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 Great Panther Silver (GPL). GPL is a junior silver miner with producing mines and development projects in Mexico, and it is led by CEO Robert Archer.
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, and I would encourage all precious metals investors to understand this concept.
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 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 GPL - Q2FY13
Let us now use this methodology to take a look at GPL'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 gold-to-silver ratio of 61.2:1, a 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.
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Note About Above Table: Great Panther Silver reports its earnings in Canadian dollars and not US Dollars, so we've converted their income statement into US Dollars based on the average CAD/USD conversion rate for the quarter and shown their US Dollar numbers above.
Observations for Investors
True Cost Figures - GPL's true all-in cost figures for Q2FY13 was $25.11 per silver-equivalent ounce, which was flat when compared to Q1FY13 costs ($25.12) but a little bit of an improvement when compared to FY2012 costs of $26.49 per silver-equivalent ounce. We do note though that GPL did record a $2 million tax benefit which helped lower costs, so when comparisons are made with earlier quarters this must be taken into account because the current quarter's true all-in costs are lower than what they would have been without the tax benefits.
We haven't analyzed all the other primary silver companies' Q2FY13 numbers yet, but compared to the ones we have analyzed, GPL's costs are about average for primary silver producers. Competitors such as Pan-American Silver (PAAS) (costs over $25), Endeavour Silver (EXK) (costs over $25), Hecla Mining (HL) (costs over $22), Coeur D'Alene Mines (CDE) (costs just over $30), Silver Standard Resources (SSRI) (costs over $25), and cost leader First Majestic (AG) (costs under $20). So from a true all-in costs point-of-view, Great Panther Silver is producing silver-equivalent ounces at a cost comparable to the majority of silver miners.
One thing to note is that GPL's true all-in costs were still substantially higher than the current silver price, which is the case for many of their competitors, but is something that needs to change and costs need to be cut further. Which leads us to our liquidity analysis.
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. As of Q2FY13, GPL reported around $21 million in cash and cash equivalents with no outstanding debt. The cash figures are pretty much unchanged from the previous quarter, but since they were operating at a loss for the quarter the majority of the cash used seemed to come from a reduction in their short-term investment position that dropped around $5 million dollars during the period. All in all GPL remains only adequately liquid, and we would want to keep a close eye on the company's Q3FY13 earnings to see if cost-cutting efforts have reduced the true all-in costs to more sustainable levels at current silver prices.
Conclusion for Investors
The company has successfully contained the rise in costs that have plagued the mining sector, but their costs still remain over $25 per silver-equivalent ounce. This means that at current silver prices, the company is losing money and needs to engage in further cost-cutting strategies to keep mining sustainable. In terms of liquidity, the company has enough cash reserves to weather the current environment for the short-term, but it will be important to monitor Q3FY13 cost-cutting efforts because in the middle to long-term the company cannot sustain itself at current silver prices without outside financing or lower true all-in costs.
Additional disclosure: Our GPL position is rather small and we may completely liquidate it or add to it in the short-term depending on future developments with the company primarily related to cost control efforts.