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 come 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 Yamana Gold (AUY), a mid-tier producer primarily focused in South America with mines in Brazil, Argentina, Mexico, and Chile. The projects in Argentina have a higher element of political risk, which is something investors should note, but this discussion is outside the scope of this article. Nevertheless, investors interested in AUY should keep tabs on the political situation in Argentina because events there may significantly impact the future of AUY's operations in that country.
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, and I would encourage all precious metals investors to understand this concept.
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.
Tax Calculations - Since we are removing Derivative Gains/Losses, Foreign Exchange Gains/Losses, and Write-downs we have to estimate the approximate tax benefit (or 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.
True Costs of Production for AUY Q2FY13
Let us now use this methodology to take a look at AUY'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 Q2FY13. This results in a silver-to-gold ratio of 61.2:1 and a copper-to-gold ratio of 436:1. Since our conversions change with metal prices, this may influence the total equivalent ounces produced for past quarters - which will make current-to-past quarter comparisons much more relevant.
Important Note: When calculating gold equivalent ounces, our gold equivalent production may differ a little bit from AUY's numbers. The reason is that even though we are using the same base numbers, depending on the ratio of conversion it may change the number of total equivalent ounces. We believe our use of recent LBMA prices is the most accurate in terms of predicting future gold equivalent production. It also allows investors to compare AUY with other gold companies because by using our methodology the comparisons will be apples-to-apples, while using individual gold miner calculations may yield much different results since each miner may use a different equivalency calculation (There are no GAAP gold equivalency calculations).
Also, when analyzing AUY's report, they do NOT include copper production into their calculation of gold-equivalent ounces, so their gold-equivalents will be significantly lower than the gold-equivalents specified in our calculations. They do not acknowledge it as gold equivalent but they do subtract it when calculating their per ounce production costs - it is just a different way to arrive at the same goal.
Note about Production Totals for AUY
We do not include Yamana's Alumbrera production totals because the company accounts for Alumbrera as a joint venture rather than joint operations, and thus only includes the net income from Alumbrera in its income statement.
This affects true all-in costs in two ways. First, this method removes all revenues and costs associated with Alumbrera, 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 from 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 $1500, then its cost per ounce is $5 and its net profit is $10 per ounce or $1000 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 $1000. 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 remove Alumbrera production from our calculated attributable ounces for AUY. We will treat Alumbrera in the same way AUY treats this mine, as an equity investment not as an operations segment - this will allow us to get the true cost of each ounce produced.
Observations for AUY Investors
The first thing that investors should notice is that AUY's true all-in costs for the quarter were $1316 per gold-equivalent ounce, which was an improvement on a year-over-year basis from the $1395 of Q2FY12 and an improvement sequentially from the $1358 of Q1FY13. Compared to FY2012 costs, AUY's second quarter was up about 3%, which is not unusual and has been a trend across the industry.
We haven't analyzed all the other gold miners' Q2FY13 numbers yet, but compared to the ones we have analyzed, AUY ranks about average in terms of its true all-in costs. Competitors such as Barrick Gold (ABX) (costs around $1300), Goldcorp (GG) (costs over $1250), Allied Nevada Gold (ANV) (costs over $1300), Alamos Gold (AGI) (costs under $1250), and Richmont Gold (RIC) (costs over $1300).
Compared to the Q1FY13 numbers (for general comparison purposes only since these are FIRST QUARTER numbers), AUY's competitors such as Goldfields (GFI) (costs over $1500), Randgold (GOLD) (costs just under $1200), Iamgold (IAG) (costs around $1400), Silvercrest Mines (SVLC) (costs below $1100), Kinross Gold (KGC) (costs just under $1400), Newmont Gold (NEM) (costs around $1300), and Agnico-Eagle (AEM) (costs around $1400).
Corporate Liquidity - Liquidity is very important for investors to monitor in this current gold environment, especially for producers that have higher true all-in costs and negative earnings. Yamana Gold reported a balance sheet of around $380 million of cash and $1.06 billion of long-term debt. Anytime a company has a large amount of debt compared to cash on hand, it is important to understand the debt repayment schedule. For AUY it is the following:
As investors can see, the vast majority of debt is due after 2018. Since AUY's production costs are slightly below the gold price and the company has sufficient cash on hand, we don't see any real liquidity risk for Yamana.
Production Numbers - AUY's gold production increased for the quarter on a sequential basis to 247,625 ounces, though it was down from the stellar Q4FY12 of 265,604 ounces. Copper production was also up about 10% sequentially, while silver production fell about 15% sequentially.
AUY's true all-in costs were $1316 per gold-equivalent ounce, which puts the company around average compared to other large gold miners. Even though debt has grown, liquidity remains sufficient and the lion's share of debt repayments have quite a bit of time before they are due. Production of gold and copper were up sequentially, though silver was down, which led to an increase in gold-equivalent ounces on a sequential basis.