Fortuna sees a reversal of fortunes

Vancouver — Fortuna Silver Mines (FVI-T, FSM-N) is the latest company to get hammered for cost escalations after missing 2011 projections and forecasting higher costs for 2012.

The company announced year-end results after market close on Friday March 23, showing annual net earnings of US$19.5 million compared with US$16 million in 2010, and a fourth quarter net loss of US$1.8 million compared with net earnings of US$4.3 million in the same quarter of 2010.

The fourth quarter results, which worked out to a loss per share of a penny, were much lower than the 8¢ earnings per share projected by CIBC’s Brian Quast and the 10¢ per share earnings projected by Canaccord’s Nicholas Campbell.  In a research note Quast said the unexpected drop for the quarter — especially surprising because production and cash costs were pre-released — was caused in part by abnormally high taxes, metal sales that were less than production, a $2.3 million pricing adjustment, and higher-than-expected smelter charges at San Jose.

Due to the escalating operating costs at both of Fortuna’s mines, plus the risk of smelter cost increases, Quast reduced his price target for the company from $9 to $6.50 and his rating from sector outperform to sector perform. Quast noted that costs per tonne have almost doubled over the past three years, while the company is expecting cost inflation of 20% in 2012. Factoring in the long-term increase in costs resulted in a “somewhat disastrous effect” on his NAV for Fortuna.

In making the downgrade, Quast noted that Fortuna is “one of the best operators in the silver space” but that “unfortunately, this quarter’s release has shown that even the best operators are not immune to the challenges of the mining industry.”

Following the CIBC downgrade Fortuna’s share price dropped $1.02 on 3.5 million shares traded, making for a $1.79 drop to $4.38 over the three days of trading since the results were released.

In the results, Fortuna disclosed that a driller died and a supervisor was injured in an accident at its Caylloma mine in Peru on February 26, the first fatality in the company’s six years of operation. The accident had to do with a premature detonation of explosives, while operations resumed on February 28.

The company also disclosed that a second anti-mining activist had been shot dead this year near its San Jose mine in Mexico’s Oaxaca state. Bernardo Vasquez Sanchez, the leader of a group opposed to the San Jose mine, was killed on March 15 while his cousin, Rosalinda Dionicio Sánchez, and brother Andres Vésquez Sánchez were hospitalized with bullet wounds. On January 19 Bernardo Méndez Vásquez was fatally shot while protesting a local water project.

Fortuna CEO Jorge Ganoza flatly denied any involvement in the incidents during a conference call and condemned the violence.

The local opposition appears to centre around water concerns, though the San Jose mine was designed so it would not need to tap into local aquifers or waterways. The company currently sources its water from a reservoir incorporated into its tailing dam, which is designed to supply the vast majority of the mine’s water. Fortuna is still working to connect the last two km of pipeline that will link a sewage treatment plant in San Jose to its mine and provide a secondary source of water, though local opposition in one community has so far blocked that project.

Shortly after releasing its financial results Fortuna also updated the reserve estimates at its two mines. Proven and probable reserves at Caylloma, combining the silver-heavy and more polymetallic veins, stand at 4.6 million tonnes grading 135 grams silver per tonne, 0.33 gram gold per tonne, 1.33% lead, and 1.93% zinc. At the San Jose mine, probable reserves stand at 3.6 million tonnes grading 204 grams silver and 1.59 grams gold.

Fortuna produced 2.5 million oz. silver, 6,800 oz. gold, 19.7 million lbs. lead and 23.4 million lbs. zinc in 2011. At Caylloma production cash costs were US59¢ per oz., net of by-product credits, while at San Jose, which reached commercial production in September, cash costs ran at US$4.51 per oz net of by-product credits.

For 2012, the Caylloma mine is scheduled to produce 2 million oz. silver, 2,400 oz. gold, 21 million lbs. zinc and 18 million lbs. lead, while San Jose is scheduled to produce 1.7 million oz. silver and 15,000 oz. gold.

As to drilling in 2012 the company has planned a 15,000-metre regional drill program around San Jose, and is actively working through a 24,000-metre exploration program and 3,500-metre underground drill program at Caylloma.