Endeavor Silver: Limited margin of safety at current levels

A little over seven weeks ago I wrote on Endeavor Silver (NYSE:EXC) and noted that while the company’s operating performance was solid for the year, its margin profile left a lot to be desired. This is due to the all-in sustaining cost [AISC] came in H1 at $20.22/oz while the all-in cost was over $26.00/oz. While this cost profile may have worked during the silver crisis and for part of fiscal 2021, with silver prices below $20.00/oz it doesn’t work nearly as well as the Company is experiencing today. Additionally, the recent decision to hold back inventories certainly hasn’t paid off for now.

Given the negative all-in-sustaining expense margins, it was hard to justify owning the stock. Unsurprisingly, the stock is down more than 20% since my last update, with silver prices continuing to suffer. The stock has recovered since late September, but little has changed from a fundamental standpoint. If anything, the investment thesis has weakened, with Endeavor potentially borrowing at a higher interest rate since it’s used to fund Terronera. Let’s take a look at the third quarter results below:

Q3 production

Endeavor Silver released its preliminary Q3 results last week and reported quarterly production of ~1.46 million ounces of silver and ~9,200 ounces of gold. This represented an 11% increase in silver production over the same period last year, partially offset by a 13% decrease in gold production. However, considering the Company was operating with two mines versus three (closure and sale of El Compas), this was a solid performance and above plan due to Guanacevi’s above average salary performance. As a result, Endeavor is poised to potentially reach the high end of its forecast range of ~8.0 million silver equivalents [SEOs]with ~6.3 million SEOs YTD.

The star, as usual, was Guanacevi, whose mine produced ~1.33 million ounces of silver and ~3,600 ounces of gold in Q3 2022. This represented over 1.60 million SEOs over the period, beating the results of Q3 2021, although up against tough competition as it represented an increase of over 45% year-on-year for the mine. On a two year basis, production at Guanacevi has increased by approximately 65%, supported by increasing grades at the plant. Endeavor noted in the third quarter that high grades at El Curso helped increase production and beat budget, with grades further supported by ore purchases from third parties (representing 12% of quarterly minerals processed during the period). tons).

Remarkably, this increase in production came despite heavy rainfall, which affected throughput at the end of September and resulted in slightly fewer tonnes processed than planned. Guanacevi processed ~97,700 tonnes at an average grade of 468 g/t silver and 1.29 g/t gold in the third quarter, at an average recovery of 90.6% for silver and 89.9% for gold. The Company noted that it continues to explore opportunities to potentially increase throughput beyond the 1,200 tpd capacity and is investigating the possibility of changes in grind size and leach time.

According to Bolanitos, the mine produced approximately 126,300 ounces of silver and approximately 5,600 ounces of gold, increasing year-to-date production to approximately 470,000 ounces of silver and more than 16,000 ounces of gold. This represented a slight increase in silver production over the same period last year offset by a decrease in gold production impacted by much lower grades and slightly lower throughput (1.88 g/t gold vs. 1.09 g/t gold). . However, the problem for Bolanitos will be reserve replacement, with combined Reserves and Measured & Indicated resources now only amount to ~1.3 million tonnes (year-end 2021), which at the current processing rate equates to barely three years of mine life.

Silver price & current developments

While Endeavor’s operational performance is commendable and certainly much better than what we’ve seen in previous years, this has been overshadowed by a sharp decline in silver prices and rising costs. From the point of view of operating costs, the total cost of Endeavor [AISC] came in at just under $20.50/oz in the first half of this year, giving the company razor-thin margins. However, assuming slightly higher costs in the second half of 2022 and silver prices below $20.00/oz, I would expect AISC margins to turn negative. Regarding Q3, I wouldn’t be surprised to see AISC margins of (-)$0.70/oz, with the average realized price possibly under $20.50/oz.

That’s certainly not ideal from a profitability standpoint, and it doesn’t help that Endeavor is holding back inventory in the second quarter to sell at higher prices, which didn’t work this time. In fact, Q3 silver futures price spent less than five trading days above its Q2 lows, and Endeavor currently has ~1.53 million ounces of silver, ~3,200 ounces of gold and additional concentrate in its inventory. Endeavor has had some success with this strategy so far, but I don’t like this strategy in a turbulent market environment for the S&P 500 (SPY) where many assets are being dragged down past expected support levels.

Some investors may note that the current cost profile of $21.00/oz is not a big deal and a move back above $24.00/oz will easily put the company back in good shape from a profitability standpoint. However, this is not the case as the Company’s total costs for H1 2022 are in excess of $26.00/oz including growth exploration/assessment and growth investments. This means that from an overall cost perspective, Endeavor is actually losing $6.00/ounce for every ounce it sells at current prices.

With Guanacevi grades significantly exceeding reserve grades year-to-date and the Company grappling with inflationary pressures, we could see total costs continue to rise above $26.50/oz in fiscal 2023, which would make it very challenging the company to generate free cash flow without higher gold/silver prices. So while I previously assumed that cash flow from operations could help fund Terronera a bit, with silver prices well above $25.00/oz for much of 2021, that doesn’t appear to be the case, at least based on the current landscape. Let’s get to the rating:

valuation

Based on approximately 195 million fully diluted shares and a share price of $3.30, Endeavor has a market capitalization of approximately $644 million. This represents a P/NAV multiple of 1.31 compared to its estimated net asset value of $490 million. While this has been at the bottom of the stock’s range for the past two years, Endeavor is also in the weakest position from an operational perspective it’s been in the past two years, down from four mines to two mines and likely two consecutive quarters of negative all-in sustaining expense margins unless the silver price can recover very quickly.

Based on what I believe to be a conservative multiple of 1.25x P/NAV to reflect Endeavor’s leverage and solid development pipeline offset by the high cost profile, short reserve life at Bolanitos and less favorable jurisdiction profile I see a fair value for Endeavor at $3.15 per share. This suggests limited upside potential for EXK from current levels, particularly if the company sees any share dilution in its funding of Terronera over the next 18 months.

With over $100M in cash and the ability to fund the remaining ~$100M with debt (estimated ~$200M adjusted for investment for inflation), I don’t see any significant stock dilution as likely. However, given the current silver prices, it cannot be ruled out that no free cash flow is currently being generated. So if we saw stock dilution, Endeavor Silver’s fair value would continue to fall from its current $3.15. In summary, I think there are far more attractive bets elsewhere in the sector from a valuation perspective. With a required 30% discount to fair value to justify buying small-cap miners, EXK would only become interesting below $2.20.

Technical picture

The technical picture confirms that EXK is not yet in a de-risk buy zone with strong resistance at $4.05 (broken previous support) and no strong support until $2.50. Based on the current share price of $3.30, this translates to an unfavorable risk/return ratio of 0.94 to 1.0, with $0.80 of potential downside to support and $0.75 of potential downside Upward move to resistance. In a cyclical bear market like the one we are witnessing in the Silver Miners Index (SIL), the ideal strategy is to go long at the support ($2.50) or fold all the way. So, technically, I don’t see a cheap entry here either, as the ideal pre-year swing trading entry is $2.52 or below (within 2% of support).

summary

Endeavor Silver had another solid quarter in Q3 and when it comes to things under its control it has done a great job this year in meeting expectations. However, the price of silver, which is beyond its control, has weighed heavily on margins. This has given Endeavor a negative all-in cost and even a rally back to $24.00/oz is not going to help much. Given that EXK continues to lag industry margins and first production at Terronera is at least two years away, I continue to believe that strong rises above $3.75 will provide take profit opportunities. In summary, I see far better opportunities elsewhere in the sector, favoring names with lower cost profiles like SilverCrest Metals (SILV).