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, we 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 First Majestic Silver (AG), a primary silver miner with producing mines and development projects in Mexico.
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 Revenues 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 their production. Miners also use payable silver and not produced silver when calculating their cash costs, so this is pretty standard.
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 these pre-revenue costs are not reported 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 AG - 4Q 2012 and FY2012
Let us now use this methodology to take a look at AG'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. This results in a gold-to-silver ratio of 53:1, lead-to-silver ratio of 33:1, and an iron price per ton of $120, and a zinc-to-silver 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.
Observations for AG Investors
The first thing that investors should notice from the table above is that AG's true all-in costs of $21.69 are still quite good compared to other silver miners, even though the profit margins at current silver prices are very slim. Their costs are significantly lower than the true all-in costs of their competitors such as Pan-American Silver (PAAS) (costs just under $25), Silver Standard Resources (SSRI) (costs just under $30), and Endeavour Silver (EXK) (costs around $25).
On the negative side costs are still rising for AG, with Q1FY13 costs 6% higher than the 2012 average and also higher on a sequential basis. Though to be fair to management, costs have been rising across the gold and silver industries and AG is starting from a much lower cost basis than competitors. Management is also implementing rigorous cost-cutting initiatives which should flatten or even reduce all-in costs, but we will have to wait until the second quarter before we start seeing the result of these measures.
Liquidity is also very important for investors to monitor in this current silver environment - one costly quarter exacerbated by low silver prices could cause a significant hole in the corporate treasury. Though AG does not have to worry about this yet because even with its tight margins it still has over $110 million in cash and cash equivalents - plenty of liquidity to weather the current environment.
In terms of production, AG did a very good job increasing production in almost every category. Silver production was increased slightly on a sequential basis (about 1%), but was increased significantly on a year-over-year basis by almost 500,000 ounces. Zinc and lead production also increased significantly from the fourth quarter, and are on pace to beat last year's production numbers. Though investors should pay close attention to second quarter results because the newly implemented cost-cutting measures may result in reductions in production, which is not necessarily bad but should be taken into consideration.
Even though true all-in costs rose in the first quarter, AG still remains one of the lowest cost primary silver miners. In the current silver environment this provides investors with some safety because they do not have to worry about a cash crunch at First Majestic. The company's low cost structure and ample liquidity provide it with plenty of cushion to weather the storm. Investors looking for steady, low-cost silver production should take a look at AG.
For those who invest in the silver ETFs (SLV, PSLV, CEF) or silver as a commodity, it is important to note that even First Majestic is having trouble containing costs. This is a positive for those who hold silver as a commodity, and the fact that even a low-cost producer like AG is engaging in cost-cutting measures is a sign that production will flatten or start to drop. Investors should look to this as an opportunity to buy an asset that sells for below or at production costs - especially when the fundamental picture for precious metals remains bullish.