Hycroft Mining Holding Corp (HYMC)

[Tommy]

$ANV - What It Really Costs To Mine Gold: Allied Nevada Gold At A Crossroads

http://seekingalpha.com/article/1627772-what-it-really-costs-to-mine-gold-allied-nevada-gold-at-a-crossroads?source=email_macro_view&ifp=0

Summary

Allied Nevada Gold's (ANV) recent quarter was a major letdown for investors - and the drop in share price reflected this disappointment. The company's production numbers were in-line with Q1FY13, but since that quarter was a poor performance quarter this was not cheered by investors. Additionally, it is becoming clearer that the company's liquidity situation is a bit stretched and that is limiting ANV's development options for operations (including the cancelling of construction of its mill).

It is not all doom and gloom for ANV, and if management can hit its heap-leach forecasts of 225,000 ounces of gold and 2.8 million ounces of silver for 2014 onwards without increasing true all-in costs, then this company may yet have some brighter days ahead of it.

There is quite a bit of uncertainty with ANV in terms of its liquidity, its production totals, and production costs - which will make for quite a bit of volatility in the share price. This gives investors a lot of opportunity and risk, but we believe if management can demonstrate a strong third quarter, it will be very helpful in regaining some of the trust with investors they have lost.

Introduction

In an earlier article, we 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 FY2012 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.

In this analysis we will calculate the real costs of production of Allied Nevada Gold , a junior miner that produces gold and silver in the United States. Its flagship and only producing property is the Hycroft mine located in Winnemucca, Nevada, though the company does own other advanced and early stage properties in Nevada. ANV is led by CEO Robert Buchan, the founder and former CEO of Kinross Gold (KGC).

Calculating the True Mining Cost of Gold - Our Methodology

In the previously mentioned article, we gave a thorough overview of the current way 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.

Explanation of Our Metrics

Cost Per Gold-Equivalent Ounce - is the costs incurred for every payable gold-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable gold and not produced gold, because payable gold is the gold that the miner actually keeps and is more reflective of their production. Miners also use payable gold and not produced gold when calculating their cash costs, so this is pretty standard.

We then add Derivative Gains (or minus Derivative Losses), which will give investors total costs without the effects of derivatives. Finally, we add Foreign Exchange Gains (or minus Foreign Exchange Losses) to remove the effects of foreign exchange on the company's costs.

Cost Per Gold-Equivalent Ounce Excluding Write-downs - is the above-mentioned "Cost per gold-equivalent ounce" minus Property/Investment Write-downs and Asset Sales. This provides investors with a metric that removes exceptional gains or losses due to write-downs and asset sales.

Cost Per Gold-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs - is the above-mentioned "Cost per gold-equivalent ounce excluding write-downs" adding in smelting, refining and all other necessary pre-revenue costs. This is a new metric that we are now introducing to our true all-in cost series because it will more accurately measure all-in costs and allow comparisons between miners.

Most investors are unaware that many miners will remove smelting, refining, and other costs before reporting their total revenues figures and these pre-revenue costs are not reported in the income statement. The result of this is that it skews all-in costs higher for miners that refine themselves or include the costs in their income statement, while inaccurately showing lower costs for miners that remove it before reporting revenues.

A simple test can be done on any miner to see if there are any pre-revenue costs that are not reported in the income statement. Simply take payable production and multiply it by average realized sales price and this should come relatively close to the total revenues figure. If it gives you a number much higher than reported revenues then there are pre-revenue costs that are not being reported.

This line should alleviate these issues and allow comparisons on a fair basis.

Real Costs of Production for ANV - Q2FY13 and FY2012

Let us now use this methodology to take a look at ANV's results and come up with their average cost figures. When applying the methodology for the most recent quarter and FY2012, we standardized the equivalent ounce conversion to use the average LBMA price for Q2FY13. This results in a gold-to-silver ratio of 61:1. 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.

(click to enlarge)

Observations for ANV Investors

True Cost Figures - ANV's true all-in costs for Q2FY13 jumped to $1324 per gold-equivalent ounce, which was higher on a sequential basis compared to the $982 experienced in Q1FY13. Additionally, Q2FY13's costs were higher than the $1115 true all-in costs that were averaged in FY2012. According to management, the increase in true all-in costs can be primarily attributed to lower recovered gold and silver grades and rising costs of commodities used in processing (lime and cyanide). Additionally, management expects that "Adjusted Cash Costs" may rise to $800-$825 per ounce (Q2FY13 Adjusted Cash Costs were $775), so we believe that the equivalent rise in true all-in costs will be around 5% for the rest of the year or around $1350-$1400 per gold-equivalent ounce.

Though these costs are currently higher than the current gold price, they are not exceptionally high compared to competitors and are pretty in-line with the average costs experienced by other competitors based on Q1FY13 numbers. Costs for Q1FY13 for competitors such as Yamana Gold (AUY) (costs just over $1300), Goldcorp (GG) (costs just under $1200), Silvercrest Mines (SVLC) (costs below $1100), Kinross Gold (costs just under $1400), Newmont Gold (NEM) (costs around $1300) Agnico-Eagle (AEM) (costs around $1400), and Barrick Gold (ABX) (costs around $1200), were all relatively around the same range and do not place ANV particularly high on the cost scale. Obviously Q2FY13 numbers are not out for all these companies so these numbers may change, but we do not expect these competitors' costs to be significantly lower in Q2FY13.

Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment. At the end of Q2FY13, ANV had $246 million of cash and cash equivalents and around $190 million of ore and inventories (which may not be very liquid). Additionally, the company has a $120 million rotating credit facility to help finance operations and expansion plans. Since their true all-in costs are above current gold and silver prices, operations may need to be supplemented with cash and cash equivalents to maintain production, so investors need to do a much more careful job analyzing ANV's liquidity.

The company has postponed its mill construction (which contributed to the large drop in share price), but ANV still has a number of significant cash outlays to fund over the next few years as shown below:

(click to enlarge)

The company has stated the following in terms of its capital outlays situation:

We believe that cash flow from our ongoing business, when combined with our other sources of liquidity, including our existing cash and cash equivalents, future cash provided from collecting accounts receivable balances, the Revolver, and capital lease financing arrangements, will be sufficient over at least the next twelve months to meet operational needs, make capital expenditures, invest in the business and service debt due.

As investors can see, these obligations will require quite a bit of cash and liquidity to finance, and though management believes that funding is sufficient for the next twelve months, we believe that investors need to be very cognizant of the fact that ANV's liquidity situation is very tight. If gold prices drop further, grades deteriorate, or an unexpected cash outlay event occurs then the company will need additional financing even in the short-term.

Production Numbers - Gold production increased slightly on a sequential basis from around 38,000 ounces to a little over 39,000 ounces, but silver production did experience a large drop. This was primarily due to lower silver grades and lower silver recoveries which dropped silver production by over 50,000 ounces on a sequential basis - though since silver production makes up less than 5% of ANV's gold-equivalent production this didn't affect the company's gold-equivalent output by very much.

Since management has decided to suspend mill construction, ANV will only be doing heap leach operations and forecasts an annual production rate of 225,000 ounces of gold and 2.8 million ounces of silver from 2014-2020 (approximately 55,000 ounces of gold and 700,000 ounces of silver per quarter).

Both of these numbers are significantly higher than current production totals and investors would be better served with a wait-and-see approach to make sure that the company can meet these totals with its currently stretched financing situation and the geological issues it has encountered with current operations. Additionally, with production costs around the current spot price of gold, even if the company meets these production totals, investors would need to see either a significantly higher gold price or a significantly lower true all-in costs total for ANV before these production totals will be appealing.

Conclusion

On a true all-in costs basis, ANV's costs rose significantly in the second quarter on both a sequential and year-over-year basis, though the company's costs are not significantly higher than other gold companies and they did turn a slight profit in the quarter. The big concern for investors regarding ANV is their liquidity situation, which remains very tight.

The company forecasts that it will not require any additional financing other than its current liquidity instruments over the next twelve months, and we believe this to be true. But there is very little leeway and if any extraordinary situations arise such as a further drop in gold prices, lower production totals, or outside events (such as a loss of financing commitments or a mining accident) - ANV will need to draw additional capital and that may be very difficult since its share price has dropped significantly and it already carries a large debt load.

The company does predict significantly higher production totals in 2014, though we caution investors to take more of a wait-and-see approach with these numbers and see how Q3FY13 turns out in terms of production totals before jumping on management forecasts. Having said that, the share price is quite depressed and a lot of negativity is already built into them. If production totals do increase and costs stay flat, then a rising gold price may significantly change the stressed liquidity situation of the company. We believe Q3FY13 will be a very important quarter for the company and we will need to see how some of these production numbers and costs will play out - investors should stay tuned.