Sierra Metals (SMT) - Base Metals in Mexico and Peru

Interview with Luis Marchese, new CEO of Sierra Metals (TSX: SMT).

Whilst precious metals are an extremely popular investment class at the moment, investors shouldn't underestimate the potential value that base metals can offer up. Large reflation packages, like the one currently being pursued in China, are intended to kickstart the economies of countries post the first wave of COVID-19.

The base that all of these strategies are built upon is industry and construction: exactly the areas that can make base metals demand thrive.

Base metals explorers, developer and producers are now actively positioning themselves to garner your investment. One such base metals explorer, developer and producer is Sierra Metals. There is a small precious metals component to this story, but this is first and foremost a mid-tier base metals production play.

Marchese only became the CEO of the company 3-months ago, so maybe we should have gone a little easier on him...

The company is built around 3 core producing base metals assets: Yauricocha, the company's flagship Peruvian polymetallic asset, Bolivar, a growing Mexican underground copper mine, and Cusi, the company's smallest operation but nonetheless an expanding silver mine in Mexico.

The company also has 8 Peruvian and 8 Mexican exploration tenements.

Let's expand a little on the 3 core projects so you have a better idea of what Sierra Metals has got here:

Yauricocha

This is Sierra's flagship polymetallic project and accounts for 68% of the company's total revenue. Yauricocha churned out 187,672oz Zinc eq. at an AISC of $0.79/oz Zinc eq. sold.

It is an underground mine with a sub-level caving, cut and fill mining methodology. To process the ore, Sierra Metals opts for crushing, grinding and floatation as its methods of choice. Sierra Metals acquired 82% of Minera Corona in May 2011 through its wholly owned subsidiary, Dia Bras Peru S.A.C. Minera Corona owns 100% of the Yauricocha mine.

Sierra Metals has spent $15M on developing Yauricocha this year. It has been slightly down on the original plan because the company has only focussed on non-discretionary CAPEX due to COVID restrictions and uncertainties. The construction of the shaft has been delayed and the company is currently considering when to restart it. The discretionary CAPEX is being actively reassessed.

Marchese is pleasingly candid. He acknowledges that Yauricocha is not where the company wants it to be yet. Right now, it has a solid resource base, but growth is at the forefront of the management team's minds. They feel there is a lot of potential for growth in the area and have "high expectations."He hopes to bring "some surprises" to the market. When asked exactly what these surprises might be, his response is "I dunno. It's very prospective." This is not exactly what we wanted to hear given he has been at the helm since May this year. He did expand a little, touting the hunt for porphyries in the area, but maybe this is a topic the new CEO is only just getting his head around. Exploration, as always, will hold the key to unlocking value here.

With 14% of the project's revenue coming from Silver and 2% from Gold, the precious metals element of this operation is not meaningful, but with skyrocketing prices it is clearly becoming more significant and it will be interesting to see if the company adjust its explorations plans accordingly, especially considering the fact that Zinc and Lead have had a difficult time of things as of late. Zinc futures continue to be a worry and will give the company concern and we shall see how they adapt. Nothing is set in stone and the company is currently reviewing the best way forward.

Bolivar

Over in Mexico, this growing copper asset is the second priority for Sierra Metals. It creates 26% of the company's total revenue, and is a 70% Copper, 14% Silver and 16% Gold Resource, producing 27,236lbs CuEq. in 2019 at an AISC of $2.86/lbs Copper sold. It is an underground mine that operates under a long-hole mining methodology with a 5,000tpd milling and processing capacity. Crushing, grinding and floatation are once again the processing methods of choice.

The company already has "$40M of Resources" at the property and is targeting expansion. This is a project that Marchese is really excited about, though his extensive track record in the Copper space might have something to do with that. He expects Bolivar to become a larger component of the revenue stream. The company is currently panning an exploration programme, but Marchese was vague on the details and didn't clearly elucidate on the potential of this project. There is a porphyry 50km away from the project, but I want to hear more details. Marchese should perhaps try to market this a little better. Copper is hot right now, and people will listen if he knows the right things to say.

I did appreciate his honesty on the permitting front. Many investors already understand the difficulties of getting permitted in Mexico; it is an extremely protracted process. Marchese is hoping things will be expedited a little, but he has no control over this.

Cusi Mine

This is an extremely small scale silver project, delivering 1,029oz Silver eq. in 2019 at an AISC of $30.89/oz AgEq. It is an underground mining operation and the company deploys a sub-level caving and long-hole mining operation. It was placed on care & maintenance during the COVID-19 lockdown, and it appears Sierra Metals timed a restart of production to perfection, hitting the silver uptick at the right moment. Luck, or exceptional foresight?

However, it looks like there may be an exploration upside. Investors will need to be patient, but they will be hoping Sierra Metals can leverage the booming silver price to conduct additional exploration to grow the resource meaningfully.

Marchese's Track Record

Marchese is a mining engineer by trade, but he has a vast amount of resource in the mining sector: 25-years, in fact. Most of his time was spent at Anglo American, so his track record of large scale mining is beyond question. He doesn't feel he was brought into the fray due to any "problem" beyond the usual difficulties inherent in the mining industry. He has clearly been viewed as a steady, conscientious hand to push the company in the right direction.

It seems to be working, because after a difficult decade for the company, and an especially difficult recent few years, the share price is finally back moving in the right direction. There is still a lot to do though, and these favourable market conditions will not last forever, so investors will want to see substantial progress sooner rather than later.

Arias Resource Capital Management LP is a c. 52% shareholder in Sierra Metals, but the previous CEO Igor Gonzales made it clear in September 2019 that Arias wants to offload 30% of its position, creating a huge overhang and general market concern. Investors have wanted some clarification on what exactly is happening here. Marchese seemed unaware of this discussion and claims that Arias is a loyal and supportive shareholder in the company. What do you think? We have been pointed in the direction of Arias for answers. This is a worry. I would expect the company to be in constant contact with the single largest shareholder and for them both to clarify their positions jointly.

Sierra Metals is a well run company and has a "strong cash position" to push things forward with around c. $40M in the treasury. It has outstanding debt with PCP Capital, which it will start making repayments for next year. By battening down the hatches during the COVID-19 lockdown, Sierra Metals has managed to conserve its cash position. Operations are now proceeding to full capacity, and this appears to be a steady vessel that is gradually growing. However, progress will need to accelerate if investors are to see the sorts of returns they will desire. Expect some impactful decisions to come at the end of the year.

What did you make of Luis Marchese and Sierra Metals?