In our complete Q2FY13 cost analysis, we went over a number of the industry's all-in costs to mine an ounce of gold in Q2FY13 and 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 Q2FY13 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 true costs of production of Agnico-Eagle (AEM), a mid-tier producer with mines in Canada, Mexico, and Finland. Also, the company is led by Mr. Sean Boyd, one of my personal favorite CEO's in the mining industry..
How to Use Our All-in Costs Analysis with Your Investments
In the previously mentioned article, we gave a thorough overview of the current way that 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.
The best way to use this analysis for individual companies is to compare the different production cost metrics with the company's profits to look for any anomalies (e.g. large net profits but high costs). Also, we provide historic data to allow investors to check out any trends in regards to costs or production totals that may be an early warning to future successes or failures for the company. Ultimately, this analysis is best used as a first step to further investigative work, and that is our purpose with releasing this series.
Explanation of Our Metrics
All Costs per Gold-Equivalent Ounce - These are the costs incurred for every payable gold-equivalent ounce. It includes all company costs to produce gold including write-downs, smelting and refining costs, taxes, etc. 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.
This is the broadest measure of costs, and since it includes write-downs, it is essentially the "accounting cost" of producing gold-equivalent ounces. When there are large write-downs, it can have a significant portion of costs that are the decline in value of existing assets, which is not a cash cost.
Costs Per Gold-Equivalent Ounce Excluding Write-downs and S&R - This is the cost to produce each gold-equivalent ounce when subtracting write-downs and smelting and refining costs, but including everything else. Removing write-downs allows this cost to be a much more relevant cost to what it truly costs to produce each ounce of gold, but since it does not include smelting and refining costs (which is a requirement to be able to sell mined gold) it will underestimate true production costs.
Costs Per Gold-Equivalent Ounce Excluding Write-downs - This is similar to the above-mentioned "Costs per Gold-Equivalent Ounce Excluding Write-downs and S&R" but includes smelting and refining costs. That makes this measure one of the best ways to estimate the true costs to produce each ounce of gold, since it has everything (including taxes) except for write-downs.
The one flaw with this measure is that when removing write-downs it is necessary also to remove the tax benefits associated with those write-downs, which we have to estimate based on the size of the write-down. 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.
Costs per Gold-Equivalent Ounce Excluding Write-downs & Taxes - This measure includes all costs related to gold-equivalent production excluding all write-downs and taxes. Essentially this is the bottom dollar costs of production with an artificial 0% tax rate (obviously unsustainable) which works well because it removes any estimates of taxation due to write-downs or seasonal fluctuations in tax rates which can be significant.
The negative to this particular measure is that since it does not include taxes, it will underestimate the true costs of production. All companies ultimately pay taxes, and by removing them you create a production cost figure that is a bit optimistic and may be misleading to investors.
As investors can see, all the cost approaches above have their pros and cons, but we believe the last two are the most effective in evaluating the true costs of gold production - so we will focus on these approaches even as we list the cost figures for the other two for comparison sake.
True Costs of Production for AEM
Let us use this methodology to take a look at AEM's results and come up with the true cost figures for each ounce of production. When applying our methodology, we standardized the equivalent ounce conversion to use the average LBMA price for Q3FY13 which results in a silver-to-gold ratio of 62:1, copper-to-gold ratio of 413:1, and a zinc-to-gold ratio of 1580:1. 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.
Observations for AEM Investors
We weren't too thrilled with last quarter's performance by AEM, but they turned in a stellar third quarter in terms of their true all-in gold costs and production totals. Agnico-Eagle's Q3FY13 true all-in costs (costs excluding write-downs) plunged on a year-over-year basis from $1308 in Q3FY12 to $1138 in Q3FY13 which is an excellent 10% reduction in costs. Sequentially, true all-in costs fell from $1404 in Q2FY13, which is another major reduction in costs.
In terms of AEM's core costs (removing taxes and write-downs), costs also dropped from $1164 in Q2FY12 to $1047 in the current quarter. Additionally, this quarter's costs were lower than the average annual costs incurred by the company over the last two years by all measures - a significant achievement.
In AEM's Q3FY13 press release, they state the following:
"On the back of strong operating performance from our Meadowbank mine in the third quarter, and positive contributions from our other mines, we are pleased to announce record quarterly gold production and an increase in our 2013 production forecast with an associated reduction in the total cash cost estimate," said Sean Boyd , President and Chief Executive Officer. "Further cost reduction initiatives are being incorporated in our 2014 budget process, and will be reflected in our year-end financial results and three year forecast, scheduled for release this coming February," added Mr. Boyd.
The combination of cost-cutting measures and increased production led to one of the best quarters that we've seen in quite some time from any mid-tier gold miners.
Since Agnico-Eagle is one of the first companies we are analyzing in terms of Q3FY13 results, we do not have many comparisons yet from other companies' third quarter reports. The only other Q3FY13 report we've analyzed is Goldcorp's (GG) and they registered costs above $1100 per gold-equivalent ounce.
But comparing AEM to the second quarter true all-in costs of other companies they compare as follows: Barrick Gold (ABX) (costs just under $1300), Yamana Gold (AUY) (costs over $1300), Newmont Gold (NEM) (costs over $1600), Eldorado Gold (EGO) (costs under $1100), Goldfields (GFI) (costs over $1500), Allied Nevada Gold (costs over $1300), Alamos Gold (AGI) (costs under $1250), Kinross Gold (KGC) (costs over $1500), Randgold (GOLD) (costs over $1000), IAMGOLD (IAG) (costs over $1300), and Richmont Gold (RIC) (costs over $1300), and Silvercrest Mines (SVM) (costs over $1000).
We caution investors to do those comparisons with a grain of salt since these comparisons are for different quarters and use different metal conversion rates.
Agnico-Eagle management put in an excellent quarter according to each of our all-in cost measures and we have to do something that we have had little reason to do recently with gold miners - applaud management's efforts. A combination of aggressive cost-cutting measures and increased gold production led to outstanding third quarter results. Additionally, management predicts that production should be increasing over the next year, so investors may see another good quarter from AEM in Q4FY13.
The biggest issue we have with the company's third quarter performance is that it still has a fairly large debt position of $950 million dollars that increased by $100 million during the third quarter. That would be something we would want to see come down rather than up since it can be very dangerous for a company especially if it has to be refinanced in a rising interest rate environment.
Regardless, an excellent quarter for AEM and hopefully a watershed moment for the company as it may be moving from a higher cost producer to one of the lowest cost mid-tier producers.