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 US - the Green Creek mine in Alaska and the Lucky Friday mine in Idaho. Additionally, HL just purchased Aurizon Mines and all of their properties so these will be added to HL's mining portfolio and production numbers.
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 cost 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.
Tax Calculations - Since we are removing Derivative Gains/Losses, Foreign Exchange Gains/Losses, and Write-downs we have to estimate the approximate tax benefit loss based on this removal - otherwise we would be removing a gain/loss but not removing the associated benefit/loss associated with the taxes related to that gain. We use a 30% base tax rate for these calculations, but investors can use whatever tax rate they feel most comfortable with.
For example, if a company reports a $100 million dollar write-down, we will remove $100 million from its total costs (removing the effect of the write-down) and then add $30 million to costs (30% * $100 million) to represent the estimated tax benefit that the company gained from this write-down. You must do this if you want to remove any item from the income statement, otherwise you will be using taxes based on a removed income statement item.
Real Costs of Production for HL - Q2FY13
Let us now use this methodology to take a look at HL's results and come up with their 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 Q2FY13 which results in a silver-to-gold ratio of 61:1, lead-to-silver ratio of 24.8:1, and a zinc-to-silver ratio of 27.8:1. Investors should remember that our conversions change with metal prices and this will influence the total equivalent ounces produced for past quarters - which will make current-to-past quarter comparisons much more relevant.
Notes about True All-in Costs Table: Since we've updated our gold-to-silver ratio to 61:1 it has lead to a drop in true all-in costs for silver miners with large non-silver output. Hecla Mining qualifies as one of these miners with large non-silver production and thus both their silver-equivalent ounces and their cost per silver-equivalent ounce will benefit compared to other primary silver producers. The new ratios have been applied to ALL previous quarters so that comparisons can be done on an apples-to-apples basis.
Observations for HL Investors
True Cost Figures - HL's true all-in cost figures for Q2FY13 was $22.07 per silver-equivalent ounce, which was a slight improvement on a year-over-year basis and a slight decline on a sequential basis. Additionally, these costs were pretty flat compared to the $22.00 silver-equivalent ounce cost experienced in FY2012. Hecla Mining seemed to benefit greatly from its non-silver production which helped lower its silver-equivalent costs.
We haven't analyzed all the other primary silver companies' Q2FY13 numbers yet, but compared to the ones we have analyzed, HL ranks well in terms of its true all-in costs. Competitors such as Pan-American Silver (PAAS) (costs over $25), Endeavour Silver (EXK) (costs over $25), and Coeur D'Alene Mines (CDE) (costs just over $30).
Compared to the Q1FY13 numbers (for general comparison purposes only since these are FIRST QUARTER numbers), HL's competitors such as Silver Standard Resources (SSRI) (costs just under $30), Great Panther Silver (GPL) (costs around $29), Gold Resource Corporation GORO) (costs around $28), and cost-leader First Majestic Silver (AG) (costs just under $22).
So based on these numbers, HL does pretty well when compared on a true all-in cost basis to most of its competitors. One very important thing investors should note is that even though HL's true all-in costs were good, the settlement price for precious metals was extremely low.
These low realized prices (combined with the costs related to the Aurizon acquisition), prevented Hecla from having a much better quarter. This differential between the realized price and the average London silver price is simply unacceptable, and investors should expect that management takes steps to remedy the situation - it does no good to have low production costs if sales costs are lower. This is a situation that investors should monitor closely and watch for an improvement in average realized prices for silver in future quarters.
Corporate Liquidity - Liquidity is very important for investors to monitor in this current silver environment, especially for producers that have higher true all-in costs and negative earnings. Hecla Mining reported around $170 million of cash and $490 million of long-term debt, which is not terrific but we believe this should not concern investors at this point.
Other Notes - Investors should keep in mind that any time a company makes a major acquisition there are significant changes that happen to the company. The Aurizon acquisition is no exception, and we would advise investors to expect quite a bit of change during this transition. The first obvious change is that gold production will increase significantly as the Casa Berardi mine (a primary gold mine) is integrated into HL's operations. Investors should monitor Q3FY13 numbers carefully to see how well the acquisition is being integrated and how it affects income and costs.
Hecla has been a strong performer in terms of its true all-in costs and Q2FY13 was no exception. Benefiting from its base metal and gold production (and the subsequent drop in the silver-to-gold-ratio), Hecla kept costs relatively low at $22.07 per silver-equivalent ounce.
However, investors should note that the realized price for silver ($16.27) was extremely low compared to the average silver price during the quarter, and investors should expect from management a much better realized price for future quarters. Liquidity seems sufficient, though the issuance of a large amount of debt for the Aurizon acquisition remains something worth monitoring.
We remain neutral on Hecla Mining and at this point we would wait to see how the Aurizon acquisition is integrated into the company. Though true all-in costs are very good, we would want to see a much better price realization on sold silver to boost revenues and ultimately EPS.