The following analysis is from the August 10th issue of my Mining Stock Journal. Click MSJ Information to learn more about this mining stock newsletter.
Fortuna Silver (FSM, FVI.TO – US$2.95) – Fortuna released its Q2 numbers after the close on August 9th. The stock was shot in the head, opening down as much as 12%. Unfortunately the current market sentiment and environment with respect to mining stocks is such that any unexpected “miss” in earnings, even when the causation is non-recurring and the numbers will bounce back the next quarter, triggers a big sell-off in the share price. This occurred with SILV (reviewed below) and Hecla.
On a YoY basis, FSM’s sales declined 6%, mine operating income fell 2% and operating income dropped 41%. Net income actually rose from $1.6mm in Q2 2022 to $3.2mm in Q2 this year due a huge reduction in the income tax attributable to a loss at San Jose as well as lower income before taxes. Unless the prices of gold and silver move substantially lower in Q3, I expect that the decline in revenues etc will be a one-quarter issue this is almost entirely attributable to non-recurring issues during Q2.
The reduction in operating income was due mainly because of the lower volume of metal sold at San Jose from the 15-day mine stoppage due to the illegal blockade at the mine and lower volume at Lindero related to the mine sequence (transitioning from a depleted reserves “block” to the next reserves block). While sequencing occurs intermittently, it is a temporary issue but resulted in higher input costs and lower processed gold grades.
Fortuna settled the labor dispute expeditiously and decisively. However, the Company incurred a $6.3 million non-recurring expense connected to the work stoppage and strike settlement ($2.8 million related to the new labor agreement) and $3.5 million related to one-time charges at San Jose and Yaramoko. In addition, a $1 million administrative penalty payable to the Ministry of Mines was incurred at Yaramoko. The Yaramoko non-recurring expenses were connected to the temporary stoppage of underground mining at the mine.
All of the above had the effect of an unexpected spike higher in the all-in sustaining costs (AISC) per ounce for the quarter. The largest component of this was due to the stoppage at San Jose which resulted in lower Au-Eq ounces sold which caused the cost per ounce to soar for the quarter. In addition, the sustaining capex at Lindero jumped due to the additional expense related to Phase 2 of the leach pad expansion and higher capitalized stripping costs related to the sequencing. Stripping costs a Lindero will revert to a normalized level in Q3 and decline from there in Q4. In addition, the additional capex for higher underground development plus the work stoppage to accomplish this at Yaramoko added to the temporary AISC increase. Note that additional capex/sustaining capital expenditures at Lindero and Yaramoko are positive net present value investments.
Also note that although over 4,000 ounces of gold were produced at Seguela, the gold was not sold until early in Q3. This means that the Company did not get the benefit of the revenues from the gold produced but it has to account for the expense of producing that gold and ramping up the processing facility in the period that the gold was produced. Again, FSM will recapture this loss in Q3. Additionally, Seguela will contribute a full quarter of production, operations returned to normal at San Jose at the end of Q2, Yaramoko is now performing above expectations and the stripping phase at Lindero was completed in Q2. This should result with revenues, profitability and free cash should more than bouncing back in 2H 2023.
The Company reiterated that it expects to achieve full-year production guidance of 6.3mm to 6.9mm ozs of silver and 282k to 320k ozs of gold. San Jose is at risk of finishing the year below guidance offset by Caylloma and Yaramoko achieving the upper end of their guidance range. Seguela is expected to meet the lower end of its guidance range and Lindero is on track to achieve guidance. San Jose and Seguela are both sources of potential upside surprise.
I expect FSM’s numbers to more than recover from the non-recurring events that affected the Q2 results. The additional capex at Yaramoko and Lindero should improve the profitability of those two gold mines. Also, Yaramoko is now performing above the expectations that were set when the Company had to revise lower the proven/probable reserves. Stripping costs at Lindero will improve to less than 1:1 in Q4 which will boost profitability per ounce.
Because I have this conviction, I put on large position in the September 15th $3’s in my personal account (one of my largest call positions ever). If the stock does not recover in the next couple of weeks, I’ll move the calls out to December.