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 Gold Resource Corporation (GORO). GORO produces slightly more silver than gold on an equivalent basis, thus we have characterized it as a silver miner, but depending on future silver and gold production, this designation could change. Their primary activities are focused on the El Aguila project in Mexico which hosts the La Arista vein system, which they currently explore and mine.
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 GORO - Q2FY13
Let us now use this methodology to take a look at GORO'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, a lead-to-silver ratio of 24.8:1, and a zinc-to-silver ratio of 27.8:1, and a copper-to-silver ratio of 7.1:1. 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.
Observations for Investors
True Cost Figures - GORO's true all-in cost figures for Q2FY13 was $21.46 per silver-equivalent ounce, which was a significant improvement when compared to Q1FY13 costs ($25.68) but was a little higher than the average costs of $18.25 experienced during FY2012. One thing investors should note is that taxes for Q2FY13 were -$1.26 million dollars (i.e. a tax benefit) while previous quarters had higher taxes, so the all-in costs experienced in Q2FY13 were significantly affected by these factors. With a normalized tax rate we would expect GORO's Q2FY13 costs to be in the $23 - $25 range.
Compared to other primary silver producers we have analyzed, GORO's Q2FY13 costs were fairly good and compare to competitors such as Pan-American Silver (PAAS) (costs over $25), Endeavour Silver (EXK) (costs over $25), Hecla Mining (HL) (costs over $22), Great Panther Silver (GPL) (costs over $25), Alexco Silver (AXU) (costs over $30), Coeur D'Alene Mines (CDE) (costs just over $30), Silver Standard Resources (SSRI) (costs over $25), Fortuna Silver Mines (FSM) (costs around $20), and cost leader First Majestic (AG) (costs under $20). GORO's costs were around the lower level of most of their competitors.
One other thing investors should note is that production numbers were down across the board over the last two quarters in all metal production except for gold (though up year-over-year). At this point we would just note this production drop rather than be worried about it because mining production normally fluctuates a bit quarter-to-quarter. Additionally, the company could be trying to conserve lower grade resources (i.e. "high-grading") so that may contribute to lower production totals.
Finally, GORO management does expect to lower per ounce and per tonne production costs with the completion of its new mill:
"With the decrease in precious metal market prices, and the gold-to-silver ratio working against us this quarter, our team was still able to deliver respectable production results. We look forward to the completion of our mill construction so we can focus our efforts on the Arista mine and increasing production tonnages to match the enhanced Aguila mill capacity. We expect a decrease in per ounce and per tonne production costs with higher mill throughput."
If the company can continue to lower production costs they can clearly enter the top-tier of low-cost silver producers - which would be good for investors.
Corporate Liquidity - Liquidity is very important for investors to monitor in this current silver environment, especially for producers like GORO that pay high dividends. As of Q2FY13, GORO reported around $34 million in cash, cash equivalents, and bullion with no outstanding debt. Their cash flow for the quarter was a net negative $5 million outflow, with close to $16 million in dividends paid during the quarter and a $5 million dollar capital lease inflow. But based on this, it seems the company has a decently liquid position based on its fairly large cash position. Additionally, in any cash crunch the company can cut its dividend which was a significant drain on cash flows for the quarter. At this point we wouldn't be concerned about the cash position of GORO, though we would want to monitor it to make sure it stays stable.
One Thing to Note for Investors
In October GORO had its CEO William Reid retire and its CFO Brad Blacketer resign due to "personal reasons." Whenever there is large turnover at the top of management it's always something investors should note and perhaps be concerned with - which is one of the reasons we believe the share price has underperformed even other silver producers. These events would take further analysis that is beyond the scope of this article but we felt it prudent to mention them.
Conclusion for Investors
Gold Resource Corporation had a relatively good quarter in terms of its costs of production, though much of it was due to tax rebates for the quarter. But the company does expect that after the completion of its mill, costs will fall further - which would be positive for investors. Cash flows were negative, but a large portion of those cash flows are dedicated towards paying the company's extremely high dividend, so it can be reduced to conserve cash so it doesn't seem there are any liquidity issues with GORO currently. Finally, investors should note that there is a transition at the very top of the company that has resulted in a share price underperformance versus other silver miners.
GORO makes an interesting investment case because it has been hit very hard by investors, but if it can continue to lower costs and new executive management can prove themselves to investors - this may be one of the silver miners that can outperform its competitors with any rise in the silver price. This would be a very interesting company for investors to research further who are looking for higher risk and higher reward silver producers.
Additional disclosure: The position in GORO is fairly small - though we may increase the position.