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a plague o both your houses

Guest Article by reader BW: “Lifting the Dress on All In Sustaining Costs” (from IKN339)

I’ve been asked to put this piece, part of IKN339, onto the blog. So here it is.

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Guest
Article by reader BW: “Lifting the Dress on All In Sustaining Costs”

(Alt. title “How things can grow
out of virtually nothing when you run a blog”)

First a
little background
: In the last couple of weeks over at the blog, both myself
and reader ‘BW’ have been playing on the theme of All In Sustaining Costs
(AISC). It’s one of those subjects that’s itched at me for a while, because it
doesn’t need much numbercrunching to see that AISC is a neat new way of
spinning costs figures, rather than a useful metric that applies to all mining
companies equally. Thing is, I haven’t really got round to throwing darts at
AISC (even after being egged on by a couple of friends on more than one
occasion) but then a couple of weeks ago I broke the ice with a very simple
post and observation, it turned out to be the way in.

It all started on October 28th
and my post “Understanding “All In Sustaining Costs”, Detour Gold (DGC.to) edition”, which as a missive was
simplicity itself and to shed light on the “virtually nothing” sub-header above
I’ll even tell you how it all happened. That day I was about 30 minutes early
for an appointment in Lima and feeling a little drained after a long day, so I
decided to pause for a coffee in a nearby Starbucks. While there it just so
happened that the DGC 3q15 financials NR was published, I picked up the
corporate NR on my (rather basic HP) tablet and, amused at the spin they gave
the numbers, tapped out the straightforward post seen that day on the virtual
keyboard. I didn’t look at the SEDAR filings at all, it took about 15 minutes
start to finish, I hit Send, finished my latte and went to the meeting. By way
of a reminder, here’s the main numbery bit of that post:

Detour Gold (DGC.to) just reported its 3q15 and here’s my
favourite bit:

Gold sold: 126,241 oz
Average realized price per Oz Au: U$1,164
All In Sustaining Cost per Oz Au: U$1,071
Difference between two: U$93/oz
Total revenue difference: + U$11.74m

Net loss: US$44.3m
Adjusted net loss:U$13.3m

Hey, d’ya think that All In Sustaining Cost might not mean what you thought it
meant? Perhaps?

It was meant as a quick snark-shot
and I thought nothing else of it until a couple of days later when ‘BW’ (whose
ID will remain out the public eye but I will say he’s an excellent financials
person who’s modest to a fault about his undoubted ability) wrote in with the
mail that became this post “Great feedback on the Detour Gold (DGC.to)”
which took my basic idea on DGC and ran a lot further with it (it was very well
done too, I recommend a (re) read).

From there and with all thanks to
BW, the idea was lodged in my mind and last week I ran a couple of posts, the
first one called “More “All In Sustaining Costs” baloney, Primero Mining (P.to) (PPP) edition” which was
basically the same as the DGC idea but applied to Primero, then finally on
November 4th there was the post “Having your cake and eating it” which covered in conceptual style the reason why
Deprecation Depletion and Amortization (DD&A) is important to include in
operating costs models.

Now for
the good news
: Due to those last two amateurish efforts on my part, ‘BW’ wrote in
again late last week and expanded a little on his original comments about
Detour Gold (DGC.to), but this time taking Primero Mining (PPP) (P.to) as his
example (and quarry). While his mail was obviously meant for my eyes and
education, it was so good I asked him on Friday evening if he would let me run
his mail as a Guest Article in this Sunday’s edition of The IKN Weekly. He
kindly agreed and here we are, though he did insist that I add that his piece
is a simple proxy for other metrics, e.g. EBITDA. The purpose behind his mail
was to get ME (not anyone else) to apply it to show the true production costs
of any given miner (not just his example of Primero) from the data published in
an income statement. But me, I’m keen to let as many people as possible benefit
from BW’s smarts on this subject which is why I asked BW if he’d let me run it
here (some very slight editing and formatting done, but it’s really as-is).
Therefore without further ado here’s BW:

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Lifting The Dress on All
In Sustaining Costs

By ‘BW’

Prompted by your piece on Primero as
well as your response to a reader’s question regarding the “importance” of
considering DD&A, you have provoked me to offer you consolidation of my
thoughts regarding AISC and its noble goal to offer transparency, a.k.a.
eloquent obfuscation, to the market (excerpt below from my database). 
Well, lifting up that dress a bit more, we could consider AIC, but taxes, debt
service, and dividends are not included there.  It baffles the mind why
these items are not considered a part of a company’s sustainability.  I
reckon we don’t want to pull that dress up any higher for fear of what is
beneath!

Since you are one of the few who
unabashedly exposes the BS out there concerning the mining industry, at the
risk of being presumptuous, below I offer some suggestions as well as make some
other observations.

In the case of Primero, for Q3,
sales were 71,417AuEq oz for which revenues were $1,109/AuEq oz (low because
they have 2 streaming deals, which can’t be conveniently buried somewhere)

1.      
AISC = $775/AuEq oz  (includes $87/AuEq oz for G&A, marginally high at
11%)

2.      
Finance charges                     = $43/AuEqoz

3.      
Other (assumed not in AISC) = $75/AuEqoz

4.      
Taxes                                      = $243/AuEqoz

  

Subtotal: $1,136/AuEq oz  (i.e. cash
outlays)

5.      
DD&A   = $273/AuEq oz

Subtotal: $1,409/AuEqoz (i.e. cash
outlays + past cash outlays, of which only some sustaining capital was
accounted for previously)

6.      
5.75% Debenture    = $82/AuEq oz  ($75M over 38
months, so $5.921M/Q) – 38 months is earliest redemption date, which can occur
up to 62 months

Subtotal: $1,491/AuEq oz (i.e. cash
outlays + past cash outlays, of which only some sustaining capital was
accounted for previously + future outlays)

7.      
Mark-to-Market  = negative $126/AuEq oz (if debenture is amortized
and applied to cost, which is only fair to include)

Final
total $1,365/AuEq oz
(i.e. what it really costs Primero to produce an ounce of
gold or gold equivalent).

They also have some equipment
leases, but appear to add only incremental cost on a per-Q basis and therefore
not included.

They have $43.1M in cash, but $30.4M
in payables – net cash = $12.7M.

They must pay off $49.684M for 6.75%
Brigus debenture by March, 2016, which I suspect that they will do with shares.

But no worries – they have a $75M
credit line. (otto note: I laughed
hard at BW’s dry sense of humour here
).

Finally, another note on Cash Flow
Models (CFM) as applied to new projects and acquisitions. Once the project
starts construction and/or is acquired, the investor focuses on margins, i.e.,
FCF; the NPV becomes irrelevant, but investors want to see the “profit” earned
from the outlays. The CFMs are not updated for any financing for public
purview; I have never seen a “forensic” pre-project/acquisition review
available to the public. If there is debt on the project, this review
essentially occurs every quarter in order to determine compliance with regard
to covenants, but only general statements are made to the public regarding
covenant compliance. This only points out that there is no “means test” in
the public domain for the copious use of the word “accretive”.

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IKN339 back and sincere thanks
again to BW for first taking the time and effort to write to me, then allowing
me to publish his musings to a wider audience. I’m fully aware that he
considers them basic and ballpark (especially compared to what he usually does)
but I also know that this type of insight is greatly appreciated by at least
some of the IKN audience.

As well as BW’s model on Primero,
which shows just why the company recorded a net loss of 3c/share despite
claiming to have an AISC of $775/oz, I liked the last paragraph which looks at
the question reader ‘DB’ asked me in the have-cake-eat-it post from a different
and better angle. Again, if any given company had no debt (in real terms, we
shouldn’t fret too much about payables as long as there are receiveable and/or
cash to cover them) and had already raised all its required capex from the sale
of equities (placements etc), fundies theory states that the company’s
operational profitability, not just its net profitability will reflect directly
in its share price. But when debt gets in the way it needs to be serviced from
somewhere, then eventually principle needs to be paid off from somewhere and
that doesn’t just happen from money created out of thin air.

When you (the investor) buy a
share, you buy a part of the equity of the company in question. The definition
of “equity” is straightforward, it’s “assets minus liabilities”. Therefore if
your company’s main fixed asset is non-renewable, e.g. a mine with valuable
rock that you pound into bits for its metal content, when the metal’s gone so
is all the fixed asset value. The only thing you’re going to have left is the
cash you generated from all that mining activity, minus any debt on the books.
Therefore it stands to reason that if you use all (or even most) of the cash
you generate to pay off the debt holders, there’s going to be precious little
left for the people holding the shares at the end. No distributions, no
dividends, no soup for you.

Which is why I love this cartoon so
very much and use it on the blog when given a legitimate opportunity.

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