Gatos Silver (NYSE:GATO) released Q4 production results earlier this month, and according to my calculations, AISC likely declined dramatically last quarter.
Before I get into the details, the company stated in their Q3 2021 earnings press release that during October 2021, their CLG silver mine in Mexico had seen a dramatic improvement in its mined grades, averaging 316 g/t silver (~25% higher than the prior quarter), 4.4% zinc (+8%) and 2.6% lead (+10%), while achieving record plant throughput of 2,620 tonnes per day.
As I told subscribers of The Gold Edge at the time, it was unclear if these robust operational metrics would continue in November and December, but if they did, then Q4 2021 was setting up to be an outstanding quarter as Gatos was pushing more tonnage through the mill and at a higher grade.
My back-of-the-envelope calculation — at the above throughput and grade — was that silver production would increase ~500,000 ounces in Q4 compared to Q3.
Q4 2021 silver production increased ~600,000 ounces QoQ to a record 2.3 million ounces. Plant throughput also hit a new record. My forecast was based on the 316 g/t mined silver grade in October continuing in the final two months of the year. But as it turns out, grade further improved in November and December and the average for the quarter was 331 g/t Ag. The record silver recoveries of 90% also helped increase output. The company produced 7.6 million ounces of silver in 2021 and exceeded the guidance of 7.4 million ounces. While silver grade at the CLG mine got better as the quarter progressed, lead and zinc grades didn’t hold up. Lead production dropped to 10.2 million pounds in Q4 from 10.8 million in Q3 2021, while zinc output declined to 12.9 million pounds, down from 13.5 million pounds. This isn’t a negative mark on the operational performance, as they were both within the guidance range for the year. It would’ve been a blowout quarter had lead and zinc grades remained robust.
The weaker base metal production does impact by-product credits. However, while zinc and lead output fell QoQ, the prices of both metals were higher in Q4 2021. Gatos’ realized lead and zinc prices in Q3 2021 were $0.99 and $1.40 per pound, respectively. I would estimate the realized prices in Q4 were ~$1.05 per pound lead and $1.50-$1.55 per pound zinc. The increase in prices for both metals more than offsets the production decline, and I believe that by-product credits in Q4 2021 will be higher than the prior quarter’s.
How Do The Production Figures Translate Into Lower AISC?
Before I get into my AISC forecast for Q4 2021, below were my estimates for payable silver ounces, by-product credits, and AISC for Q2 2021, along with the actual results — which were exactly in line with my forecast. I’m applying the same calculations to my estimates for the last quarter.
I’m estimating 2.1 million of payable silver ounces in Q4 2021. Given the higher base metal prices, I believe by-product credits were in the $29-$30 million range, which is slightly better than Q3 2021 (as shown on the highlighted line below). Cash costs (in total dollar terms) are the trickiest to forecast, but I would estimate they stayed in the $34-$35 million range. In the Q3 2021 conference call, the company said they expect to spend between $70-$75 million on sustaining capital this year, vs. the guidance range of $65-$75 million. So I will be conservative and calculate for the upper end of that guidance range, which would put sustaining Capex at ~$23 million last quarter. Add it up, and total sustaining costs were ~$57 million. That’s higher than the prior quarter, however, payable silver production is 500,000 ounces higher as well. As a result, AISC per ounce of payable silver should be at ~$13.00 in Q4 2021 compared to $16.71 in Q3 2021. If sustaining Capex is more around the $70 million level for the year, then AISC in Q4 could’ve been $11.50-$12.00 per payable silver ounce. If cash costs are at the higher end and by-product credits at the lower end, then AISC could be closer to $14 per ounce. So the range would be $12-$14 per ounce, and I think $13 per ounce is a solid estimate. Either way, I expect a sharp drop in costs.
Performance Of GATO – A Tale Of Two Halves
GATO responded positively since production results were announced less than two weeks ago, rallying 9%. But I don’t believe that investors understand how much AISC likely declined as the stock has yet to recover from the plunge in July 2021 – when the company diluted shares to extinguish all of the JV debt – and is down 20% over the last year (in line with its peers). Weaker Q3 2021 production and higher costs also likely contributed to the selling pressure over the last 4-5 months.
Having said that, Gatos’ performance should be kept in perspective, as since it went public in late 2020, the shares are still up close to 60% vs. a decline of ~18.5% for the Global X Silver Miners ETF (NYSEARCA:SIL).
GATO was incredibly undervalued coming out of the gate, and the slump in the stock over the last year – especially since the 2021 peak – has made its value extremely appealing again.
The market is underappreciating Q4 2021 production results and is underestimating (or unaware of) the impact on costs.
I continue to believe that GATO is one of the best silver mining stocks because the company has some of the lowest costs in the industry, is a large-scale producer with significant reserves, and is undervalued compared to its peers.
A More Robust Outlook For 2022
The fundamentals are there, and according to the technical report on the Cerro Los Gatos mine, they will improve further in 2022 as production is expected to increase to 15.5 million AgEq ounces (100% basis, GATO owns 70% of the CLG mine). If production rises to that level, I’m expecting AISC per payable silver ounce for the year to decline compared to 2021.
If you compare the production and cost profile to some of Gatos Silver’s peers such as Endeavour Silver (NYSE:EXK), the value is clear. In 2022, EXK expects to produce 6.7 – 7.6 million AgEq ounces at an AISC of $20-$21 per silver ounce. Yet EXK only trades at a slightly lower enterprise value. While Endeavour has the Terronera project (Mexico) and is acquiring the Pitarrilla project (also in Mexico) from SSR Mining (NASDAQ:SSRM), GATO is still trading at a discount.
We still need to see 2022 guidance from GATO to confirm that production is tracking to plan, but the company did state in its latest presentation (dated January 19, 2022):
Physical silver has also rebounded sharply over the last month and is moving back toward the middle of its multi-year consolidation channel. If the trend holds, then not only will GATO see production increase this year, but there should also be margin expansion.
Net Cash Builds
While GATO was hit last summer because of the share dilution, it allowed the company to significantly reduce its liabilities both at the corporate and JV level.
GATO only had $12.6 million of debt on its balance sheet at the end of Q3 2021 and held $12.4 million of cash, giving it almost zero net debt.
The JV held $10 million of cash and was debt-free as of September 30, 2021, as it fully repaid the entire Dowa Term Loan. GATO stated in its latest presentation that the LGJV had over $20 million cash on December 31, 2021, implying that net cash has increased.
A Change Of Momentum, Finally?
Operationally, GATO is strong. Financially, the company is also extremely well positioned and doesn’t have the debt burden to worry about anymore.
As for the technicals, there is clear support at ~$9.20, as the stock recently rebounded from that level. The question is, will the successful retest of support, in conjunction with the bullish Q4 2021 news, be enough to change the momentum finally? I think that depends on whether silver has bottomed and what 2022 guidance looks like, but I will say that at current prices, GATO is quite a compelling buy. A break of support would be short-term bearish and a reason to lighten up. But if silver keeps rallying and Gatos releases a strong outlook for this year, I think GATO will move aggressively to the upside (50-100% return) and should notably outperform others in the sector.
Any investor looking for leverage to rising silver prices, I believe GATO is one of the best options. Even if silver remains in a trading range for the next 6-12 months, GATO is undervalued enough that it should produce near-term moderate gains of 15-30% if it can deliver on the CLG mine plan this year.