Silver Endeavor (NYSE: EXK) is a silver mining company with two producing assets in Mexico. The company’s modus operandi has traditionally involved the acquisition and subsequent turnaround of mature and seemingly depleted silver mines. The two mines in operation, Guanacevi and Bolanitos, are success stories in this regard, but there are also examples where Endeavor Silver‘s business model has produced less than ideal results (think El Cubo mine for example).
A change in the management team at the beginning of last year also led to a change in the business model. The company is now advancing its growing portfolio of development projects, with the apparent aim of building its next future silver mines in-house rather than acquiring them. The Terronera project is an example of this new approach, a project the company has taken from initial exploration to the feasibility stage over the past twelve years, with a final construction decision expected shortly. And doubling down on this new strategy, the company is in the process of completing the acquisition of the Pitarrilla project from SSR Mining (SSRM), another advanced development project likely to take second place in the company’s project development pipeline, ahead of another in-house development story, the Parral project.
With the recent divestment of the El Cubo mine, the pending construction decision on Terronera and the acquisition of the Pitarrilla project, the company seems committed to this change in business model and will need to execute this new strategy in the coming years to maintain credibility with investors. The company deserves credit for embarking on this strategic shift, but the timing left Endeavor Silver in a vulnerable position.
There is no shortage of examples of mining companies experiencing delays and cost overruns when building a mine at the best of times. And unfortunately, the task of carrying out capital mining development projects has just become more difficult, as times are far from “better” right now. Price volatility has increased dramatically and the supply of labour, building materials and equipment has indeed become very unreliable. The combination of execution risk factors to be managed during mine construction has certainly increased significantly in recent times.
We’re not talking about outlandish theoretical risk factors here. In fact, the manifestation of increased levels of execution risk can be observed in real time at many mine construction sites. To list just two examples of textbooks to emphasize this point:
- IAMGOLD’s (IAG) 70% share of the initial investment for the construction of the Cote mine was estimated at $900 million when the construction decision was made in mid-2020. Fast forward to the end of the first quarter of this year: the project is 49% complete; however, the remaining investments to be financed by IAMGOLD decreased only slightly to $875 million (midpoint of the range provided in both cases).
- Or consider Argonaut Gold (OTCPK:ARNGF) and its tribulations at the Magino Gold Project as another example. When the construction decision was announced in October 2020, the initial investment needed to build this mine was estimated at $370 million. Fast forward to the end of the first quarter, the mine is half built and the capital expenditure estimate has soared to $715 million, leaving Argonaut to raise capital on ruthless terms.
Arguably, both of these projects would have struggled down the road, regardless of the overall market environment. However, it’s also pretty obvious that at a bare minimum general cost inflation, supply chain issues, and ongoing COVID-related challenges have exacerbated the fallout (if they didn’t cause the challenges first place, as others might say). This is not to say that miners cannot deliver investment programs on time and on budget despite difficult market conditions (the recent completion by Alamos Gold (AGI) of the La Yaqui Grande mine in the Mulatos mining complex in Mexico is a good example). However, these feats are fewer in number and more widely spaced out than before and generally reserved for experienced and accomplished mine builders; and Endeavor Silver do not fall into this category.
Endeavor Silver could still deliver the Terronera build within budget, but the risk of not delivering the project within budget increases. Financial institutions certainly understand the current high execution risk environment and assess that risk accordingly when financing mine construction projects. The Terronera Project Feasibility Study presented a strong project when released in September 2021. The study showed a NPV (5%) of $174.1M and an IRR of 21.3% for a project of 175 M$. However, with rising construction costs, the reported NPV is bound to come under pressure; and with the rising cost of capital, a discount rate higher than 5% would probably have to be applied. And given these considerations, the project suddenly begins to look much less solid under current conditions. Endeavor Silver is currently setting up a financing program for Terronera and the terms offered by financial institutions will most likely reflect the increasing risks discussed above.
All this to say that general market conditions have taken a turn against Endeavor Silver’s planned change in business plan over the last year or two – risks and costs are rising, and so is the cost of capital.
The decision to build Terronera is still pending and Endeavor Silver could still decide to postpone construction of the mine until market conditions have calmed down again. However, if this idea were to take hold, investors would most likely refocus on the performance of the company’s existing portfolio of producing mines. And it’s not really the prettiest of looks. Both operating assets did not generate free cash flow in 2021, even if one discounts growth capital and only considers maintenance capital.
Some green shoots are appearing in Q1 when it comes to free cash flow generation, but even though we are optimistic and extrapolate Q1 results for the rest of the year, Endeavor Silver is still trading at 17.5xFCF. This valuation is warranted as long as the current organic growth story underpins it, but it would most likely be significantly reduced if this growth story were delayed.
Additionally, there is another issue that will weigh on the FCF multiple if the market decides to price Endeavor Silver this way. Capital investment at the two operating mines has been minimal in recent years, and reserves and resources have declined to worrying levels, particularly at the Bolanitos mine. As it stands, Bolanitos has just over a year of reserve-based mine life left, plus a few resource years. This mine is at acute risk of running out of crusher feed in the near future, and if left unaddressed, this issue will weigh heavily on the company’s valuation. Interestingly, there is an obvious solution, or better, there was until just a few days ago. Great Panther Mining (GPL) operates the San Ignacio mine in the immediate vicinity of Endeavor Silver’s Bolanitos mine. Several known veins run from property to property and are mined on both sides of the fence by the two respective companies. As we have repeatedly argued over the years, the two mines really should be combined into one operation.
With Great Panther struggling financially due to its misadventures in Brazil, one would assume that there might have been a distressed potential seller of the San Ignazio mine – and it turns out that assumption isn’t. not far from the truth; except that it is not Endeavor Silver that benefits from the situation, but Guanajuato Silver (OTCQX:GSVRF). This is the same junior miner that purchased Endeavor’s El Cubo mine and is now acquiring Great Panther’s Guanajuato operations, consolidating large parts of the Guanajuato silver district. Now, there are several question marks hanging over this particular transaction, especially in the context of the original Guanajuato mine, which is also part of this deal, but San Ignacio would certainly have fit into the portfolio very well. ‘Endeavour.
Seeing how Guanajuato Silver has consolidated the Guanajuato silver district, we speculate if Endeavor Silver is talking to the junior about a possible sale of the Bolanitas mine. Such a move would make sense for both parties and, from Endeavor Silver’s perspective, would allow the company to focus more broadly on building Terronera, while reducing exposure to financing terms (assumed ) expensive.
Summary and investment thesis
Endeavor Silver has changed its business model, and rather than acquiring another producing silver mine, the company will most likely announce a construction decision for its Terronera project in the near future. Execution risks are increasing, and this will be reflected in the financial package the company is putting in place. In this context, we see potential in the sale of the Bolanitas mine to supplement financing and allow greater management focus on the construction of the Terronera mine.
The market is apparently attributing value to Endeavor’s pipeline of development projects, adding pressure on the management team to go ahead with construction of the mine rather than wait for more conditions. favorable.
Endeavor Silver’s share price has performed in line with its peers and there is little reason to believe that will change as the company’s intention to build the Terronera mine has been known to the market for some time. time. Weighing the risks, we see increasing downside risks in the short to medium term as construction gets underway; and we only see upside potential in the longer term as Terronera begins to generate cash flow. We are therefore not buying at the moment; but we will follow developments from the sidelines with great interest. After all, buying opportunities tend to arise when a company is exposed to high levels of risk.