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 Hecla Mining Company (HL). HL is a primary silver miner with two large primary silver mines in the U.S. - the Green Creek mine in Alaska and the Lucky Friday mine in Idaho. Additionally, HL has purchased Aurizon Mines and it will be adding Aurizon's production and development projects to the company's mining portfolio. This transaction fully closed after the first quarter report, so all production and expenses related to the new combined company will not be included in this analysis.
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, which is an important concept for all precious metals investors to understand.
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 revenue 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 HL - 1Q13 and FY2012
Let us now use this methodology to take a look at HL's results and come up with its 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 ratio of 53:1, a zinc ratio of 37:1, and a lead ratio of 33:1. 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 HL Investors
True Cost Figures - HL's true all-in cost figures for Q1FY13 was $24.53 per silver-equivalent ounce, which was an improvement on the year-over-year and sequential basis. It is also slightly below the average cost for 2012 of $25.18. This is not too surprising since HL is just now ramping up production at its Lucky Friday silver mine, which was closed due to safety issues for the 2012 calendar year.
HL's costs for the first quarter put it in the low-cost tier of silver miners, with many competitors having higher costs than HL. Competitors such as Pan-American Silver (PAAS) (costs just over $25), Silver Standard Resources (SSRI) (costs just under $30), Great Panther Silver (GPL) (costs around $29) Endeavour Silver (EXK) (costs around $25), Coeur D'Alene Mines (CDE) (costs just over $25), Gold Resource Company (GORO) (costs around $28), and cost-leader First Majestic Silver (AG) (costs just under $22).
Corporate Liquidity - Liquidity is very important for investors to monitor in this current silver environment, especially for producers like HL that have true all-in costs above the current silver price. As of the publishing of first quarter results, HL had around $170 million of cash, which gave the company plenty of liquidity. But investors should note that the Aurizon acquisition was not closed until after the first quarter, so the company's liquidity based on the first quarter balance sheet is not going to be very useful. Second quarter results should provide investors with a much better picture of corporate liquidity.
Production Numbers -HL's produced silver was up on a year-to-year basis, but that is no surprise since the current quarter includes Lucky Friday mine production. But what is interesting is that silver production was actually down sequentially (by about 1.8 million ounces of silver), even with the Lucky Friday mine reopening. This is strange because we would have expected increased production numbers sequentially, though this may be attributable to weather or seasonal issues -- investors should not read too much into this but note it down for future quarter analysis.
Investors should also note that silver makes up only about 50% of HL's production on a silver equivalent basis, and with the Aurizon acquisition, this ratio may drop even further. Unfortunately, we will have to wait until second quarter results are out before we have a better idea of what HL's production portfolio will look like.
HL's first quarter true all-in costs rank it in the lower-tier of silver miners -- it is relatively a lower-cost producer than most competitors, but not by too much. The major event of the quarter was the Aurizon acquisition and investors will really have to wait until the second quarter to get a better feel for HL's cost of production and production portfolio. We feel like this acquisition will really be key in determining HL's future since it did significantly increase its debt load, we will have to wait and see how the combined company looks.