In an earlier article, I discussed one of the most important metrics to analyze the silver industry, the actual cost of mining an ounce of silver, which can help an investor figure out whether it is time to buy SLV and/or the silver miners. In that analysis, we used the 3Q 2012 financials to calculate the combined results of a number of publicly traded silver companies and come up with the average cost it takes to mine each ounce of silver. Once the 4Q FY12 reports from all gold and silver miners are out, I will be posting the consolidated true production cost calculations for both gold and silver, so investors who are interested can follow me and you will receive that report.
In this analysis we will calculate the real costs of production of Silver Standard Resources (NASDAQ:SSRI), a primary silver miner with a large producing mine in Argentina (the Pirquitas Mine) and two major development projects in Peru and Mexico.
Calculating the True Mining Cost of Silver - Our Methodology
In a previous article about Goldcorp's (NYSE:GG) cost of gold production, I gave a thorough picture of the current way mining companies report their cost of production and why it is inaccurate and significantly underestimates costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, and I would encourage all precious metals investors to understand this important concept. It is important for investors interested in miners or those who focus on gold and silver as a commodity investment, because the true costs of production will show where a possible floor exists for a commodity (the production cost) which is important to silver (SLV investors) and is also an obvious way to differentiate miners.
Real Costs of Production for SSRI - 4Q 2012 and FY2012
Let us now use this methodology to take a look at SSRI's results and come up with their average cost figures. When applying the methodology for the most recent quarter and FY2012, we standardized the equivalent ounce conversion to use the average LBMA price for Q4FY12 and this results in a zinc ratio of 37:1. We like to be precise, but minor changes in these ratios have little impact on the total average price - investors can use whatever ratios they feel most appropriately represent the by-product conversion.
Important Note: When calculating silver equivalent ounces, our silver equivalent production may differ a little bit from SSRI's numbers. The reason is that even though we are using the same base numbers, depending on the ratio of conversion it may change the number of total equivalent ounces. We believe our use of the most recent LBMA prices is the most accurate in terms of predicting future silver equivalent production. It also allows investors to compare SSRI with other silver companies because by using our methodology the comparisons will be apples-to-apples, while using individual silver miner calculations may yield much different results since each miner may use a different equivalency calculation (There are no GAAP silver equivalency calculations).
Observations for SSRI Investors
The first thing that investors should note from the table above, is the asset sales line which had a tremendous impact on the average cost per silver ounce. Since it is a write-down line item, the negative number represents a POSITIVE gain, while a positive number would represent a write-down cost (for example in 2012 SSRI gained $49 million from asset sales).
This has an effect of driving down the cost per ounce, so in 2011 average cost of production was $9.24 when including asset sales, but it was really $17.71 when you strip out asset sales from the production figures. These asset sales were primarily the result of the sales of shares of Pretium Resources (NYSE:PVG), which SSRI acquired when it sold the Brucejack project to PVG in 2010. SSRI has been gradually disposing of its stake of PVG, which has contributed significantly to its bottom-line.
The second thing to note is that the Q4 FY11 numbers for SSRI were significantly impacted by a tax adjustment, which led to the unnaturally low $7.27 production cost number. In a nutshell, SSRI was basically overtaxed in a previous 2011 quarter and they recovered theses taxes in the fourth quarter of 2011. I did not adjust it here to keep the comparisons standardized, but when adjusting taxes to a standardized amount, the Q4 FY11 costs would be around $17.80 per ounce.
Now that we have explained some of the statement abnormalities, we are ready to analyze the numbers. On a quarter to quarter basis, the Q4 numbers rose from the adjusted $17.80 per ounce to $22.30 per ounce in Q4FY12. This rise is in-line with the annual rise in costs from 2011 to 2012, so it does not strike us as particularly unusual, though it is a significant rise in costs. Though on a positive note, costs for Q4 FY12 were lower than the average FY12 annual production cost, which may be a positive sign as SSRI tries to contain its costs. It is something that investors should keep an eye on.
For SSRI, the annual cost figures are much more relevant than the quarterly costs since their quarterly costs tend to fluctuate significantly between quarters. In 2011, SSRI produced silver at an average cost of $17.71 and this rose to $24.72 in 2012 - a large annual rise in costs. When compared to competitors Pan American Silver (NASDAQ:PAAS) and First Majestic (NYSE:AG), SSRI's costs were significantly higher on an annual basis - PAAS had an annual cost of $20.81 and AG had an annual cost of $18.44. The high costs of production compared to their competitors is an issue that SSRI management needs to address and hopefully Q4 FY12 costs of $22.30 per ounce are steps they are taking to bring down costs - but investors will have to wait for future reports to verify this.
Finally, in terms of production numbers, SSRI management is doing a good job increasing silver output. On annual basis it increased silver production from 7.3 million to 8.9 million ounces of silver equivalent - more than a 20% growth in silver production. This may have been a contributing factor to the large rise in costs per ounce, ramping up production tends to raise costs before the costs stabilize.
For a silver miner, SSRI production costs were a good deal higher than its competitors and were primarily negated in the bottom line by the sales of its investments in PVG. Though on a positive note, productions costs were down in 4Q FY12 and the amount of silver produced was also increased on an annual basis. Investors need to keep an eye on these production costs in future quarters to make sure SSRI management is effectively controlling them, costs as a whole in the silver industry are rising but SSRI should at least have its costs more in-line with its competitors.
Something to note for those who invest in silver as a commodity, it is important to see that another major silver producer is producing silver in the low to mid $20's and costs to produce silver are rising across the industry. This is bearish for miners but is very bullish to those who hold silver as a commodity (SLV, SIVR, and PSLV investors) because rising costs are a precursor to lower production as silver becomes less profitable to produce.