Mining Investor Digest: Reviewing the Cash Flow Statements of Major Gold Miners

Mining Investor Digest is generated for investors by investors who have spent countless hours researching and analyzing the mining and metals sector and want to share their findings. This article is the second in a series. Read the first here.

This series of articles aims to highlight relevant characteristics of accounting for mining in order to help readers with no formal training or background in accounting gain a better understanding of financial reporting in mining and identify key issues in mining operations. Here we continue our review of cash flow statements.

An examination of the cash flow statements of seven of the world’s largest gold-mining companies (Agnico Eagle Mines (TSX:AEM,NYSE:AEM), Barrick Gold (TSX:ABX,NYSE:ABX), Eldorado Gold (TSX:ELD,NYSE:EGO), Goldcorp (TSX:G,NYSE:GG), Newmont Mining (NYSE:NEM), Randgold Resources (LSE:RRS) and Yamana Gold (TSX:YRI,NYSE:AUY)) reveals that operating expenses (OPEX) and investment in mining property (IMP) are the main uses of cash in mining; combined, they ranged from 62 to 91 percent of revenues in the 2005 to 2013 period, averaging at 76 percent. That leaves very little cash for day-to-day operations or flow back to the company.

OPEX is indirectly classified under cash flow from operations and represents the direct costs attributable to the production of goods sold.

IMP, also known as expenditure on mining interest or capital expenditure, is classified as an outflow from investing activities in cash flow statements and increases plant, property and equipment (PPE) on the balance sheet. IMP never makes its way onto the income statement except in the form of non-cash depreciation expense or until there is a writedown of PPE (both of which are ignored in most reported per-ounce cost estimates). It is important to note here that cash spent on the acquisition of new assets has its own separate category in cash from investing activities, and is not included in IMP.

Investing activities by definition are used for the purchase or creation of long-term assets, which are expected, in theory, to generate future returns. IMP should therefore extend the life of, or increase cash flows from, operations; that translates into either increasing the size of the reserves and resources or increasing the level of production. Since IMP represents such a significant percentage of revenue each year for mining companies we should expect reciprocal increases in production levels or the reserve and resource base.

A review of the seven mining companies shows that:

1. IMP has had little to no impact on production levels and/or reserve and resource base.
2. Significant changes to production levels and/or the reserve and resource base are a direct result of acquisitions.
3. Incremental changes to the reserve and resource base are a function of gold price adjustments because companies recalculate the number annually to reflect current metals prices.

When valuing mining companies it is important to keep in mind some key characteristics of these companies and the industry at large. These characteristics can make classification and interpretation of cash outflows challenging.

Our planet has a finite quantity of natural resources. Mineral deposits contain a certain amount of ore, and when that ore is mined out the deposit is depleted. Consequently, the longevity of a mining company depends on astute acquisitions and successful exploration. This reality makes the conventional distinction between investing and operating cash flows rather difficult.

Due to the nature of accounting regulations, mining companies have a lot of leeway with what they classify as initial capital vs. sustaining capital vs. OPEX. For instance, the deepening of a mine shaft might be deemed an additional capital expenditure because it will continue to be used for many years, but in reality it will have to be deepened again in a few years, so either the depreciation rates need to be greatly increased or this type of cost should be treated as an ongoing expense of mining. It is not a secret that even the most vigilant auditors admit that they struggle with drawing lines between OPEX and capitalized expenses.

In addition, the mining and metals industry has a highly cyclical nature and is subject to commodities prices and/or the economic cycle. Commodities companies have little control over these cycles and therefore are for the most part price takers. The other special feature of mining is the high fixed cost of operations. Mining companies often keep mines operating even during low points in price cycles, the reason being that the costs of shutting down and reopening operations are prohibitive. These realities create very strong incentives to fit in the lowest-cost quartile of producing a particular commodity.

A close examination of the cash flows of miners is very necessary when valuing a mining company. In the next article we will take a closer look at miners’ free cash flow to equity and overall cash adequacy.

Columnist Elena Tanzola is a partner at Cipher Research. Cipher Research is an independent research and analysis company that covers the mining and metals sector of the commodity markets. For more information on Cipher Research please visit: https://www.cipherresearch.com or contact info@cipherresearch.com.