Pan American Silver Corp. (PAAS)

[alj14]

TeSanbrunobaby: I couldn't agree more with what you say, and I sincerely apologize for taking so much time before posting a reply. For now few people seem motivated to post here, though I feel sure that will change before long. The logic of worldwide easing by most of the central bank inevitably means that when easing ends and interest rates are allowed to rise, very strong inflationary forces will be unleashed. The consequences are easy to imagine.

In the meantime I am posting a recent article on Seeking Alpha (source: Hebba Investments), because it is so directly relevant to the current costs of mining silver and the extent to which PAAS management is succeeding is coping with this problem.

It's quite a hefty piece, but well worth the read. Like you, the author notes the importance of PAAS policy on rewarding shareholders with a good, regularly paid dividend:


http://seekingalpha.com/article/2475535-what-it-really-costs-to-mine-silver-the-pan-american-silver-q2-edition?uprof=14


Hebba Investments, Hebba Investments LLC (806 clicks)
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What It Really Costs To Mine Silver: The Pan American Silver Q2 Edition
Sep. 6, 2014 9:03 AM ET | 6 comments | About: Pan American Silver Corp. (PAAS)
Disclosure: The author is long PAAS. (More...)
Summary
• The company's core costs have continued to decline from FY2012 and FY2013 and are now consistently below $20 per ounce.
• On a sequential basis, the company's second quarter saw a rise in core non-tax costs per ounce as gold production dropped significantly from the first quarter.
• The company expects second half metal production to hit existing targets, and thus we do not expect costs to lower in the next few quarters.
• The company will continue to tread water at silver prices below $20 per ounce, but the juicy dividend should make it more attractive than other silver miners.
Introduction

In our previous complete Q3FY13 gold cost analysis, we went over a number of the industry's all-in costs to mine an ounce of gold in 2013 and discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, we used the 2013 financials to calculate the combined results of publicly traded gold companies and come up with a true all-in industry average cost of production to mine each ounce of gold.
We're going to do the same thing for the silver industry and try to compute the true costs it takes to mine silver. One thing that needs to be known about the silver industry is that most mined silver is produced as a byproduct, and thus silver production isn't limited simply to the costs that it takes to mine silver.
But that does not mean that investors should entirely ignore the costs to mine silver as it still is very important for the following reasons:
1. 30-40% of annual mined silver is produced by primary silver miners who obviously are driven by the costs of production
2. As the price of silver drops, it causes the costs of non-primary silver miners (i.e. byproduct miners) to rise as they get less money for their byproduct silver
3. Silver costs usually rise in parallel with gold costs, and gold miners produce a lot of the byproduct silver and thus rising silver costs suggest that gold (and other minerals) are costing more to mine
We're still working on completing and publishing a complete FY2013 and first half 2014 all-in costs for the industry, so if you are interested in receiving it and keeping up-to-date on consider following me (clicking the "Follow" button next to my name) or join our free email list where we send out a weekly email summarizing all the important events in the gold and silver industry, which includes our latest articles and research pieces and all of our all-in pieces as they are published.
In this analysis we will calculate the real costs of production of Pan American Silver (NASDAQ:PAAS). Pan American Silver is one of the largest primary silver producers in the world and they have operations that span North and South America. Their countries of operation include Argentina, Mexico, Peru, Bolivia, Canada, and the United States.

How to Use Our All-in Costs Analysis with Your Investments
In the previously mentioned article, we gave a thorough overview of the current way that mining companies report their costs of production and why it is inaccurate and significantly underestimates total costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, which is an important concept for all precious metals investors to understand.

The best way to use this analysis for individual companies is to compare the different production cost metrics with the company's profits to look for any anomalies (e.g. large net profits but high costs). Also, we provide historic data to allow investors to check out any trends in regards to costs or production totals that may be an early warning to future successes or failures for the company. Ultimately, this analysis is best used as a first step to further investigative work, and that is our purpose with releasing this series.

Explanation of Our Metrics
For a detailed explanation of the metrics and each metric's strengths and weaknesses please check out our previous full quarterly all-in costs gold report where we discuss them in detail.

All Costs per Silver-equivalent Ounce - These are the total costs incurred for every payable silver-equivalent ounce, which includes everything. This is the broadest measure of costs, and since it includes write-downs, it is essentially the "accounting cost" of producing silver-equivalent ounces.

Costs Per Silver-equivalent Ounce Excluding Write-downs and S&R -This is the cost to produce each silver-equivalent ounce when subtracting write-downs and smelting and refining costs, but including everything else.

Costs Per Silver-equivalent Ounce Excluding Write-downs - This is similar to the above-mentioned "Costs per Silver-equivalent Ounce Excluding Write-downs and S&R" but includes smelting and refining costs. That makes this measure one of the best ways to estimate the true costs to produce each ounce of gold, since it has everything (including taxes) except for write-downs.

Costs per Silver-equivalent Ounce Excluding Write-downs & Taxes -This measure includes all costs related to silver-equivalent production excluding all write-downs and taxes. Essentially this is the bottom dollar costs of production with an artificial 0% tax rate (obviously unsustainable) which works well because it removes any estimates of taxation due to write-downs or seasonal fluctuations in tax rates, which can be significant. The negative to this particular measure is that since it does not include taxes, it will underestimate the true costs of production.
True Costs of Production for Pan American Silver

Let us use this methodology to take a look at the company's results and come up with the true cost figures for each ounce of production. When applying our methodology, we standardized the equivalent ounce conversion to use the average LBMA price for Q2FY14 which results in a silver-to-gold ratio of approximately 66:1, copper-to-silver ratio of 6.3:1, lead-to-silver ratio of 20.6:1, and a zinc-to-silver ratio of 20.8:1. Since our conversions change with metal prices, this may influence the total equivalent ounces produced for past quarters - which will make current-to-past quarter comparisons much more relevant.

Observations for Investors
Pan American Silver's Q2FY14 core costs (costs excluding write-downs) fell on a year-over-year basis from $25.56 in Q2FY13 to $19.73 in Q2FY14 as costs rose less than the production increase - thus the lower costs. But we do caution that the core costs method can be a little skewed if companies report large write-downs, so for companies that experience large annual or quarterly impairments we prefer to use the core non-tax costs (removing taxes and write-downs), which will give us a good idea of the comparative change in costs (i.e. are they rising or falling). But it will also understate costs since it removes taxes from the cost figure - so the true costs of production will be somewhere in between these numbers.

For the second quarter, Pan American's core non-tax costs dropped from $19.63 per ounce in Q2FY13 to $19.00 in Q2FY14, which was to be expected for the same reason that we saw core costs dropped (cost increases less than production increases). On a sequential basis though, costs actually rose from the first quarter's stellar $17.68 number due to a combination of rising costs and lowered gold production. This drop in gold production (close to a 20% drop) ended up hitting silver-equivalent production fairly hard and was the primary reason for the sequential drop in silver-equivalents.

Conclusion for Investors
We haven't yet published any other silver producers' numbers, so until then we can't do a comparative analysis of the company's numbers. But the important thing that investors would want to be looking for is the ability of Pan American Silver to keep the core costs below the price of silver - it has obviously been tough but for now costs have come down enough to allow the company to break-even, or make a small profit.
For the outlook for the second half of the year, management stated the following:

With silver and gold production during the first half of 2014 at or above the Company's expectations and with Cash Costs per Ounce at or below forecast, the Company remains confident that it will achieve its guidance of annual consolidated production of 25.75 to 26.75 million ounces of silver and 155,000 to 165,000 ounces of gold at AISCSOS of $17.00 to $18.00 and Cash Costs per Ounce of $11.70 to $12.70.

Based on that statement we expect production to be similar to what we've seen in the second quarter, which means that the company will continue to tread water in the current silver environment. It is not an easy world to be operating as a primary silver producer with silver prices below $20 per ounce, and we have a feeling we will see similar "treading above water" with the rest of the primary silver miners as we break down their earnings.

One advantage Pan American Silver does offer investors is its sizable dividend - so even if the company is breaking even, investors will be paid fairly well to wait for a higher silver price.

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Tagged: Macro View, Gold & Precious Metals, Basic Materials, Silver, Canada
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