Endeavor Silver Stock: Rauer H2 Ahead (TSX:EDR:CA) (EXK)
The Q2 earnings season was difficult for the Silver Miners Index (SIL) as several companies reported sharp falls in margins as they outweighed the benefit of higher silver prices (SLV) combined with a strong price Increase in costs (labor, steel, energy, fuel). Based on easy year-on-year comparisons for the second quarter of 2021 from a cost perspective and a solid quarter for production, Endeavor Silver (NYSE:EXC) bucked this trend. However, this will not be the case in the second half of 2022. In fact, Endeavor’s margins will turn negative. Given the rough Q3 and Q4 results on deck, I continue to see far better bets elsewhere in the sector.
A little over six weeks ago, I wrote about Endeavor Silver (EXK) and noted that while the stock was in a low-risk buy zone at $3.00 from a swing trading perspective, rallies above $3.75 before October created profit-taking opportunities would represent. Since then, the stock has rallied strongly to alleviate its oversold condition but peaked at $3.85 and failed to maintain its bullish momentum in a turbulent market environment as silver prices were unable to get off the mat and level from $20.00/oz. Although we have now returned to the same price level, EXK remains in a much weaker position than its peers, making it a riskier buy-the-dip candidate. Let’s take a closer look below:
Q2 production & distribution
Endeavor Silver (“Endeavour”) released its second quarter results earlier this month and reported quarterly production of ~1.36 million ounces of silver and ~9,300 ounces of gold, both exceeding my estimates. Impressive grades at Guanacevi (465 grams per tonne silver) and better silver grades at its Bolanitos mine helped. Solid performance prompted Endeavor to raise its full-year guidance by ~10% at mid-term and now expects 7.6-8.0 million silver equivalent ounces [SEOs] vs a previous forecast of 6.7-7.6 million SEOs, a commendable performance at a challenging time for many miners (work shortages, COVID-19 lockdowns).
While this may cause some investors to cheer, it is important to note that based on this updated forecast, Endeavor expects lower H1 production with the potential for grades at Guanacevi to moderate following a phenomenal H1 performance. Assuming grades drop closer to 400 grams per tonne silver, slightly offset by higher throughput, we should see a 10% decrease in Endeavour’s SEO production on a consolidated basis from H1 2022 to H2 2022. This is not ideal from a cost perspective Endeavor notes that cost pressures are likely to continue as higher steel, reagent, energy and labor prices impact costs and costs are already well above industry average despite increased production levels.
The only trade-off is that if silver prices stay at these levels, Endeavor will see a slight advantage from a royalty perspective, with El Curso (Guanacevi) royalty growing at 9% with silver prices below $20.00/oz down from 13% previously ($20.00/oz – $25.00/oz).
From a sales perspective, higher production certainly wasn’t reflected in revenue, which fell 35% year over year to $30.8 million. This was because the company held significant inventory for sale due to lower silver prices. During the period, Endeavor noted that it sold only 602,900 ounces of silver (~45% of payable ounces) and ~9,800 ounces of gold (107% of payable ounces produced), giving it a inventory of approximately 1.4 million ounces of silver in value had ~$27 million at average realized silver prices in the third quarter. While the sales decline was disappointing, this was largely due to Endeavor’s strategy of holding back a large portion of inventory during downturns and selling off during stronger ones.
Adjusted for this silver inventory, revenue would have been up more than 20% year over year despite having one less asset operating.
Costs & Margins
Looking at Endeavor’s costs, the results were a lot less pretty, as the company reported all-in-sustaining costs [AISC] of $19.56/oz in the second quarter and AISC of $20.22/oz year-to-date. While this translated into higher AISC margins year-on-year in the second quarter ($3.16/oz vs. $1.43/oz), this was only due to Endeavor having brutally easy year-on-year peers that lapped a quarter AISC from $25.39/oz (Q2 2021). However, year-to-date AISC margins have fallen to just $3.73/oz, but this is due to the average realized silver price of $23.95/oz.
While these margins may not seem too bad, and they exceeded my estimates in the second quarter due to higher than I expected second quarter production, the poor margins the company was enjoying have been wiped out by recent silver price weakness. This is because silver is currently priced below $19.00/oz and Endeavor had expected fiscal 2022 costs to be at the high end of its guidance range ($20.00 – $21.00/oz). This indicates that Q3 costs are expected to be in excess of $21.60/oz resulting in AISC margins of (-)$1.30/oz even if Endeavor sells at an average price of $21.30 in Q3. This seems unlikely given that silver’s quarter to date averaged $20.00/oz.
Some investors might forgive this margin squeeze and choose to stay the course and stay invested, believing that a move above $21.00/oz in silver will fix these issues immediately. However, as the chart above shows, Endeavor’s total cost in H1 2022 (growth capital and exploration) was ~$26.00/oz and is likely to increase to over $26.50/oz in H2 2022. The little pink box highlights the full-in cost estimates for fiscal 2022 and shows how many days Endeavor was sold at a profit from an overall cost perspective. With silver prices falling out of bed, even a 30% rally in silver prices would still result in selling at a loss on an all-in-cost basis.
That’s important, because while a company can temporarily get by on reduced spending (growth capital, exploration), it’s not sustainable over the long term, and it’s not healthy for an exhausting asset to make ends meet on reduced exploration spending. That point couldn’t be more relevant in an inflationary environment where companies may need to rely on growth capital and higher-value discoveries to offset margin erosion. So while silver’s fall below $20.00/oz is not the end of the world for Endeavor, it would be negative for its assets if it were unable to recover above $22.00/oz for an extended period of time.
One risk is that Endeavor may need to further dilute shareholders if it wants to invest appropriately in these assets. That’s because its treasury and debt will be consumed primarily by funding Terronera, with upfront investments expected to exceed $200 million ($175 million estimate at a 15% cost escalation due to inflationary pressures). Let’s check out Endeavor’s rating below:
Review & Technical Image
Based on an updated, fully diluted share count of approximately 195 million and a share price of $3.10, Endeavor has a market capitalization of approximately $605 million. This represents a P/NAV multiple of 1.23 compared to its estimated net asset value of US$490 million (adjusted lower to reflect higher operating costs at existing mines and higher construction costs at Terronera). While this is the lowest valuation Endeavor Silver has traded at in years, Endeavor is also in the weakest position it has been in in the last two years and is expected to have two consecutive quarters of negative all-in-sustaining reports. Report cost margins.
The key differentiator for Endeavor over its other high-priced peers is Terronera, a high-grade and ultra-low-cost asset that could become the Company’s third mine by Q2 2025. However, this does not help Endeavor today and wins. That won’t help them in 2023 or 2024. While I think Endeavor could become investable at the right price or closer to Terronera’s original production, I don’t see that as the case at this time. That’s especially true given that Terronera faces some downside headline risk if inflationary pressures drive capital spending well above projected levels ($175 million), even if this has been partially mitigated by purchases of some long-term items.
Endeavor Silver could have one of the best undeveloped silver assets in its portfolio from a margin standpoint, and there’s no question that this could be a very different company after 2024. However, given that it will take more than 26 months to reach commercial production, I see a higher risk of stock dilution to commercial production if the silver price stays below $22.00/oz (assuming Endeavor wants to invest appropriately in its assets) . There is also risk of reserve deletions as Endeavor bases its mineral reserves at $23.00/oz and cut-off grades are likely to rise due to inflationary pressures.
While I think those risks are partially priced in and Endeavor has more momentum than ever due to its even higher cost profile, it’s not easy to determine a fair value for the company when stock count could be a moving target when it comes to trading Silver goes Prices do not improve. In the meantime, some headline risk could weigh on the stock if Terronera’s capex is revised above $200 million and/or a disappointing reserve update in Q1 2023. Given these risks, and with Terronera more than two years away, I continue to see EXK as uninvestable and a much riskier way to play silver. If I were looking for silver I would prefer SilverCrest Metals (SILV) with ~55% AISC margins even at current silver prices.