Whenever a mining company publishes its year-end results, it usually attaches a news release highlighting the best parts. There’s nothing wrong with a company putting a positive spin on the numbers. After all, it’s the job of management to attract investment, not repel it. But from the perspective of a shareholder or potential investor, it’s good to know what to look for beyond the fluff and below the top-line numbers like net earnings, cash flow, and dividends.
Production: Cash Costs, AISC, and Profitability
Despite their complexity, mining companies have two principle aims: mine as much ore as possible; and do it as efficiently as possible. This is as true for single-metal (pure-play) miners of all types as it is for diversified miners. An exception is vertically integrated miners like Glencore that have additional revenue streams outside of metals and minerals.
Finding out how much a miner produces is simple: there’s a line item (or items) for it in the financial report. Each metal or mineral should be reported according to its own standard unit of measurement. For example, gold production is usually expressed in ounces (oz), copper in pounds (lbs), and iron ore in dry metric tonnes (Mt).
Because precious metals like gold are mutually interchangeable (fungible), the realized price per ounce of gold is the same no matter who’s doing the selling. Other minerals, like iron ore, are extracted at different grades and are therefore sold at different prices. But regardless of which product a mining company is selling, they have virtually no control over what they can sell it for (unless a cartel is formed).
The best way mining companies can become more profitable is to reduce the cost of mining itself. If Miner A and Miner B sell the exact same quantity of gold on the spot market at the exact time, they’ll earn roughly the same amount. But if Miner A spends less than Miner B to produce the gold, it will become the more profitable company.
The confusing thing about mining costs is there are multiple ways of reporting them. For the purposes of this guide, we will be focusing exclusively on the method used by precious metals producers. They report cash costs, all-in sustaining costs (AISC), and all-in costs (AIC) as per the World Gold Council’s guidelines.
Cash costs comprise mainly on-site mining costs, permitting and community costs related to current operations, royalties and production taxes, and third-party smelting and refining costs. All-in sustaining costs add capital expenditure, general and administrative costs, exploration and study costs, and reclamation cost accretion and amortization. All-in costs are added only if a company incurs costs related to new operations or to major projects at existing operations where these projects will materially increase production.
Cash Costs vs AISC for Select Mining Companies
|Cash Costs ($/oz)||AISC ($/oz)||Cash Costs ($/oz)||AISC ($/oz)|
|Cash Costs ($/oz)||AISC ($/oz)|
|Cash Costs ($/oz)||AISC ($/oz)|
Before drawing any definitive conclusions, it’s important to remember these are non-GAAP metrics without standardization, which means companies will often omit substantial factors that affect its bottom line (income taxes, impairment charges, financing costs, etc.). With that said, investors can cautiously look to these numbers for guidance on the relative costs for overhead and new developments, as well as a company’s general sensitivity to gold prices. Of course, these metrics (and their plausibility) must be considered relative to the company’s stock price and production capacity to determine its true investment potential.
Balance Sheet: Striking the Right Debt-to-Equity Ratio
Strong balance sheets are generally considered a good thing, but is there such a thing as too strong? The answer to this question will depend on the individual shareholders and whether they’re thinking short-term or long-term. Let’s dive deeper with a look at the balance sheet trends of the mining industry over the past few years.
Gearing, the ratio of net debt to equity, dropped from 42% to 34% among the world’s top 50 miners as companies focused on debt reduction in 2016, according to EY. Debt fell almost 25% in the sector from 2014 to 2016 as companies opted to manage their balance sheets with caution while the commodities supercycle drew to an end.
After repairing their balance sheets, the world’s largest miners were awash in cash. The industry saw a small uptick in capital expenditure in 2017, a trend that may have accelerated in 2018. But a huge chunk of the spare funds was allocated to shareholders, with the global mining industry seeing a 27% growth in dividends for the 2017 financial year – beating every other industry.
Few shareholders would have argued when the payouts landed in their bank accounts, although EY warned about the dangers of mining companies going too far. “Companies face the very real risk of letting debt levels fall to lows that create inefficient balance sheets and overlooking necessary investment in projects to generate returns down the road,” Lee Downham, EY Global Mining & Metals Transactions Leader, said in mid-2017.
Overall, if an investor is concerned with a company’s short-term performance, then why would they say no to a record dividend? But if one is considering the long-term picture, they may be interested in companies with a healthy balance of debt to equity.
Guidance: Production Estimates and Cash Costs
If statements of production, income, and cash flow tell us how a mining company performed last year and balance sheets shed light on a company’s current position, then guidance tells us how a company thinks it will perform in the coming year.
Usually, a mining company will provide guidance for production and costs based on its mine plans and the method by which it will mine reserves at each site. This should give investors an idea of the company’s projected profitability for an assumed metal price.
For those wanting to dig deeper into the numbers, look no further than the mineral reserves and resources statement. This document, which most companies release at the same time as their year-end report, provides a picture of what a company could produce based on what they have in the ground. For context, a company’s resource represents the total amount of mineral owned (inferred, indicated and measured), while its corresponding reserves represent one part of the whole, the economically viable portion (probable and proven).
Mineral reserves and resources statements display each reserve and resource by the amount of ore in the ground and the grade. For example, gold reserves are reported by the amount of ore (expressed in tonnes), the grade (expressed as grams of gold per tonne of ore), and the contained ounces (the maximum amount of gold the miner could hope to produce from the ore). Iron ore reserves are reported by in-situ tonnes and grade (which is typically between 56% Fe to 65%).
Depending on the type of commodity, the grade can be a good indicator of the economic viability of a project or the value of the ore on the spot market. Higher grades are better, although other factors such as depth of ore zone (the closer to the surface the better) and thickness of the drill intercept (the thicker the better) can also improve a project’s viability. Mining companies will always talk up their best discoveries or prospects – investors must always be careful. For a full picture, the mineral reserves and resources statements reveal all the numbers according to internationally standardized measurements.
Wrapping Up with Risk
Finally, while we’re on the topic of guidance, it’s always a good idea to dig through a company’s report to see what they have to say about risks, including geopolitical risk. Mineral reserves don’t discriminate: they can be found in stable and unstable countries. Companies doing business in unstable jurisdictions can find themselves at risk, in the best case, of a little exchange rate volatility, and, in the worst case, of having their property expropriated or nationalized. Most mining companies outline the steps they’re taking to mitigate market risk somewhere toward the bottom of their year-end report.
In closing, there are a lot of factors to track when assessing a mining company’s viability as a short-term or long-term investment. It will take a careful eye for detail and a solid understanding of the fundamentals to be able to find the diamonds in the rough.
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