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January 2014
Digging deeper into all-in cost disclosure Mining’s new frontier
www.pwc.com/ca/mining
2 Mining’s new frontier: Digging deeper into sustaining costs
Investors and analysts are increasingly calling for a more complete and transparent disclosure of total costs of production in the mining industry as margins have been squeezed by the recent decline in commodity prices.
Industry bodies have released reporting guidelines to address issues of transparency and consistency in the disclosure of non-GAAP all-in sustaining and all-in cost measures. These frameworks however do not provide detailed direction and are meant only to provide guidance, in order to allow situational flexibility in interpretation for companies. This lack of definitional clarity has resulted in ambiguous all-in sustaining and all-in cost disclosures within the mining industry.
Classifying capital costs as sustaining or growth in nature provides the greatest opportunity for “improved reporting”. “Improved reporting” can be achieved by providing increased transparency (e.g. more information), and consistency of definitions.
In lieu of a mining industry wide adopted reporting framework to achieve consistency, it appears vital for miners to provide clear definitional explanations within company reporting to enable users to perform informed company analysis and benchmarking.
This report compiles findings from an analysis of 72 company financial reports and numerous conversations PwC has held throughout the global mining industry. We review shortfalls in current disclosure practices, and highlight several ‘grey areas’ in current industry guidance, contrasted with the growing demand for increased disclosure to achieve “improved reporting”.
The case for improved transparency and clear definitions in all-in sustaining and all-in cost reporting
Mine site cash costs have been the industry’s widely accepted and disclosed yardstick of operational efficiency. In recent times of high prices and high margins, few questioned the transparency and comparability of non-GAAP disclosures made by mining companies. Profits were being made and growth targets being met. However, cash costs alone do not capture many of the expenses required to maintain a long term sustainable mining operation.
Capital required for sustaining and expanding operations, typically not included within standard disclosures, are often considered discretionary and dependent on available cash flow.
Due to the cyclical nature of the industry, in today’s environment when cash flow is tight, growth capital to expand the mine life, increase the production throughput, and upgrade facilities may be deferred to conserve cash. However, these investments cannot be eliminated entirely without posing a high risk to a mine’s long term sustainability, productivity, and cost base. For example, not addressing a need to replace a fleet of ageing trucks on time will lead to a reduction in productivity and an increase in maintenance costs due to more frequent and unplanned breakdowns. Additionally, costs incurred to comply with newly introduced safety, environmental, and governance requirements cannot be removed without directly impacting a company’s social license to operate.
Stakeholders are now calling for fuller disclosure of sustaining and all-in costs in order to better assess long term company viability and sustainability on a comparable basis.
“This year’s sharp fall in the (gold) price has put the industry under more pressure than it has known for almost a decade and heightened investors’ interest in miners’ true profitability.” — Financial Times, September 16 2013
Calum Semple
Mining Consulting Leader for the Americas
416 815 5325
PwC 3
2) A need to identify marginal operations:
Weak commodity prices have highlighted a troubling anomaly; several miners that have commenced disclosing a more transparent and complete picture of costs to operate have disclosed current all-in sustaining costs above prevailing metal prices. In the case of gold, some companies have reported all-in sustaining costs of over $1,400 an ounce while the metal has traded well below that level since the spring of 2013. Similarly for silver miners, analysts reported many companies with all-in sustaining costs above the silver price of $22/oz in the same period. Without all-in cost reporting, it is difficult to clearly identify companies who may be operating unprofitably in the current low commodity price environment. As a non-GAAP measure, if companies are ‘underwater’ there is little incentive to disclose this level of detail as they will likely be punished, or at minimum questioned, by investors and analysts.
3) Companies want to defend or highlight performance:
Mining company executives who are already disclosing or plan to disclose all-in sustaining or all-in costs indicate that they want to:
• Demonstrate to governments, who may be demanding a bigger slice of profits in the form of taxes and royalties, that low margins, or even losses, are being realized in the low commodity price environment. A truer measure of overall costs enables mining companies to illustrate that margins are often more slender than they appear when presented on a cash-cost basis.
• Make a clear case for executing on difficult decisions such as workforce reductions, care-and-maintenance announcements and divestitures.
• Compare their company to other perceived higher cost operations to demonstrate that effective cost management has been achieved by management. All-in cost reporting and monitoring provides a tool for management to demonstrate effective operating cost control and improve capital spending discipline.
• Highlight to the market that while current total costs may be high due to peak expenditure in growth capital, these growth costs will subside in future years once projects have been completed.
It is also clear that a greater focus is being applied by management on defining and measuring costs for internal purposes. Loose internal definitions may not identify what is in fact discretionary growth capital. Ultimately, tighter definitions will lead to greater visibility in the capital allocation process in order to avoid “wish lists” to the corporate office from mining operational sites during the budget cycle.
“The biggest weakness for me is the use of cash costs instead of all-in costs. As an investor you want to know what it costs in total per unit produced.”
“Companies do a good job of reporting what they produce, but a terrible job of disclosing how much it cost to produce it.”
All-in cost of production
“I need more information about what is under ‘investments’ and to be able to see capital expenditure by asset, not type of spending; not just what is expensed vs. capitalized.”
Capital expenditure reporting, including sustaining and growth capital information
“Sector benchmarking, particularly on cash costs, is really hard due to the inconsistent definitions.”
“All the different definitions create layers of complexity and uncertainty that end up disappointing investors.”
Consistency of definitions across the industry to allow sector benchmarking
Why is all-in sustaining and all-in cost reporting topical?
Pressure to provide disclosure transparency and consistency of definitions are driven by increased shareholder information requirements, a need to identify marginal operations, and management’s need to defend and highlight performance.
1) Increased shareholder information requirements:
A PwC global survey of 32 institutional investors and analysts titled “Extracting value – what do investment professionals need from mining company reporting?” released in September 2013 highlighted the three key areas of improvement needed from reporting in the mining sector. The following direct quotes were compiled from this survey:
4 Mining’s new frontier: Digging deeper into sustaining costs
Addressing the disclosure gap
As with cash costs, there is no reporting standard that requires companies to disclose sustaining or growth capital. However, the World Gold Council (WGC) has taken a step towards formalizing the concept with the publication in June 2013 of a “guidance note” on the components of “all-in sustaining costs” and “all-in costs” that companies can use as part of their overall reporting disclosure.
The WGC noted that “it is up to individual companies to determine how they report to the market and to decide whether their stakeholders will find these new metrics of value in understanding their businesses.” The WGC expects that many may choose to start using the new benchmarks from January 2014 based on year end.
Other organizations such as the Canadian Institute of Mining, Metallurgy, and Petroleum (CIM) are also reviewing production cost reporting with intent to establish standard practices for reporting of costs. Once established, these standards may eventually be incorporated into the NI 43-101 standards of disclosure and their global counterparts.
“For decades, we have disguised our true costs to look better to providers of capital by focusing solely on cash costs, rather than reporting all the costs that go into mining. This created the impression that, even at present depressed prices, the industry is making healthy profits, when it is, in fact, marginal.” — Nick Holland, Gold Fields chief executive, writing in Business Day (South Africa), August 15 2013
Current reporting transparency and definitional guidance is lacking:PwC conducted a survey of the top 40 global mining companies by market capitalization as identified in the 2013 PwC publication “Mine: A confidence crisis”, and found that as of Q3 2013:
PwC expanded the survey sample to include a total of 72 companies including the top 40 by market capitalization, 18 World Gold Council members, and several other predominantly North American headquartered mining companies. Of these 72 companies:
As these numbers show, very few companies currently disclose their all-in costs or a sustaining capital value, and even less provide a definition of what is included within their categorisation of sustaining capital, making comparable analysis between companies extremely difficult.
Publish a figure for sustaining capital
Only14 of the 40 largest mining
companies
Publish a figure for sustaining capital
Only33 of 72
mining companies
Disclose their definition of sustaining capital
6 of 40
Disclose their definition of sustaining capital
11 of 72
Disclose all-in sustaining costs7 of 40
Disclose all-in sustaining costs20 of 72
Disclose all-in costs28 of 72
Disclose all-in costs9 of 40
PwC 5
‘Grey area’: What is a sustaining cost and what is a growth cost?
The WGC provided the following guidance to its members when defining sustaining and growth costs:
“Non-sustaining costs are those costs incurred at new operations and costs related to ‘major projects’ at existing operations where these projects will materially increase production.
Companies need to publically disclose those operations and ‘major projects’ which are considered non-sustaining. All other costs related to existing operations are considered sustaining.” World Gold Council – Press release June 2013
This guidance allows for interpretation by companies. As a result, companies categorize capital expenditures differently based on how they apply the guidance, and how they foresee growth versus sustaining activities at their mining operations.
The typical concept of “sustaining capital” used by the industry captures capital costs incurred to sustain and maintain existing assets to achieve constant planned levels of production. This includes spending to ensure that assets retain their existing productive capacity, and to enhance assets to minimum reliability, environmental and safety standards.
Growth (non-sustaining) capital costs are typically those that increase productive capacity of the operation or result in increased financial benefit after a material investment has been made.
The challenge is that different companies - and even different managers’ within those companies - can legitimately measure “sustaining capital” and “growth capital” in different ways, depending first on whether they adopt the WGC guidance, and second on their interpretation of what a ‘major project’ or ‘material increase in production’ means for their company or operation. For instance, if an owner invests a large capital cost to buy a fleet of trucks in order to transition from a contractor operated to an owner operated mine at same production levels, should this be considered a sustaining cost or growth cost?
The variety of adopted definitions and interpretations have resulted in a spectrum of disclosures; ranging from companies treating any capital expenditure on a property that is in operation being considered sustaining, to any capital that increases the current life of mine plan or resource being treated as growth in nature. Most companies fall somewhere in the middle. Regardless, the lack of definitional consistency and clarity has made disclosure of all-in sustaining cost and all-in cost less insightful for users of these disclosures.
6 Mining’s new frontier: Digging deeper into sustaining costs
Development costs, exploration costs and general and administrative (G&A) expenses are among the most challenging grey areas:
• Development costs. For example, some companies classify any underground development or above ground stripping activity within the perimeter of existing operations as a sustaining cost, whether or not the outlay extends the life of the mine. But others specifically exclude costs that extend mine life from sustaining costs, and treat them as growth costs.
These costs can make up a significant component of a mine site’s expenditure depending on the phase of mine development.
• Exploration costs. Our survey suggests that only 45% of companies currently report exploration costs as part of their sustaining capital line item. WGC members that follow the all-in cost reporting guideline typically report exploration cost as a separate line item to sustaining capital. However, companies that do not provide an all-in cost reporting framework generally provide no guidance as to whether their sustaining capital number includes exploration expense or not.
The determination of whether exploration costs are considered a sustaining capital item or a growth capital items also varies widely from company to company. Like development costs, exploration costs which extend the mine life may or may not be treated as a growth capital item - some companies consider any exploration occurring within the boundaries of an existing mine lease as sustaining in nature, while others specifically define any cost which results in an increase in mine life as growth in nature.
Among other anomalies, junior companies often start capitalizing exploration costs as soon as they have a legal right to begin work. Yet bigger companies tend to capitalize these costs only when a project is well underway.
• General and administrative (G&A) expenses. The WGC guidelines suggest that G&A is a sustaining cost. However, companies that are able to directly attribute specific portions of G&A costs to growth projects argue that these costs should be grouped with the growth capital project which they relate to, and not within sustaining capital.
Additionally, analysts typically want costs provided on a per site basis, which cash costs were able to provide. However, this requirement provides challenges for the allocation of G&A costs which are typically measured at an enterprise level, with any attribution to site being arbitrary in nature.
The guidance provided by the WGC provides a strong start towards improved reporting. However, disclosures on a line item basis are still highly varied, and often there is disparity and ambiguity between companies who treat costs as sustaining or growth due to definitional differences or presentation choices.
The WGC guidance was directed towards its gold company members, though some non-gold companies have already adopted this guidance in their own external reporting in the second half of 2013. Other methods of measuring and comparing total production costs such as the “Brook Hunt” method typically used by base metal producers has resulted in some level of consistency and comparability between what are termed as C1, C2, and C3 costs. However, it does appear that more and more companies are moving towards the WGC guidance, and it will be interesting to see if continued industry discussion, comprehension and clarity of all-in sustaining and all-in cost reporting leads more and more non-gold mining companies to adopt this approach.
Investors and analysts increasingly want more transparent disclosure of total costs, specifically related to sustaining and expanding operations.
PwC 7
Spotlight Financing activities included in all-in costs?One of the areas that the World Gold Council guidance excluded from all-in-costs was certain financing activities: interest and dividends. The main items that were included in the reconciliation of all-in costs from the cash flow statement were the investing cash flow on capital expenditures. However, where a fleet of trucks is financed through capital leasing arrangements, companies will have to consider how they treat such cash outflows which are financing cash flow activities, notwithstanding being a capital addition on the balance sheet.
Differing methods could be determined such as including the one-time value of the capital expenditure, as if the equipment had been acquired “for cash”. Alternatively, the financing payments may be included in each period and added to the investing activities.
Either way, consistency in presentation will be important as well as clear articulation of which path the company is following.
James Lusby
Partner, Audit and Assurance Group, Mining
416 365 8181
What is the Company’s overall approximate all-in sustaining cost forecast for 2014? Per ounce for gold companies
$1,201-1,300
9%
Greater than $1,300
5%
Less than $900
24%
$901-$1,000
23%$1,001-$1,100
25%
$1,101-1,200
14%
What costs have you reduced and by how much to address lower revenue levels?
Expansion projects
23%G&A
56%
Exploration
57%Capital Project development
32%
www.pwc.com/ca/mining
Gold, silver and copper price report 2014
Metals mired in
global uncertainty
8 interview: Dundee Corporation
16 interview: Pan American Silver
20 interview: KGHM 24 interview:
Coeur MiningA PwC global survey of a cross section of 150 gold, silver, and copper companies provide the following insights into all-in sustaining costs for 2014.
8 Mining’s new frontier: Digging deeper into sustaining costs
Challenges to reporting all-in sustaining and all-in costs
Some companies indicate they are hesitant to adopt a non-GAAP or non-IFRS measure for reasons including:
• extra effort and cost during the reporting cycle is required to comply with additional reporting measures;
• uncertainty and inconsistency in definitions and applications lead to inaccurate and potentially unfavorable benchmarking of companies;
• a current inability to measure and track sustaining capital expenditures within existing IT systems and finance processes; and
• management’s belief that all-in sustaining costs are irrelevant to understanding and benchmarking the operation.
All-in cost disclosure samples
Typically, no further definitional guidance or discussion about the inclusions or exclusions of the line items in the disclosure table are provided anywhere within the MD&A or financial report, leaving analysts to infer or attempt to estimate various line items within their models and market guidance. Consequently, analysts are increasingly pushing management to provide clearer and consistent disclosure to avoid assumptions having to be made.
Ambiguous disclosures make comparability difficult
The following illustrative disclosures are similar to a number of actual disclosures presented in Q2 and Q3 2013 company reporting. These clearly illustrate the challenges of inconsistent reporting formats, definitions, and labels.
According to PwC’s “Extracting value” survey results released in September 2013, 84% of investor and analyst respondents would gain comfort from knowing that non-GAAP measures adhere to some basic “ground rules”.
Company B
Cost of sales $6,049,567
General and administrative expenses
$1,325,674
Sustaining capital expenditures $188,675
Royalties $12,042
Exploration costs $1,900,768
Total all-in sustaining cash costs
$9,476,726
Are there any underground development or open cut stripping costs included in the all-in sustaining costs of either company? It appears not.
There appears to be development costs within all-in costs for company A. Does this infer that all development costs are growth in nature and no development costs are required to sustain the operation?
Company B has chosen to only disclose all-in sustaining cost, not total all-in costs.
Exploration expense is not a sustaining item in company A, but is in company B. Is this a company policy to treat all exploration as growth for company A, or are sustaining exploration expenditures captured in the sustaining capital expenditures line item?
Company A '000 US
Cash operating costs $100,500
Site rehabilitation $120
General and administrative costs $5,201
Royalties $7,500
Sustaining capital expenditures $10,540
All-in sustaining costs $123,861
Development capital expenditures
$19,868
Capitalised evaluation and exploration expenditures
$349
Exploration expenditures $783
All-in costs $144,861
PwC 9
“…Good corporate reporting isn’t purely about following the rules. It requires management teams to think specifically about how they can best meet the needs of the investment community.” — PwC report: Extracting value, What do investment professionals need from mining company reporting?
Perhaps the biggest hurdle is that the requirement for increased transparency puts a spotlight on companies with a high all-in sustaining cost profile which, until now, may not have been evident to the market.
Many companies have indicated that they prefer to be followers of their peers rather than pioneers in adopting new disclosure formats. However, most companies are engaging in a dialogue internally and within industry forums to explore the concepts. They want to ensure they are prepared to clearly define and disclose sustaining and all-in costs in the future, and be able to respond to market queries in the meantime.
We expect a staged adoption of the WGC guidance will continue. Some companies are being restrictive about how transparent they wish to be by providing all-in sustaining costs without the growth component shown to sum to all-in costs, while others provide an all-in cost number without sufficient granularity to understand the all-in sustaining component.
10 Mining’s new frontier: Digging deeper into sustaining costs
Spotlight Building a better MD&A With a focus on transparency, there is a need for companies to not just comply with regulatory requirements around disclosure, but to use Management’s Discussion and Analysis (MD&A) as an investor relations tool to help stakeholders interpret financial statements and provide key insights to performance.
While the WGC has provided guidance on all-in costs, companies need to consider this in the context of the regulators. The Canadian Securities Administrators (CSA) has provided guidance on disclosure of non-GAAP financial measures to ensure that these are not misleading to investors – “an issuer should clearly define the measure and explain its relevance. “
Within this guidance, CSA specifies that an issuer “should explain why the non-GAAP financial measure provides useful information to investors and the additional purposes, if any, for which management uses the non-GAAP financial measure”. In the case of disclosure of all-in costs, there is little debate within investors and analysts regarding the merit of understanding total costs of production information to provide key insight.
However, the CSA also specifies that an issuer “should state explicitly that the non-GAAP financial measure does not have any standardized meaning”. This appears to contradict the intent of disclosing all-in costs since, as a non-GAAP financial measure, they are by definition “unlikely to be comparable to similar measures presented by other companies” per the CSA. This lack of comparability compromises the utility for analysts and investors to gain insight into performance and compare performance with industry peers.
There exists a strong need in the mining industry to agree on how to report and disclose all-in costs in support of building a better MD&A.
Geoff Leverton
Partner, Capital Markets Group
416 815 5053
“Improving reporting” – the next steps
Despite these obstacles, a consensus is building that sustaining and growth capital are relevant and useful data points in providing improved reporting. Furthermore, a culture that recognizes the benefits of more transparent disclosure appears to be taking hold in the mining community.
Pundits of the World Gold Council’s all-in sustaining and all-in cost guidance highlight that the framework provides:
• a clear and comprehensive breakdown of cost line items;
• direction to be able to reconcile non-GAAP cost line items to financial statements; and
• a clear demarcation between operating, sustaining and all-in costs;
which if followed, should provide a disclosure which is a relevant and useful yardstick for the investment community as well as for miners themselves to benchmark and compare companies and operations.
To get there, mining companies need to first ensure they have clearly defined and can measure sustaining and non-sustaining costs internally. The next step is for companies to disclose definitions and explanations of cost inclusions and exclusions for all-in sustaining and all-in cost line items. In lieu of an adopted standardized reporting framework, the provision of clear definitions and explanations will go a long way to removing the ambiguity and uncertainty that is creating challenges for analysts and investors when attempting to review companies production cost performance.
The longer term question is whether companies continue to desire and drive transparency around disclosing full costs. If prices start to increase, will the focus from shareholders and analysts be diminished? In a forecasted period of tight margins, we should expect the focus to remain for a while to come.
Mining companies need to first ensure they have clearly defined and can measure sustaining and non-sustaining costs internally. The next step is for companies to disclose definitions and explanations of cost inclusions and exclusions for all-in sustaining and all-in cost line items.
PwC 11
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www.pwc.com/ca/mining
Gold, silver and copper price report 2014
Metals mired in global uncertainty
8 interview: Dundee Corporation
16 interview: Pan American Silver
20 interview: KGHM 24 interview:
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Review of global trends in the mining industry—2013
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Contacts
Key contributors
James Lusby 416 365 8181 [email protected]
Joe Rafuse 416 941 8447 [email protected]
Chris Sullivan 416 687 8005 [email protected]
Jessica Lewis 416 941 8383 ext. 13526 [email protected]
Calum Semple
Mining Consulting Leader for the Americas
416 815 5325
Dean Braunsteiner
Leader, Toronto Mining and National IPO services
416 869 8713
Mark Platt
Leader, Vancouver Mining
604 806 7093
Nochane Rousseau
Leader, Quebec Mining
514 205 5199
