to drag the company's results down.


Endeavour Silver is an excellent company run by a very experienced management team. In my opinion, although currently the company's shares are overvalued against its peers, in the long-term Endeavour Silver should be a very attractive investment target. The chart below shows that since 2002 the company's shares have been much stronger than the other gold and silver big miners. However, in the short and medium - term these shares, due to production cut, may be lagging behind peers. 

                            source: www.stockcharts.com

As I noted above, the main issue is whether the company's management is going to change its mind and quickly increase production when silver and gold prices continue their current rally. If it does not change its mind I think that other silver miners should be more attractive than Endeavour Silver. 

1 comment:

  1. Interesting take on this miner from a short and long term perspective My guess is there is an attached premium tied to the management of this company similar to what we are seeing in McEwen and Randgold. Money follows management afterall.I particularly like the management thinking behind acquiring old and depleted mines