This Analysis Assigns a Hold rating for Ero Copper Corp
Ero Copper Corp. (NYSE:ERO) (TSX:ERO:CA) – a metals company based in Vancouver, Canada with copper and gold mining and exploration assets in Brazil – is given a “Hold” rating by this analysis, reflecting a downgrade from the “Buy” rating of the previous analysis of Ero Copper.
The previous valuation was based on good growth prospects for Ero Copper’s copper business, while the stock market offered an opportunity to benefit from a statistically low price. The promising future of copper as an essential metal for global energy transition projects and gold as a safe place in a macroeconomic environment full of threats to the portfolio were seen as positive for this stock. Ero Copper’s strategy is to respond to the rapidly growing demand for these metals by increasing its supply in the market.
These expectations have been reinforced by some positive updates to Ero Copper’s growth project portfolio, but based on past patterns and what may happen in the coming weeks, the market value of the shares is not currently viewed as an attractive entry point.
Ero Copper Corp Performance Vs. Competitors and Sector in the Long Run
The stock market could create better pricing conditions for a “buy-and-hold” investment strategy or benefit from strong metal price increases, such as those expected for gold in 2024. In the long term, the stock tends to perform significantly better than most competitors and the materials sector, which supports the first investment strategy, even if the Ero Copper holding does not pay dividends. Ero Copper’s shares’ positive correlation with copper or gold price movements supports a short-term strategy aimed at capitalizing on metal price changes. Concerning the near term, an opportunity for a strong gold bull market is seen in 2024.
Since the retail investor is active in the markets to increase his wealth, he should aim to align with the long-term growth of the Global X Copper Miners ETF (COPX) through an appropriate combination of both strategies.
Ero Copper Corp. shares grew 67.23% under the ERO stock symbol and grew 72.21% under ERO:CA stock symbol over the past 5 years beating the Materials Select Sector SPDR® Fund ETF (XLB) +56.20%, United States Copper Index Fund, LP ETF (CPER) +38.28%, and VanEck Junior Gold Miners ETF (GDXJ) +7.22%. XLB is the benchmark for the basic materials sector, while CPR and GDXJ are the benchmarks for copper miners and junior gold miners, respectively.
Growth Catalysts for Ero Copper
This is broadly Ero Copper Corp.’s situation: the company has a very consistent growth strategy with an eye on the future of the metals in question. The company has almost reached the culmination of its project to expand its copper ore processing capacity and add another copper production line next year. As for the gold business, operations will benefit from recently discovered high-grade/low-cost gold veins.
Growth catalysts in Ero Copper’s portfolio:
About the Gold Business: The exploitation of the new “Matinha” vein in Ero Copper’s 97.6% interest in the Xavantina operation in the state of Mato Grosso, 15 km northwest of Nova Xavantina, Brazil, has a positive impact on gold production and grades. Simultaneously it reduces the operating costs per metal. Xavantina is performing so well after the lucky discovery of Matinha that this asset should therefore have supplied the market with 55,000 to 59,000 ounces in 2023, up from the original target level of 50,000 to 53,000 ounces. Additionally, the increase in gold production will result in cost savings, with the company expected to incur full-year C1 cash costs of $375 to $475 per ounce in 2023, down from the previous range of $475 to $575 per ounce. The company is expected to deliver full-year AISC of $900 to $1,000 per ounce, down from the previous range of $1,000 to $1,100 per ounce.
About the copper business The improvement in the average copper grade of production activities at Ero Copper’s 99.6% stake in the Caraíba copper operations, 385 km NW of Salvador, Brazil, should lead to an improvement until reversing trends in production (23,734 tons in Q3-2023 vs. 24,669 tons in Q3-2022) and costs (C1 cash cost per pound was $1.82 in Q3-2023 vs $1.46 in Q3-2022).
Ero Copper supports Xavantina gold operation and Caraíba copper operation with a solid balance sheet: available liquidity of $237.6 million (20% is cash and equivalents, 20% is short-term investments and 60% is undrawn credit lines) stands lower than total debt of $419.42 million. However, more than 95% of total debt is only due in the long term, avoiding costly refinancing activities when credit costs are still elevated. In addition, the debt incurred a 12-month interest expense of $16.6 million, but that is six times less than the 12-month operating income of $98 million, and this ratio will remain as long as copper and gold prices remain robust. The likelihood of robust prices is influenced by the following growth catalysts: S&P Global Market Intelligence signals robust copper prices amid a dramatic increase in global copper consumption over the coming decade, driven by the use of battery and electric vehicle technologies as well as the deployment of charging infrastructure. Against this favorable backdrop for copper prices and demand, likely Ero Copper states more broadly, and not solely based on the Tucumã project, that:
“the timing of its growth trajectory could not be better”, as “the recent shift in copper supply and demand will point to a supply deficit in 2024 and 2025”.
For this year alone, analysts at Goldman Sachs Group, Inc. (GS) see a copper market deficit of 428,000 tonnes, compared to a deficit of 182,000 tonnes in the previous forecast.
Indeed, it should also be said that the risk of deterioration in this financial solvency ratio is on track to get lower and lower as the interest rate cut promised by the Federal Reserve in 2024 will improve the outlook for metal demand, while the company’s production is headed to higher levels. Gold demand for hedging strategies should also benefit greatly in a global environment that is becoming increasingly difficult to manage due to geopolitical crises in Eastern Europe and the Middle East as well as tensions between the West and the Eastern Bloc of countries.
Another Growth Catalyst Added: Financial Situation Strengthened
The financial condition was strengthened by net proceeds of approximately $111 million from the completion of Ero Copper Bought Deal Financing, which can now be used to fund the following activities: a) The development of higher grade underground deposits at the Santo Antônio Mine, which may result in the Xavantina operation producing approximately 60,000 ounces per year for the next few years, at least until 2026; b) Exploration activities in search of further gold deposits for exploitation in the Xavantina region, which appears to offer good growth potential; c) The expansion of the plant’s operational capacity in Xavantina to process the mineral, which, if able to accommodate a larger volume of material, is estimated to enable gold production of up to 24,000 ounces per year; d) The implementation of hedging programs to protect the company’s profitability against the damaging effects of an excessive appreciation of the local currency, the Brazilian real, against the US dollar. However, Brazil’s central bank has already initiated a downward trend in overnight interbank rates, which should help mitigate the risk of an unfavorable exchange rate that would otherwise affect costs and business growth. Net proceeds will also provide gas to support e) the project to increase the mill’s processing capacity from 3 million to 4.2 million tons of copper ore per year at Ero Copper’s 99.6% interest in the Caraíba copper operations; f) the plan to use superior-grade material from the upper levels of the Pilar mine at the Caraíba copper operation. e) + f) leads to a potential to reach higher annual copper production by up to 18,000 tons. This means that once the expansion is complete, the Caraíba copper company should be able to supply between 62,000 and 65,000 tonnes of copper concentrate per annum instead of 44,000 to 47,000 tonnes (or approximately 97 million to 103.6 million pounds).
The development of Ero Copper’s 99.6% interest in the Tucumã project, located 308 km southwest of Marabá, Brazil, in the southeastern state of Pará. Here, the company plans to produce copper from an open pit mine at an average annual rate of 100,000 tons on a consolidated basis (or about 220.5 million pounds per year) starting in the full year of 2025.
The Tucumã project is 85% complete leading Tucumã’s first copper production in the second half of 2024. So, we’re almost there, and raising additional capital through the “bought deal financing” transaction removes any remaining concerns about a potential backlash.
Strategy for Ero Copper Shares: What to Consider
In line with the business of the company (75% copper and 25% gold), Ero Copper shares are more positively correlated with copper than gold.
This is indicated by the red area ((for copper)) always in the positive territory, as illustrated in the lower section of the chart. The yellow area ((for gold)) was not always above zero in 2022 as fears of a too-aggressive hawkish Fed caused some market disruption.
This applies to ERO stock:
This applies to ERO:CA stock:
From the charts above it appears that the Fed’s interest rate action and the development of the US economic cycle have a major impact on shares of Ero copper in both markets: The Fed’s three rate cuts through October 30, 2019, reversing almost all of the 2018 rate hikes had a positive impact on Ero Copper shares through the gold bull market. Gold prices benefited from interest rate cuts as zero-income gold investments became more attractive compared to U.S. Treasury bonds, which instead pay interest income based on a predetermined fixed rate. Ero Copper shares also recorded gains: a) as gold was sought as a hedge against the COVID-19 virus outbreak in mid-March 2020; b) amid propaganda about energy transition projects as part of government spending programs to support and strengthen the economy during the COVID-19 virus pandemic; c) as the outlook for the copper sector was strengthened by the reopening of the economy following lockdowns and restrictions to curb the spread of the coronavirus; e) following the high approval in the copper/gold markets for the Fed’s less aggressive rate hikes from early 2023 until the June pause and for the final 25 basis points hike in July 2023.
The highlighted trends can be used to determine the next strategy for Ero Copper stock on both exchanges.
The Stock Price Has to Move Lower First, So Hold Off for Now
Shares of Ero Copper, under the ticker symbol ERO, traded at $16.39 per unit, giving it a market cap of $1.68 billion and a 52-week range of $11.35 to $24.38.
The shares’ price does not appear to be excessively high compared to last year’s trends, as it is still well below the 200-day simple moving average of $17.54 and slightly above the 20-day, 50-day, and 100-day -SMA lines. According to this analysis, shares will not recover from these levels because while there is still room for growth, this room is too little to accommodate enough bulls, as shown by the 14-day relative strength indicator of 62.52 (the value of the indicator is a whisper away from its historical upper limit). The escalation of the crisis in the Middle East with Yemen’s Houthi rebels attacking merchant ships in the Red Sea combined with Saudi Arabia’s decision not to put more barrels of oil on the market is also influencing the Fed to continue its “higher-for-longer” stance on rates a bit longer than originally thought. The geopolitical problems put upward pressure on prices through the risk of higher energy and transport costs. To ensure inflation returns to the 2 percent target, the Fed will likely delay the first rate cut. This decision is not a good sign for gold and copper, but it will create some headwinds for Ero Copper shares. Not soon but since stock prices are expected to offer attractive entry points due to the fears of the looming economic recession, this analysis, therefore, recommends a “Hold” rating until then.
The negative cycle is good for the demand for gold as a hedge, but not good for the demand for copper. In line with a 24-month market beta of 1.62, Ero Copper’s shares will initially be treated like any other U.S.-listed stock grappling with the fallout from a growing aversion to risky assets amid a slowing economy. From these levels, shares of ERO stock are considered to have a greater probability of moving significantly lower than moving a bit higher.
The same considerations applied to Ero Copper’s shares on the Canadian stock market. Shares of Ero Copper, under the ticker symbol ERO:CA, traded at CA$21.94 per unit, giving it a market cap of CA$2.25 billion and a 52-week range of CA$15.72 to CA$32.12.
The share price doesn’t appear to be overly high compared to last year’s trends: it’s still well below the 200-day simple moving average of C$23.59. It is above the 20-day, 50-day, and 100-day SMA lines, but not by that much. According to this analysis, there is still room for shares to move higher from these levels, but this room is too small to reflect strong bullish sentiment. This view is also supported by a 14-day relative strength indicator of 62.91 (the indicator’s value is just a touch away from its historical upper limit), as well as the lack of a very near-term catalyst for higher copper/gold prices that would otherwise trigger shares of ERO: CA up.
This analysis assumes that there will be an attractive share price for Ero Copper in any market until the markets finally realize that the recession is in the cycle, sweeping away the last vestiges of the soft-landing scenario. Maybe it will happen sometime in the first half of 2024, as economists at Deutsche Bank Aktiengesellschaft (DB) believe. As Italian Economy Minister Giancarlo Giorgetti explains, the signals a central bank sends to consumers and producers through decisions to raise interest rates in the fight against runaway inflation have no other purpose than to cause an economic recession. He says the sharp slowdown in the economic cycle is necessary to bring inflation back to the 2 percent target. Now that the Eurozone, in which Germany GDP’s largest economy is already in recession, has received the same therapy from the European Central Bank that the Fed prescribed for US inflation, the US economy will also fall into recession.
The retail investor should be very careful when hedge funds say that copper stocks are currently undervalued, as these companies may be underestimating the impact of an economic recession in Western economies on copper demand and the crisis in China’s real estate sector. They may be ignoring fears of a domino effect from the liquidation of China Evergrande Group (OTCPK:EGRNQ) on other property developers and, in particular, the risk of contagion in China’s financial sector.
14-RSI’s Analysis: Additional Indications
Based on 14-day RSI levels similar to current ones, Ero Copper shares have enjoyed a notable bull market in the past, but only because it was fueled by the following catalysts: a) interest rate cuts in 2019; b) the mounting in late 2022 of expectations of a relaxation of the Fed’s aggressive interest rate policy; c) the rapid economic recovery from the COVID-19 crisis.
This applies to ERO stock:
This applies to ERO:CA stock:
Concerning the interest rate cut, this has already been factored into the markets. The market has been talking about the Fed’s pivot point for more than a year. On top of that, the Fed may delay the first rate cut further.
So, the trigger for the rapid rise in Ero Copper’s share price is currently seen only in the economic recovery from the next recession. However, the market must first recognize the signs of a dramatic slowdown in economic activity.
Ero Copper Corp is advancing its copper and gold mineral plans, and this is in line with the metals’ future growth prospects. The Canadian mining and exploration company is improving copper and gold production yields in Brazil, expanding gold production in Brazil, and will add another copper production line in Brazil in a year.
This stock is suitable for both a “buy-and-hold” approach and for taking advantage of the metal price cycle. However, it is unlikely that the stock will recover further enough to make it worth buying at this level. Shares must initially fall significantly, and retail investors should wait until the market offers attractive entry opportunities. These will arise from fears of an impending recession, which some economists believe will occur as early as the first half of 2024. “Hold” applies to this stock for the time being.
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