The first quarter of 2018 is over so it is a good time to look at and discuss the results delivered by mid-cap silver mining companies.
Let me begin with the list of the miners qualifying into my research. Here it is: First Majestic (AG), Endeavour Silver (EXK), Great Panther (GPL), Silvercorp (SVMLF), Fortuna Silver (FSM), Pan American (PAAS).
Now, a company qualifying to my study must meet the following criteria:
- Silver sales account for more than 40% of total revenue
- Annual total revenue is higher than $100 million
Unfortunately, Fresnillo plc (OTCPK:FNLPF) and Hochschild Mining (OTCPK:HCHDF) are excluded from my survey. Simply put, these companies publish financial results every six months so we have to wait until the end of 1H 2018 to see how these miners perform.
Finally, although Great Panther does not meet the second criterion (in 2017 the company reported revenue of $64M, only), I have included this miner into my research.
Exposure to silver
Now, the chart below lists silver plays according to their exposure to silver prices (silver exposure is defined as silver revenue / total revenue):
Source: Simple Digressions
As the chart shows, there are two plays demonstrating very high exposure to silver (more than 58%): First Majestic and Endeavour Silver. Interestingly, Impact Silver, a tiny company (therefore not discussed in this article) operating in Mexico, has the highest exposure in the entire industry (89.5% in 2017).
Interestingly, a few miners discussed before (for example Coeur and Hecla) do not qualify into this survey. Simply put, their exposure to silver has gone drastically down. Sadly, it looks like a general trend – the amount of primary silver miners is going down…
I have gathered the all data presented in financial statements of the above listed miners and created a joint statement of operations for the entire group of silver producers. The results are expressed in US dollars.
To calculate certain financial measures I am using the concept of the so-called “an ounce of silver equivalent”. According to this method, costs of production or margins are divided by ounces of silver equivalent (for example, gold ounces sold are recalculated into their silver equivalents).
Silver Sector - joint Statement of Operations
The table below shows the Silver Sector joint statement of operations:
Source: Simple Digressions
Note: To arrive at silver equivalents I have made my own calculations based on metals prices realized in first quarters of 2018, 2017 and 2016. In other words, I have not copied the data presented in the financial statements published by the miners (for example, most of the figures published in these statements are based on outdated gold / silver ratios)
- First of all, note that the average silver prices recorded in 1Q 2018 were a bit lower than in 1Q 2017 ($15.5 per ounce vs. $16.3). However, due to higher sales volume (27.8 million ounces of silver equivalent in 1Q 2018 vs. 25.5 million in 1Q 2017) the sector reported higher revenue
- Due to higher revenue and lower costs of production (a decrease of 4.0%, compared to 1Q 2017), the sector performed much better than in the past – all earnings across the board improved
- A sustained recovery in the precious metals industry resulted in reversals of impairment charges
- Unfortunately, silver production remains generally flat in the long term (2016 – 2018). Simply put, primary silver producers are changing their production profiles to focus more on gold and base metals. For example, the amount of silver produced in 2017 was generally flat compared to 2016 but sales, measured in silver equivalents, went up 9.0%.
Summarizing – in my opinion, the silver sector is getting better. For example, despite lower prices of silver, in 1Q 2018 the sector reported stronger earnings across the board and cut direct costs of production. On the other hand, the amount of silver produced is going down; as a result, the supply of primary silver producers is lower than before.
Economics of mining
Below I present a few very important performance measures (unit costs of production, margins and cash flows) expressed in US dollars per ounce of silver equivalent:
Source: Simple Digressions
How to read these tables? I guess it is quite easy. For example:
- In 1Q 2018 silver producers were selling their metals at an average net price (after deducting treatment and refining charges) of $15.5 per ounce of silver equivalent
- The direct cost of production was $8.3 per ounce of silver equivalent
- As a result, a gross margin was $7.2 per ounce of silver equivalent (silver price less direct cost of production)
And so on…
As the table shows, in 1Q 2018, despite lower prices of silver, the sector managed to increase a gross margin to $7.2 per ounce of silver equivalent ($6.9 in 1Q 2017). I am impressed because the miners, seeing lower silver prices, were able to cut direct costs of production appropriately. Interestingly, last year, when silver prices were stronger than in 1Q 2016, direct costs of production went also up (from $8.4 per ounce to $9.4). It looks like lower prices of silver make the management boards more disciplined. As a result, the sector is not that vulnerable to silver prices as many people think. I would even risk and say that, generally, no furious bull market in precious metals is needed to make money on silver producers. If silver prices are flat, a low-cost silver producer should be able to grow and report better earnings going forward.
Unfortunately, cash flow figures seem to negate this thesis. For example, cash flow from operations (excluding working capital items) went down from $3.9 per ounce of silver equivalent in 1Q 2017 to $3.6 in 1Q 2018. What happened? I think it is easy to explain. Apart from direct costs of production (which went down), there are many other items driving the overall cash flow figures down (overhead, finance costs, taxes paid etc.). As a result, despite cutting on-site costs of production, the final cash flow from operations was a bit lower than in 1Q 2017 (but higher than in 1Q 2016). Well, I would not bother too much about it. In my opinion, the most important pattern emerging in 1Q 2018 is this:
“Despite lower prices of silver, the sector is able to cut direct costs of production and deliver generally unchanged cash flow from operations”
This thesis is additionally supported by a very distinct and positive trend in all-in sustaining costs of production (AISC), which went down from $13.9 per ounce in 1Q 2017 to $12.6 per ounce in 1Q 2018 (a decrease of 9.4%).
Note: I have made simplified calculations of AISC using the following formula: AISC = direct costs of production + royalties and production taxes + administrative expenses + exploration expenses + share based payments (contrary to many analysts I consider share based payments as a typical salary) + other costs of production + capital expenditures
Last but not least – free cash flow, defined as cash flow from operations (this time including working capital items) less capital expenditures, went down from $0.1 per ounce of silver equivalent in 1Q 2017 to minus $0.2. Simply put, in 1Q 2018 the sector spent more on business development than in 1Q 2017 (83.9M vs. $75.6M in 1Q 2017).
In my opinion, the results delivered in 1Q 2018 support a thesis that the silver sector is heading in the right direction. First of all, despite lower prices of silver, primary silver producers surveyed in this article were able to cut direct costs of production; as a result, a gross margin was higher than in 1Q 2017 and 1Q 2016.
Secondly, the sector invested more cash into growth and operating mines, compared to 1Q 2017. However, in my opinion, it is not a big problem because the capital spent on growth and the currently operating mines should have a positive impact on the sector in the long term. In other words, I think that now the silver sector is in a much better shape than before and even lower prices of silver are not able to do big harm.
Interestingly, the latest performance of the sector supports my thesis:
Source: Simple Digressions
Note: the silver index is comprised of the following silver plays: Silvercorp, Fortuna, Pan American, Fresnillo, First Majestic, Endeavour Silver, Hochschild Mining, Great Panther, Impact Silver, Excellon and Avino.
Note that after a period of underperformance (the red arrow) since the end of 2017 the sector has been outperforming GDX, a popular mostly-gold mining ETF (the blue arrow). It looks like the increased exposure to silver makes sense now.
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Disclosure: I am/we are long CEF, GDX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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