Endeavour Silver: A Production Growth Story (TSX:EDR:CA)

Introduction

Endeavour Silver (NYSE:EXK) is a production growth story with two large projects in their pipeline. Terronera is under construction, with production targeted for Q4 2024. Pitarrilla is several years away from production, but will become their focus in 2025. Parral is their third potential development project that will likely add production.

There are many interesting silver growth stories today. We have Avino, which will steadily add production over the next five years. Then there is GoGold, which has two mines to build at Los Ricos. Also, Discovery Silver, with its huge project. Bear Creek has Corani, which is construction-ready.

All of these projects are in Mexico except Corani. In fact, all of Endeavour’s properties are in Mexico. There are several things I like about Endeavour versus these other projects. First, I think they have the best management team in the group. They are very good mine builders and operators. Plus, Terronera is already funded and under construction. That said, I’m the type of investor that would own them all. I don’t know which company will be the best performer. But I like the risk-reward the best with Endeavour.

The one thing I don’t like is the long wait until Pitarrilla gets to production. It could easily be 4 years away. So, that’s a long wait. But it is on my favorites list, and I consider it a must-own stock. Why? Because I know it will participate with higher silver prices.

I know from experience that I don’t want to watch a silver mining stock scream higher with silver prices, and I don’t own them. Been there, done that. It’s no fun. There are certain silver miners that we know are going to participate. This is one of them. Why? Because there simply are not many quality pure silver plays out there.

One thing I always like to point out is that investing in PM miners is speculating. We are gambling since so many things can go wrong. Keep your allocations low and expect to lose money on some of your PM mining stocks. What we are really betting on is PM prices going higher. If silver prices rise, then Endeavour will be in a strong position. If silver prices languish, then bad things can happen.

Stock Name	Symbol (US)	Type	Category	Share Price (US)	FD Shares	FD Mkt Cap (7/19/2023)
Endeavour Silver	EXK	Silver	Mid-Tier Producer	$3.78	195M	$737M

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Company Overview

Endeavour Silver is a silver/gold producer in Mexico. They have 2 high-grade silver/gold producing mines, with expected production of 6 million oz in 2023. They have high cash costs ($10 per oz) and high all-in costs (free cash flow) around $22 per oz. But their next mine (Terronera) has low cash costs ($1 per oz) and will reduce their all-in costs significantly.

They have about $60 million in cash and $12 million in debt. I’m somewhat surprised that their share price has held up with their high costs. But investors like their growth potential, and they are one of the few pure silver/gold miners with no base metals. Their next project (Terronera) will add 3 million oz of silver production in 2024 (Q4). All-in costs (break-even) are projected to be only about $8 per oz at Terronera. That will fix their high-cost problem and increase silver production by 50%.

They recently acquired the large Pitarrilla project from SSR Mining. This is a game-changer for the company. However, will take at least 4 years to develop a starter mine. It is a 500M oz silver deposit (about 150M oz silver underground), but is constrained by water issues. They have enough water to potentially produce 6-8 million oz a year (both open-pit and underground). They plan to focus on an underground mine.

In 2016, SSR Mining did a PFS for an underground mine at Pitarrilla to produce 6 million oz of silver. They also did a feasibility study in 2012 to produce 15 million oz of silver from an open pit. However, water issues forced them to abandon the open pit strategy. If Endeavour can find more water, this could be a huge mine.

I am only valuing Pitarrilla as a 150 million oz underground mine with 6 million oz of future production. This is a very conservative approach.

They also will develop Parral, which has a target of around 50 million oz. This could easily add an additional 2 million oz a year of silver production. This total is not included in my future valuation, since it is likely more than 5 years away.

Strong silver producers like Endeavour could really fly if we have a mania in mining stocks because there are so few pure silver producers. Look for Endeavour to use their cash flow and exploration to grow production. The other wild card is growing production growth via an acquisition. Companies of this size are always looking for ways to grow. The one thing we don’t want is for them to get swallowed up by a much larger company. Hopefully, that won’t happen.

The main thing that could hurt them is sub $20 silver prices for an extended period. However, they can raise money from equity financing or use debt to survive. They can also put a mine on care and maintenance. Note that Terronera has low costs and can survive any silver price.

I’m not that concerned about them surviving for the long term. I like the fact that management has kept their debt low. Plus, this is a company that should thrive with silver prices over $25. They plan to grow production to at least 15 million oz of silver. I consider them a growth stock. If I knew the timeline until production for Pitarrilla, I would be more excited about their long-term potential.

Pitarrilla Resource

M&I: 491 million oz silver grading 96 gpt, 1.1 million lbs of lead grading 0.31%, 2.6 million lbs of zinc grading 0.74% for a total of 693 million oz silver AgEq grading 136 gpt.

Inferred: 99 million oz silver grading of 87 gpt, 281 million lbs of lead grading 0.36%, 661 million lbs of zinc grading 0.85% for a total of 151 million oz AgEq grading 132 gpt.

Total: 850M oz AGEQ at 134 gpt.

Note: I’m only including 150M oz of silver in my valuation due to water issues.

Company Info

Cash: $61 Million.

Debt: $12 million

Current Silver Resources: 350 million oz.

Estimated Future Silver Reserves: 250 million oz.

Estimated Future Silver Production: 15 million oz.

Estimated Future Silver All-in Costs (breakeven): $25 per oz.

Estimated Future FCF Multiple: 10

Scorecard (1 to 10)

Properties/Projects: 8

Costs/Grade/Economics: 7

People/Management: 7.5

Cash/Debt: 7.5

Location Risk: 6.5

Risk-Reward: 7.5.

Upside Potential: 8

Production Growth Potential/Exploration: 8

Overall Rating: 7.5

Strengths/Positives

Production growth.

Significant upside potential.

Strong management.

Pure silver play.

Strong brand name.

Good balance sheet.

Risks/Red Flags

Long wait for Pitarrilla production.

Dependence on higher PM prices.

Location risk.

Could be acquired.

Speculation stock (high risk).

Estimated Future Valuation ($75 silver)

Silver production estimate for the long term: 15 million oz.

Silver All-In Costs (break-even): $25 per oz.

15M oz. x ($75 – $25) = $750 million annual FCF (free cash flow).

$750 million x 10 (FCF multiplier) = $7.5 billion.

Current FD market cap: $737 million.

Upside potential: 900%.

Future Valuation Explained

This is an estimated return and will only occur if all assumptions are correct. A more likely outcome will be something less than this amount, although it is not crazy talk to expect silver to exceed $75 or the FCF multiple to reach 10.

My All-In Costs are the expected costs that will generate FCF.

I used a future FCF multiplier of 10, which I think is conservative for my expectations. I expect them to receive at least a 15 multiple.

I used a future PM price of $75 silver because I am a long-term investor who plans to wait for higher silver prices. I expect to see this level reached within 3-5 years. In fact, I use $100 silver for valuations on my website since that is my expected future price. I tone it down a bit to $75 on Seeking Alpha, which I think is more reasonable.

It is my opinion that gold drives the silver price and that macroeconomics drives the gold price. The only reason I expect to see $100 silver is that I expect to see at least $3,000 in gold.

A $75 or $100 silver price may seem like pie-in-the-sky fantasy, but silver traded at $49 in 2011 when gold was at $1,935. If gold rises 50% from its current level, there is a good chance that silver will rise 150%. This is usually what happens as the GSR gets squeezed. Of course, this is an assumption.

Balance Sheet/Share Dilution

They currently have a strong balance sheet with $60 million in cash and only $12 million in long-term debt. However, large mines are expensive to develop. They may dilute shares to advance Pitarrilla. The capex for Pitarrilla will likely require debt, but that is a few years away.

Risk/Reward

As I mentioned at the beginning, investing in PM miners is speculating. Why? Because one of your assumptions is bound to get flipped. The biggest risk is that PM prices won’t rise, or inflation will cause costs to rise significantly, reducing expected margins. Many things can go wrong.

One thing that could go wrong is our expectation of margins. I’m expecting large margins as silver prices rise, which will drive up their FCF. Several things could hinder large margins, one of which is Mexican politics. They could raise taxes or even do some type of nationalization, such as requiring partial government ownership of all silver mines.

While the risk is high, the reward for Endeavour is enticing if silver prices rise substantially and they build Pitarrilla. We are betting on the future and on several assumptions, which is never a sure bet.

Investment Thesis

I see Endeavour Silver as a potential slam dunk. Why? Because of my belief that silver prices are headed higher and that Endeavour is well-positioned to participate in that outcome. Sure, silver prices might not rise, but if they do, then Endeavour is where I want exposure for silver miners.

By the end of 2024, they will increase their production to 9M oz of silver, with break-even costs per oz of around $20 (after Terronera lowers their costs). If silver is over $30, that will give them margins of around $10 per oz. Then as silver trends from $30 to $50, their margins will explode higher. If silver reaches $50 in 2025, their margins will be around $25 to $30 per oz. They will become a cash flow machine.

Then in 2025, investors will begin to look at the potential of Pitarrilla, pushing their FCF multiple higher in anticipation of future production.

Strategy to Manage Risk

I use a pyramid approach (as discussed in my book) to manage risk, along with low allocations (normally less than 1% per individual stock), whereby I use less risky assets at the base of the pyramid and riskier stocks as I move up the pyramid.

As the shape of a pyramid implies, the bulk of my portfolio is on the lower half. This means that I hold fewer riskier stocks as a portion of my cost basis. Also, the base of the pyramid should be strong enough to withstand major corrections when the riskier stocks (exploration and development) higher up on the pyramid get obliterated (sometimes down 70% or more).

Endeavour fits in the lower half of the pyramid, where I accumulate quality mid-tier producers. Ironically, it is also a high-upside stock because of its production growth profile. In many respects, I think it is the ideal stock to own. Many are fortunate it is this cheap. I don’t think it will be once silver reaches $30 to $32, when it will likely double in value.

I don’t trade. Instead, I use a buy-and-hold strategy of accumulating stocks (expanding my portfolio). Sometimes I think I am more of a stock collector than an investor.

While I am constantly accumulating stocks (I currently hold over 150 stocks), I also have an exit strategy. In fact, I have an exit strategy for each stock. I often add to stocks that crash more than 50% if I still like the story, thereby reducing my cost basis.

I rarely add to stocks that fall less than 50%, unless I think I am underweight on an exceptional stock. Moreover, I always buy big stock market corrections to improve my portfolio (this is usually the best time to buy).

I currently have a list of about 10 stocks that I want to buy on the coming correction. Of these 10 stocks, about half I already own. This will improve my portfolio.