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First Majestic: A Case Of Cost Cutting Into Your Own Flesh

Summary

A critical look at First Majestic Silver's cash cost reduction reveals one driving factor, and it's not operational efficiency.

Lack of sustaining capex spending has made AISC look good, but has created problems elsewhere.

2016 started just like 2015: with a capital raise.

The share price has rallied hard - a selling opportunity, in our view.

Compared to the prior year, 2015 was not so bad for First Majestic Silver (NYSE:AG), at least on the surface, and certainly according to CEO Mr. Keith Neumeyer, who is quoted as follows in the 2016 guidance news release:

"Our transformational strategy for reducing costs and improving operational procedures is working, and along with Santa Elena's successful integration, I feel that we have truly turned a corner in this challenging market."

The market seems to share this sentiment, and buoyed by a rising silver price, shares of the company have performed very well indeed year to date. In fact, the share price has almost quadrupled from its January bottom, outperforming both the Market Vector Gold Miners ETF (NYSEARCA:GDX) and the Global X Silver Miners ETF (NYSEARCA:SIL) by a factor of three.

We had been skeptical with regard to the fundamentals underpinning this rally, and we believe that the C$50 million capital raise announced last week proves our point. And while the market appears unperturbed by this second bought deal within a year, we view the current point as an opportunity to sell our remaining holdings in First Majestic Silver and look for exposure to the white metal elsewhere. This article explains why.

AG Chart

Cost Reductions

Mr. Neumeyer has emphasized cost reductions in the quote above and in various other communications, and points to various statistics to prove his point. The excerpt from the 2015 Q4 and full-year MD&A pasted below lists various key performance metrics supposed to give credence to this statement.

Quite clearly, First Majestic Silver has drastically reduced cash costs as well as all-in sustaining costs (or AISC) year on year, and has managed to expand margins (that didn't actually exist at all in 2014):

  • Cash costs have dropped by $1.71/oz, from $9.58/oz in 2014 to $7.87 in 2015.
  • AISC have dropped by $4.28/oz, from $17.71/oz in 2014 to $13.43/oz in 2015.
  • The average realized silver price has dropped as well, but only by $2.63/oz, from $18.69/oz in 2014 to $16.06/oz in 2015.

We would like to take a closer look at this cost cutting in the following.

Cash Costs

The table documents a 5% decrease in silver production, coupled with a 5% increase in total metal production, implying a bump in by-products and the associated cash cost credits. And indeed, by-product credits compute to $7.02/oz in 2015, up 37% from the $5.12/oz in 2014, representing a $1.90/oz increase in by-product credits year on year.

This is a substantial increase, indeed, and in fact, the rise in by-product credits seems to be the governing driver behind the cash cost reduction ($1.90/oz by-product credit increase, versus $1.71/oz cash cost reduction). A closer look reveals that base metal by-products remained at more or less same levels, but gold production more than doubled in 2015 in comparison to 2014. The cash cost reduction is therefore driven by the increase in gold output (a side-effect of the SilverCrest acquisition and the associated addition of the Santa Elena mine). It's certainly nice to have this gold kicker, but it also represents a trend away from the company's promotional line of being the purest of all silver producers. Never mind, if you ask this scribe, but a point we wanted to make nevertheless.

The company also points to a substantial reduction in mining unit costs, and lists "Total production cost per tonne" in the table above. This metric decreased 15% from $51.53/tonne to $43.98/tonne year on year. At first glance, it looks impressive and could be assumed to support Mr. Neumeyer's statement of cost efficiency and improving operational procedures. Alas, we are taking a different view. The company processed 9% more material in 2015 and still ended up producing fewer silver ounces, thanks to an 18% drop in grade, from 206g/t in 2014 to 168g/t in 2015. Slightly increased metallurgical recovery compensated for some of the effects from lower grades, but it sure needed the lower mining costs to bring the lower grades to account.

Bringing unit costs back from a per-tonne to a per-ounce basis, we note:

  • a 3% increase in mining costs, from...

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