Friday, June 12, 2015

Orvana Minerals - A Brief Comparison Of Costs Of Production

Note: it is a technical article. If you hate even basic maths, please, go for a walk...
In the mining industry, production costs, at which any company extracts and process its metals, are one of the most important metrics. There are two ways to get knowledge about these costs.


Firstly, an analyst can calculate accounting costs of production using financial statements the company publishes. These statements provide credible and standardized information.

Secondly, an analyst may study the so-called non-IFRS reports published by a majority of mining companies. In most cases these statements provide detailed information on cash costs of production.

To analyze any mining company and its costs the investors should study both statements.


But there are at least two problems an analyst will face when studying financial statements or non-IFRS reports:

·         Financial statements mirror book-keeping entries, which do not include such issues as, for example, sustaining capital spending. Apart from that, some issues as, for instance, general and administrative expenses or depreciation and amortization are reported on the overall basis while only a part of these costs is related directly to extraction and processing.   

·         Non-IFRS cash costs reports do not include depletion, amortization and depreciation, which are non-cash measures. It means that cash costs do not measure how much of an asset’s value has been used up in the production process (sustaining capital expenditures, which are an element of all-in cash costs, solve the problem only partially).


Finally, both measures, financial statements and non-IFRS reports, are constructed on the net revenue basis. This is a problem, which is not widely spotted (although some authors are well aware of it). In my opinion, a proper analysis of production costs incurred by any mining company should start from gross revenue. It is especially valid when a company produces concentrates of metals, where treatment and refining charges are significantly high.


In this article I am using the gross revenue approach to analyze production costs of a mining company. I have chosen Orvana Minerals Corp () as an example of a mining company producing concentrates of metals.  


Orvana Minerals.

Orvana Minerals is a medium gold / silver / copper producer operating two mines. One of them, El Valle –Boinas/Carle, is located in Spain and another one, Don Mario, in Bolivia. In 2014 Orvana produced around 84 thousand ounces of gold, 890 thousand ounces of silver and 21 million pounds of copper.

Similarly to a majority of mining companies, Orvana presents detailed information on its production costs in its financial statements; the company also reports non-IFRS measures in the Management Discussion sections of its financial statements.

Let me present these measures.


Financial reports.


Below I present part of the 2014 Consolidated Statement of Income (all calculations relate to the year 2014):

                                   source: Orvana Minerals 2014 Annual Report

To calculate the accounting production costs I have added up the following issues: Mining costs, Depreciation and amortization, General and Administrative, Exploration and Community relations. Impairment charge is a one-off issue therefore I am not including it into my calculations. “Other expenses” include one-offs as well (as, for example, Union payments, which relate to the period 2002 – 2012) therefore they are excluded from my calculations. Finance costs and Derivative instruments gain are financial measures, which are not correlated with mineral extracting and processing – therefore they are excluded as well.

Additionally, looking at General and Administrative expenses one can find an issue called Foreign exchange expenses ($242 thousand in 2014) – because these costs are financial issues I have excluded them as well.

After adding up the above described issues I find out that Orvana incurred costs of production of $140,285 thousand.

Now, to find out how much it costs to produce one ounce of gold, I have to divide production costs related to gold production by the number of gold ounces sold. Here is the first problem because I have to know what part of production costs relates to the gold production only. It is information, which is not available in financial statements of any mining company. Therefore, to solve this problem, mining companies offer some adjustments, of which, to make things as clear as possible, I have chosen the method based on the so-called gold equivalent ounces. It is a theoretical short-cut because mining companies do not produce equivalents of gold – they produce gold, silver, copper etc. To calculate gold equivalents ounces one has to find out how many gold ounces a company could sell for the consideration obtained for metals other than gold (in the Orvana’s case there are two such metals: silver and copper). The table below shows the way I calculate it:



As the table shows, Orvana produced 139,254 gold equivalent ounces.

Now, dividing production costs by gold equivalent ounces I may find out that Orvana incurred production costs of $1,007 per gold equivalent ounce.


Non-IFRS measures

In its Non-IFRS section of the 2014 Management Discussion (page 31) the company presents cash operating costs, all-in sustaining costs and all-in costs. According to that section, in 2014 the company incurred all-in costs of $1,075 per ounce of gold. Orvana presents these costs on a by-product and gold ounces sold basis.


                                     Simple Digressions proposal


First of all, to calculate production costs I am using gross revenue numbers. What does it mean? Let me explain.


In 2014 Orvana sold the following amounts of metals:

·         Gold: 79,858 ounces

·         Silver: 833,594 ounces, which is equal to 13,051 gold equivalent ounces (see table 1)

·         Copper: 18,935 thousand pounds, which is equal to 46,344 gold equivalent ounces (see table 1)


The company was selling its metals for the average realized gold price of $1,287 per ounce. Therefore in 2014 gross revenue was $179,220 thousand (multiply the gold price by gold equivalent ounces sold). In its 2014 Annual Report the company reported sales of $142,285 thousand. The difference is $36,935 thousand. Why gross revenue is different from sales reported in the company’s financial statements? Let me cite the company’s definition of revenue:

“Revenue represents gross revenue derived from the sales of metals in the applicable period less treatment, refining, penalties and payable metals deductions associated with such sales, plus or minus realized final payment amounts relating to metals sold in prior periods, plus or minus mark-to-market adjustments based on unrealized price fluctuations at period end relating to metals sold in the current or prior reporting periods prior to receipt of final payment for such sales.”

Orvana (and a majority of mining companies) does not specify exact figures included in the difference between gross revenue and revenue reported in the company’s financial statements. But it is not a very important issue. The most important thing is that an analyst is able to calculate that difference. From now on, let me call that difference “Gross Revenue Difference”.

One small digression on treatment charges and payable metals.

Investors should remember that Orvana sells part of its production in the form of metal concentrates (the rest is being sold as doré). When a company sells concentrate, it is paid for the so-called metals payable (for example a miner could be paid for only 95% of silver included in the concentrate – in this case the rest, 5%, is a fee paid to the smelter). Additionally, due to the fact that concentrates are non-standard substances, they have to be processed individually. Processing costs money - the more the concentrate is hard to process, the higher fee / penalty paid for that operation.


Below I am discussing the way I calculate production costs using gross revenue approach.

Gross accounting costs of production.

To calculate gross accounting costs of production I make only one adjustment – Gross Revenue Difference must be added to the accounting costs calculated in the section “Financial reports”. Therefore in 2014 Orvana incurred gross accounting costs of production of $177,220 thousand. Dividing this figure by gold equivalent ounces (139,254) I find out that it cost $1,272 to produce one ounce of gold equivalent.


This cost is much higher that that calculated using standard accounting ($1,011 per gold equivalent ounce).


Non-IRFS measures

To calculate cash cost of production, similarly to the section above, I take into account gross revenue. To simplify the matter I assume that these sales are cash sales – a company sells its metals and the consideration is paid at the time of a sale. Then, I adjust cash flow from operations (reported in the Cash Flow Statement) through excluding all working capital issues – in result I get “clean” cash flow generated by the mining operations.


Let me get figures. In 2014 Orvana reported cash flow from operating activities of $34,731 thousand; the company also reported a decrease in non-cash working capital of $2,541 thousand. Therefore cash flow from operations excluding working capital issues) was $37,272 thousand. Now, the difference between gross sales and cash flow from operations ($179,219 thousand minus $37,272 thousand = $141,947) is equivalent to cash spent on mining and processing. Additionally, cash spent on mining and processing should be increased by the so-called sustaining capital expenditures (these expenditures are necessary to keep the mine working). In 2014 the company spent $10,719 thousand on these expenditures therefore total cash cost of production stands at $152,666 thousand. Dividing this figure by gold equivalent ounces I can calculate cash cost of production per ounce of gold equivalent, which stands at $1,096.


Comparing costs of production.


Below I am comparing costs of production reported by the company and those calculated by Simple Digressions:


Simple Digressions
accounting costs
cash cost


As it is easily spotted, costs of production calculated by Simple Digressions are higher than those reported by the company.


Finally, the most interesting part...Below I am presenting margins recorded by Orvana in the first quarter 2015 and full years 2014 and 2013 (please, note that the company’s accounting period ends on September 30).



As the table shows, margins recorded by the company have been in a steady decrease since 2013. It is no wonder – since 2011 both gold and silver prices have been going down as well. But 1Q 2015 saw a negative surprise. Orvana not only became unprofitable (negative profit margin of $80 per gold equivalent ounce) but it also was losing cash ($20 on each gold equivalent ounce sold). What happened? Surely lower gold, silver and copper prices were contributing factors. But other visible factors should have had a positive impact on the company results. For example, gold feed grades reported at El Valle Boinas/Carle were higher than in 2014. Production reported by El Valle Boinas/Carle in 1Q 2015 was comparable to that reported in 1Q 2014. The Don Mario mine was performing quite well as well. But looking at gross revenue reported in the first quarter 2015 one could spot something quite peculiar. Gross Revenue Difference was much higher than in1Q 2014. What is more, this measure accounted for 26.0% of gross sales (in 1Q 2014 it accounted for only 18.4% of gross sales). If in 1Q 2015 Orvana was able to maintain Gross Revenue Difference at the level similar to that reported in 1Q 2014 it would have reported an accounting profit of $13 per gold equivalent ounce. What is more, the company would have reported a positive cash margin of $73 per gold ounce equivalent.



No comments:

Post a Comment