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Summary

IAMGOLD (NYSE:IAG) provides investors with a mid-tier gold producer that has a very liquid balance sheet. Their true all-in costs and production totals leave a good amount to be desired, but management is engaged in a cost-cutting program that may lower production costs and give investors a better cost structure.

Investors should a keep a close eye on future true all-in costs for the company because if costs can be aggressively reduced to levels on the lower end of the industry averages then that would be a huge positive for the company. We would caution that when it comes to lowering costs in the gold industry it is much easier said than done, because while some costs can be lowered other costs pertaining to geologic factors (such as ore grades) cannot be significantly affected.

Introduction

In an earlier article, we discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, we used the FY2012 financials to calculate the combined results of publicly traded gold companies and came up with a true all-in industry average cost of production to mine each ounce of gold.

In this analysis we will calculate the real costs of production of IAMGold, a mid-tier gold producer with mines in Suriname, Burkina Faso, Mali and Quebec. In addition to gold, IAG is one of the few major producers of the industrial metal Niobium. IAG is a company with operations that are quite spread out (4 mines in 3 continents) and due to operations in Mali, a higher element of political risk, which is something that investors should note, but is outside the scope of this article.

Calculating the True Mining Cost of Gold - 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 Gold-Equivalent Ounce is the costs incurred for every payable gold-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable gold and not produced gold, because payable gold is the gold that the miner actually keeps and is more reflective of their production. Miners also use payable gold and not produced gold 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 Gold-Equivalent Ounce Excluding Write-downs is the above-mentioned "cost per gold-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 Gold-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs is the above-mentioned "cost per gold-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 IAG - 1Q13 and FY2012

Let us now use this methodology to take a look at IAG's results and come up with their average cost figures. When applying the methodology for the most recent quarter and FY2012, a standardized equivalent ounce conversion to convert every 43 niobium kilograms to one ounce of gold (43:1 ratio). 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.

(click to enlarge)

Important Notes About True All-in Costs Table

IAG changed the way it does it accounting as of Q1FY13 to account for the Sadiola and Yatela mines as joint ventures instead of joint operations. In layman's terms, the company is treating these mines as an equity investment and thus is including only its share of net earnings on its income statement.

This affects true all-in costs in two ways. First, this new method of accounting REMOVES all revenues and costs associated with these projects, replacing them with only net income. Since we are interested in costs to mine gold, this would throw off the calculation because the costs are no longer included in the statement, thus we also have to treat this production as an equity investment and remove the attributed ounces of these mines form the calculation.

Here is an example to show why we have to remove these attributable ounces from the calculations. If a company produces 100 ounces of gold with a total cost of $500 and revenues of $1,500, then its cost per ounce is $5 and its net profit is $10 per ounce or $1,000 total ($15 in revenues minus $5 in profits).

If the company now changes its accounting method to account for half of production as an investment, it will remove both revenues and costs from its income statement and only report income from the project. So the company would now report total production of 100 ounces (same as before) with total costs of $250, revenues of $750, and net income of $1,000. It would seem that costs are now only $2.50 per ounce - even though absolutely nothing has changed in terms of production costs. The difference is that costs and revenues have not been reported for these mines and only their net income is being added. Thus we have to remove those 50 ounces from our calculations, which will give us our correct $5 per ounce costs.

This is why we are removing Sadiola and Yatela production from our calculated attributable ounces for IAG. We will treat them as IAG treats them, as an equity investment not as an operations segment - this will allow us to get the true cost of each ounce produced rather than skewing the numbers because of an accounting change.

The second consequence of this accounting change is that it has been applied to this quarter but not the previous quarters yet. So ounces produced for previous quarters in our table will still reflect old production (including Sadiola and Yatela) while the most recent quarter and Q1FY12 will remove these numbers. Unfortunately this will make it difficult for gold production comparisons until future income statements are released, but the true all-in costs should be accurate and comparable.

Observations for IAG Investors

True Cost Figures - IAG's true all-in costs for Q1FY13 were $1403 per gold-equivalent ounce, which was higher on a year-over-year basis, but that was to be expected since last year's first quarter's costs were lower than expected. But compared to the FY2012 costs, $1,403 was pretty much in-line with the average costs for the year.

Compared to competitors, IAG's performance was a little on the higher end but not far from average with other competitors such as Yamana Gold (NYSE:AUY) (costs just over $1300), Allied Nevada Gold (NYSEMKT:ANV) (costs just under $1000), Goldcorp (NYSE:GG) (costs just under $1200), Silvercrest Mines (NYSEMKT:SVLC) (costs below $1100), Kinross Gold (NYSE:KGC) (costs just under $1400), Newmont Gold (NYSE:NEM) (costs around $1300) Agnico-Eagle (NYSE:AEM) (costs around $1400) and Barrick Gold (NYSE:ABX) (costs around $1200).

Management has also been emphasizing its cost-cutting measures which have begun in Q1FY13 and we may be seeing some of the effects of these measures in the stabilization of their costs. Investors should keep their eyes on future quarters to make sure that these cost-cutting measures are producing reductions in true all-in gold production costs because IAG still ranks on the higher end of gold producers in terms of true all-in costs

Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment, especially for companies like IAG which now has true all-in production costs above the spot price. At the end of Q1FY13, IAG had $750 million of cash, cash equivalents and bullion, which contrasted to $639 million in debt. Even with the debt, IAG has plenty of liquidity to survive in this low-price gold environment.

Production Numbers - Production numbers are a little tricky with IAG because of the accounting change and the fact we are not including Sadiola and Yatela production in our base true all-in cost calculations. So what we will do is compare apples to apples and oranges to oranges - namely compare Q1FY12 and Q1FY13 together and then use Sadiola and Yatela numbers to compare yearly totals.

On a year-over-year basis, gold production numbers were down from 175,000 ounces to 159,000 ounces, which is a decline of about 10%, while niobium production was relatively flat. If we include Sadiola and Yatela attributable production, Q1FY13 numbers dropped from 207,000 gold ounces to 188,000 gold ounces, which is a similar 10% decline.

Compared to the annual numbers, the 188,000 ounces produced puts IAG on pace to produce less than 2012's 830,000 ounces, and significantly less than 2011's 972,000 ounces. These numbers were also before the significant gold price drop in Q2FY13, which paired with management's cost reduction focus should mean that future quarters production totals will be even less than Q1FY13's total. This should not be of much surprise to investors because we expect to see significant production drops across the gold industry as prices drop below average all-in costs for miners.

Conclusion

On a true all-in costs basis, IAG's production cost reduction program may have done a decent job preventing true all-in cost rises, but production costs are still on the higher end of the industry average. With another quarter under the belt in this cost-cutting program, investors should continue to watch for dropping production costs to make sure management is able to bring down IAG's costs.

Since IAG's true all-in costs are now significantly above the current spot gold price, liquidity is a situation that investors need to monitor. This is one area that IAG excels at and has a strong balance sheet with plenty of cash and cash equivalents on the balance sheet to make it through these prices for quite a while. We would caution that any significant reduction in on-balance sheet cash should be a cause for concern for investors because the company does have a good amount of debt and still has to prove that they can at least break-even at current gold prices.

Finally, production numbers have been dropping from previous quarters and years. Management is emphasizing that projects will only proceed if their returns are attractive and so we expect that most projects and development will be shelved until gold prices recover. Thus we expect production totals to continue their decline for IAG specifically and the industry in general.

Source: What It Really Costs To Mine Gold: The First Quarter Iamgold Edition