The earnings season is ending so it is a good time to look at a few basic figures reported by a group of mining companies focused on silver production. What is more, I think that this time my survey is particularly important. As the chart below shows (the horizontal line on the lower panel), most recently silver prices have reached a level of $14.0 per ounce, lastly seen in the beginning of the current bull cycle in precious metals (January 2016). The gold / silver ratio (the upper panel) has followed this pattern, hitting 85.9 on November 13, 2018. To remind my readers, since the beginning of the super bull cycle in gold (years 2000 – 2003) this popular ratio reached a similar level only twice: in 2003 and 2008. In both cases the precious metals market used to enter a strong bull cycle:
Well, if history repeats we may be ahead of another strong bull phase of the super cycle initiated in 2000 – 2003. If not, this survey is particularly important because in its final section it identifies a few low-cost mostly-silver producers that should survive a negative scenario (silver prices staying low or even going further down).
Note: I have excluded Hochschild Mining from this survey; the company releases its full financial reports only twice a year (1H and the end of the fiscal year). Therefore the current survey cannot be comparable to the 1H 2018 report (published on August 29, 2018).
To remind my readers, 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
Now, due to its super-large size, I also excluded Fresnillo plc (OTCPK:FNLPF) from my survey (the results reported by this excellent miner would distort the entire study). Finally, although Great Panther does not meet the second criterion (in 2017 the company reported revenue of $64M), I have included this miner into my research (by the way, after the recent acquisition of Beadell Resources, Great Panther is going to be a mostly-gold producer, no longer qualifying 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, the leader is First Majestic, offering a 57.3% exposure to silver. On the other hand, the lowest exposure is demonstrated by Pan American and Silvercorp (41.1% and 41.2%, respectively).
I have gathered the 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 sold (for example, gold ounces sold are recalculated into their silver equivalents).
Silver sector: Joint statement of operations
This time I would like to start the survey in a bit different way. In 3Q 2018 the prices of gold and silver went significantly down, compared to 1H 2018. For example, in 3Q 2018 the miners under this survey were selling silver at an average net price of $13.4 per ounce ($15.3 and $15.5 in 2Q and 1Q 2018, respectively). As a result, a gross margin delivered by the sector went down from $210M in 2Q 2018 to $156M in 3Q 2018 (a drop of 25.7%) – look at the chart below and the panel on the left:
Fortunately, not everything is that bad as it looks. In my opinion, the sector has made substantial progress, evidenced in the panel on the right. Namely, in 1Q 2016 and 3Q 2018 the silver was trading at a similar price ($13.6 and $13.4 per ounce, respectively). However, despite a similar price of silver, in 3Q 2018 the sector delivered a much higher cash flow from operations (excluding working capital issues) than in 1Q 2016 ($88M in 3Q 2018 vs. $24M in 1Q 2016). In other words, due to lower costs of production, the sector is in a much better shape than it used to be at the beginning of the current cycle. I am impressed.
Now let me go to the joint statement of operations:
Note: To arrive at silver equivalents I have made my own calculations based on metals prices realized over the first three 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)
- Over the first three quarters of 2018 the sector produced 44.3 million ounces of silver (an increase of 7.1%, compared to 2017 YTD). Sales volume also went up, from 78.9 million ounces of silver equivalent in 2017 YTD to 90.9 million ounces in 2018 YTD (an increase of 15.2%). In other words, production went up at a slower pace than sales. I think it is a common pattern – due to aging silver mines, mainly sulfide epithermal vein deposits, the sector produces more base metals (zinc, lead and copper), driving the total sales figures up.
- As mentioned earlier, in 3Q 2018 we saw significantly lower prices of silver. As a result, the average silver price realized over the first three quarters of 2018 was 7.3% lower than in 2017 YTD.
- Higher sales volume and lower prices of silver resulted in a slightly higher revenue (an increase of 6.8%, compared to 2017 YTD)
- Now, as discussed in the section “Economics of mining” (below), a unit direct cost of production went down from $8.9 per ounce of silver equivalent in 2017 to $8.5 in 2018 (a drop of 5.0%). As a result, a gross margin delivered by the sector went up from $545.4M in 2017 YTD to 563.4M in 2018 YTD (an increase of 3.3%)
- Further, the sector is heavily investing in its properties. For example, this year as much as $301M was invested in the sector’s operating assets ($270M in 2017 and 2016 year-to-date), driving their book value up. As a result, a depreciation charge went up 27.7%, compared to last year, dragging an operating profit down (from $322.6M in 2017 to $284.0M this year). However, the general picture is still positive – despite lower metal prices, the sector managed to deliver a higher gross margin.
- The other issues disclosed in the joint statement of operations are not that important as those discussed above. However, it has to be noted that the sector reported higher administrative and finance expenses. The first occurrence is negative while higher finance expenses are a result of a higher debt level ($204M at the end of September 2018 vs. $88M at the end of September 2017). Simply put, a few miners got into debt to grow their business but I am not concerned – the sector is in a good shape, holding more cash than debt.
Economics of mining
Below I present a few important performance measures (unit costs of production, margins and cash flows) expressed in US dollars per ounce of silver equivalent:
How to read this table? I guess it is quite easy. For example:
- Over the first three quarters of 2018 the sector was selling its metals at an average net price (after deducting treatment and refining charges) of $14.7 per ounce of silver equivalent
- The unit direct cost of production was $8.5 per ounce of silver equivalent
- As a result, a gross margin was $6.2 per ounce of silver equivalent (silver price less direct cost of production)
Similarly to my previous reports, I have to note that in 2018 YTD the sector cut its unit direct cost of production from $8.9 per ounce of silver equivalent in 2017 YTD to $8.5 this year (a drop of 5.0%). Definitely, it is a positive occurrence because the sector is able to cut its costs to survive a period of low silver prices.
On the other hand, due to much lower silver prices recorded in 3Q 2018, the average silver price realized this year up-to-date went down 7.3%. As a result (silver prices going down faster than costs), a unit gross margin reported by the sector decreased by 10.4%. This negative occurrence was offset by higher sales volume (an increase of 15.2%), driving the total gross margin up (as discussed in the section above). However, the general trend is clear – to sustain the margins the sector has to keep production (and sales) growing.
Cash flows and capital spending
To make this survey more detailed, below I have plotted the table showing cash flows and capital spending reported by the mid-cap silver sector. All figures have been recalculated into ounces of silver equivalent:
As the first row shows, over the first three quarters of 2018 each ounce of silver equivalent sold on the market generated $3.5 in cash flow from operations (a drop of 17.7%, compared to 2017 YTD). What is more, in 3Q 2018 the sector burned $1.0 per each ounce of silver equivalent sold. Definitely, at current silver prices it may be very difficult to show free cash flow but…I am pretty confident that silver producers should survive. Here is my simple math:
- Let me assume that silver prices are going to stay low for some time; as a result, the sector is going to burn $1.0 per each ounce of silver equivalent sold on the market (as of 3Q 2018)
- Assuming sales volume of 91 million ounces of silver equivalent per quarter or 364 million per year, it means that the sector is going to burn $364M a year (364 million ounces x negative free cash flow of $1.0 per ounce)
- At the end of September the sector hold cash of $712M so, theoretically, it should survive for the next two years at current (low) silver prices
In my opinion, despite low silver prices, the silver sector performs pretty well. For example, over the first three quarters of 2018 it reported a net income of $147.1M. Even in the third quarter of 2018, when the price of silver went down to the level last seen at the beginning of the current bull cycle, the sector was able to report a net income ($32.4M). So I am generally satisfied with these results.
However, this year the silver plays are conducting very ambitious investment programs; up to now they have spent over $300M to keep their business growing. A higher CAPEX resulted in a negative free cash flow – in 3Q 2018, due to lower prices of silver, the sector burned $1.0 per each ounce of silver equivalent sold on the market. Fortunately, according to my own calculations, the sector should be able to survive the next two years at current silver prices.
Finally, if the current (low) silver prices are going to stay here for some time, below you will find the chart identifying a few low-cost silver producers:
The horizontal red line depicts the current silver price ($14.0 per ounce). It is easy to spot that there are four producers delivering their metals at an all-in sustaining cost of production below $14.0 per ounce: Silvercorp, Fortuna, Pan American Silver and First Majestic. As usually, the lowest-cost producer is Silvercorp (AISC of $8.8 per ounce), a company operating in China (hence, it is out of favor with many investors). Then there is Fortuna Silver, a company operating in Mexico and Peru (a few days ago I published an article on this company). The third lowest-cost producer is Pan American, a multi-mine giant company operating in Mexico, Peru, Bolivia and Argentina. Unfortunately, the fourth producer, First Majestic, is close to a break-even cost of $14.0; as a result, First Majestic is more risky than its lower cost peers.
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Disclosure: I am/we are long CEF, GDX, ARREF, KL, SAND. 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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