In an earlier article, we 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, I used the FY2012 financials to calculate the combined results of publicly traded silver companies and come up with a true all-in industry average cost of production to mine each ounce of silver.
In this analysis we will calculate the real costs of production of Endeavour Silver (NYSE:EXK). This primary silver miner has operations and exploration properties mainly in Mexico, with one exploration property in Chile. It is led by one of our favorite CEOs, Mr. Bradford Cooke. Additionally, it offers investors an excellent set of Youtube videos that detail the silver mining process, drilling, EXK operations, and other silver related topics such as how silver coins are minted - we would encourage all people interested in the silver industry to watch a few of its videos.
Calculating the True Mining Cost of Silver - Our Methodology
In the previously mentioned article, we gave a thorough overview of the current way mining companies report their costs of production and why it is inaccurate and significantly underestimates total 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 concept.
Explanation of Our Metrics
Cost Per Silver-Equivalent Ounce - is the costs incurred for every payable silver-equivalent ounce. It is Revenue minus Net Income, which will give an investor total costs. We use payable silver and not produced silver, because payable silver is the silver that the miner actually keeps and is more reflective of its production. Miners also use payable silver and not produced silver when calculating its own cash costs, so this is a pretty standard measure in the industry.
We then add Derivative Gains (or minus Derivative Losses), which will give investors total costs without the effects of derivatives. Finally, we add Foreign Exchange Gains (or minus Foreign Exchange Losses) to remove the effects of foreign exchange on the company's costs.
Cost Per Silver-Equivalent Ounce Excluding Write-downs - is the above-mentioned "Cost per silver-equivalent ounce" minus Property/Investment Write-downs and Asset Sales. This provides investors with a metric that removes exceptional gains or losses due to write-downs and asset sales.
Cost Per Silver-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs - is the above-mentioned "Cost per silver-equivalent ounce excluding write-downs" adding in smelting, refining and all other necessary pre-revenue costs. This is a new metric that we are now introducing to our true all-in cost series because it will more accurately measure all-in costs and allow comparisons between miners.
Most investors are unaware that many miners will remove smelting, refining, and other costs BEFORE reporting their total revenues figures and it will not be present in the income statement. The result of this is that it skews all-in costs higher for miners that refine themselves or include the costs in their income statement, while inaccurately showing lower costs for miners that remove it before reporting revenues.
A simple test can be done on any miner to see if there are any pre-revenue costs that are not reported in the income statement. Simply take payable production and multiply it by average realized sales price and this should come relatively close to the total revenues figure. If it gives you a number much higher than reported revenues then there are pre-revenue costs that are not being reported.
This line should alleviate these issues and allow comparisons on a fair basis.
Real Costs of Production for EXK - 4Q 2012 and FY2012
Let us now use this methodology to take a look at EXK's results and come up with its true all-in 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. This results in a gold ratio of around 53:1. 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.
Note about Adjustments to True Costs Values for EXK
We had to make a minor adjustment to our true costs numbers for EXK from previous releases for FY2012 and Q4FY12. This adjustment was related to using EXK's payable silver production rather than its total mined production. Payable production more accurately measures EXK's true production numbers since payable silver is ultimately what any company produces. Additionally, payable silver production is also what EXK uses when calculating its own reported cash costs. This change resulted in a slight lowering of silver production for the previous quarters.
The result is a 53 cent reduction of costs for FY2011, a 47 cent increase in costs for FY2012, and a 36 cent increase in costs for Q4FY12. The table above reflects these changes and correctly shows EXK's true all-in costs.
Observations for EXK Investors
The first thing to note is that the Q1FY13 true all-in costs of production were a rather high $25.85 per silver-equivalent ounce, which is slightly higher than EXK's 2012 cost of $25.46 per silver-equivalent ounce. The positive news is that EXK did significantly lower costs from Q4FY12's $28.70 per silver-equivalent ounce, but management needs to continue these efforts in future quarters because EXK's current costs are still relatively high compared to its peers - much more is needed to leave the ranks of the high-cost silver producers especially when current silver prices are below its all-in costs.
Whenever a silver producer has true all-in costs above the current silver price, investors need to carefully monitor corporate liquidity. This is something that is very important because every ounce of production is costing the company more than the ounce's sale price, which will quickly burn cash. EXK's balance sheet is very strong with $28 million in cash and $40 million in inventories, so investors should feel comfortable that EXK can survive for quite a while at silver prices below true all-in costs.
In terms of silver and gold production, EXK continued to do a good job of ramping up production. EXK's Q1FY13 production of 1.46 million ounces of silver, 15,000 ounces of gold, and 2.25 million silver-equivalent ounces were a company record and were significant increases on a year-over-year and sequential basis. EXK is well on its way to meeting the higher end of its 2013 targets of 5.0 to 5.3 million ounces of silver and 46,000 to 49,000 ounces of gold - which is positive news for investors.
EXK showed slight improvement in true all-in costs from a poor Q4FY13 number, but its costs are still higher than many of its competitors, which is a negative for investors in this low silver price environment. However, on a positive note, EXK did significantly increase production on a year-over-year and sequential basis and are on track to meet or exceed the higher end of its silver production forecasts. EXK's liquidity remains strong and as a company it should be able to weather these silver prices for quite a while.
But for EXK to join the ranks of the elite silver producers it will need to continue to lower costs. Production increases are nice when margins are high, but if true all-in costs are break-even (at best) with current silver prices, we much prefer management to cut production on high cost ounces. We find it counter-productive to produce and sell silver production at current prices and we would much rather see management hold production off the market as inventory (or even cut production) until prices improve.
Disclosure: I am long EXK, PSLV, SIVR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.