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.
Silver Standard Resources (SSRI) is a primary silver resource and production company that has a portfolio of silver projects in North and South America. Its only current producing mine, the Pirquitas mine in Argentina, is the fifth largest primary producing silver mine in the world.
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 its 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 SSRI - Q2FY13
Let us now use this methodology to take a look at SSRI'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 Q2FY13. This results in a zinc 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.
Note about Adjustments to True Costs Values for SSRI
SSRI restated its Q2FY12 results and this resulted in a minor change to our calculated numbers. SSRI may restate future quarters but we do not expect these changes to significantly change the true costs above.
Unfortunately the massive write-downs experienced by precious metals companies makes it very difficult to calculate true all-in costs when there are such abnormally large write-offs, which affects not only costs, but also the taxes paid or the tax deductions received by companies.
Included in SSRI's Q2FY13 results was a $200 million write-down, which tends to create abnormal taxes for the quarter. Normally we remove the estimated taxes for the write-down, but it doesn't look like SSRI took those taxes this quarter so by doing this method we get an abnormally high $54.62 per silver equivalent ounce because the write-down would lead to an estimated tax deduction on the order of $60 million - but obviously that was not taken this quarter. To normalize these numbers we have added two rows "Normalized Total Costs" and "Normalized Total All-in Costs".
Normalized Total Costs represents all SSRI's costs for the quarter minus the $200 million write-down and plus smelting and refining costs, but without the estimated write-down on the deduction since it looks like it may be taken in future quarters. The big change here is related to taxes and how there does not seem to be a relevant tax write-off related to the $200 million write-down, which skews the true all-in costs to the displayed $54.62. That is why to normalize the all-in costs, we simply eliminate the write-down entirely and assume that SSRI will use the tax benefit in future quarters - not exact but it should be fairly accurate.
Normalized true all-in costs are simply Normalized Total Costs divided by total silver-equivalent ounces, which gives us $25.58 per silver-equivalent ounce.
Observations for SSRI Investors
True Cost Figures - SSRI's true all-in cost figures for Q2FY13 was $25.58 per silver-equivalent ounce, which was a worse on a year-over-year basis (compared to $23.32) but a substantial improvement on a sequential basis (compared to $27.88). Additionally, these costs were an improvement over the high $28.69 experienced in FY2012, though the last two years have had quite a bit of exceptional write-offs and asset sales.
We haven't analyzed all the other primary silver companies' Q2FY13 numbers yet, but here is how the company compares to the ones we have analyzed such as Pan-American Silver (PAAS) (costs over $25), Endeavour Silver (EXK) (costs over $25), Hecla Mining (HL) (costs over $22), 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 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).
During the quarter, cost reduction programs at the Pirquitas Mine were advanced with headcount reductions of 7% to date with further reductions. Additionally, the company plans on continuing its cost reduction programs with a particular focus on third party contract services and operational controls at the plant and mine. These cost reductions helped reduce true all-in costs, though we caution that this quarter's exceptional write-downs make it hard to tell if costs are falling structurally or it is the affect of the exceptional items on the income statement.
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. SSRI reported around $435 million of cash and cash equivalents and $135 million in marketable securities. This is compared to $182 million in debt. All in all, the company seems to have plenty of cash to weather the current silver price environment.
Though the company had significant write-downs, the quarter was not a terrible one in terms of true all-in costs, with normalized costs falling to $25.58 per silver-equivalent ounce. We do caution investors that the past quarter had significant write-downs - which may impact many items on the income statement. We would be more comfortable with these cost numbers if we could see them hold up in future quarters. Liquidity remains sufficient for the company, and even though there is a significant portion of debt, the company carries over $430 million in cash and cash equivalents and over $100 million in liquid investments (primarily Pretium shares).
There are many other factors an investor needs to develop a full picture of SSRI, but based on true all-in costs it seems like the company is getting a better handle on costs. We will be looking forward to Q3FY13 earnings, which will hopefully give us a clearer picture into costs without the significant exceptional items seen in the current quarter.
Additional disclosure: Positions in EXK and GPL are relatively small, may initiate larger positions in silver miners in the near future.