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Financial Performance Analysis of a Mining Company (Simple Example) - Mineral Economics

1. Analyze the financial performance of the Lihir Gold Limited for 2006. Given the Balance Sheet and Income Statement, calculating the following ratios and interpret the results.

 i.  Analyze the Liquidity/Solvency
This measures the firm’s ability to meet short term obligations i.e. debt payment.

a) Net Working Capital
 Net Working Capital = Current Assets – Current Liability
                                    = U$ 132,700, 000 –US$ 207,300, 000
                                     = – US$ 74,600, 000
Net Working Capital shows that Lihir is not capable of meeting its short term obligation. The current assets could not meet the current Liability.

 b) Current Ratio

Current Ratio= Current Assets/  Current Liability     = U$132 700 000/ U$207 300 000= 0.64
                         

Mining’s CF is highly predictable so current ratio of over 1 or 2 is acceptable. Thus Lihir has no short term debt paying ability because current ratio is less than 1.

c) Quick Ratio

Quick Ratio = Current Asset – Inventory/  Current Liability
                     =  U$ 132,700, 000 –U$75300 000/U$ 207300 000 
                     = 0.277
                                         
 Quick ratio> 1 is desired, so Lihir has no immediate ability to meet current debts.

 ii. Analyzing Activity
Activity ratios are used to measure the speed at which various accounts are converted into sales or cash.

 a) Inventory Turnover – shows how soon the inventory will be converted to cash.

Inventory Turnover = Cost of goods sold /  Inventory  = U$ 268100 000 / U$ 75300 000= 3.56
                                             
Exploration expenses = US$ 6000 000 is an expense

Therefore; Inventory Turnover = Cost of goods sold /  Inventory
                                                  = US$ 262100000 / US$75300 000 = 3.48
                                                                 

Inventory turnover is useful only when compared with that of other firms with same industry. For Mining and Petroleum inventory turnover is between 5- 10. However, Lihir has less than that (i.e.3.48) so inventory turnover is very poor. And the number of days required to convert inventory into cash is 360days/3.48 = 103.45 days.


b)Average Collection – average amount time required to collect accounts receivables

Average Collection Period = Accounts receivables /Average Sales/day

                              =  U$4600 000  /U$ 310400 000/360           = 5.3 days
                                                     

The average collection period of 5.3 is indicative of good managed credit collection or credit department.

c) Average payment period – average amount of time needed to pay accounts payable.

 Average Payment period = Accounts payable/ Av. Purchases/day*% of goods sold                     
                                         

US$ (268.1M – 6M (Exploration expense)) = US$ 262.1 M Cost of goods sold;

Average Payment period = US$ 46 600 000 /US$ 262100 000/360 * 0.84 = 76.2
                                        = 76.2 days to pay for credit purchases

 If the credit purchase term is 30 days, financial analysts could give Lihir low credit rating because 76.2 days to payback credit purchases is unacceptable.

 d) Fixed asset turn over – measures the efficiency with which bthe firm has been using its fixed, or earnings, assets to generate sales.

 Fixed assets Turnover =   Sales  /Net fixed assets
                               = US$ 310 400 000 / US$ 86200 000 = 3.6
                             

This means Lihir Mine Ltd’s turnover on its fixed assets is 3.6 times a year. It indicates fixed assets are efficiently used to generate cash flow.


 e) Total asset turnover – indicates the efficiency with which the firm uses all its assets to generate sales.

Total assets turnover = Sales /Total assets   = US$ 310 400 000 / US$ 1 496 000 000  = 0.21
                                     
The overall efficiency of using assets to generate sales is 0.21 which is not a good reflection. It could mean assets are old and need replacement.


iii)Analyzing Debt

a) Debt ratio- measures the proportion of total assets financed by the firm’s creditors.(the higher the ratio reflects greater amount of other people’s money used in an attempt to generate profit)

 Debt ratio   = Total liabilities / Total Assets       = US$ 684 100 000 /US$ 1 496 000 000
                                                                             = 0.457 = 45.7%
                                   
This indicates Lihir has financed 45.7% of its assets with debt which is good.

 b) Debt equity ratio – measures the ratios or long-term debt to stockholders equity. It generally measures the degree of financial leverage of the firm.

Debt Equity Ratio = long term debt /Stockholders equity = US$188 600 000 /US$ 811 900000 =3.23%
                                           
It means Lihir applied 23.23 % debt to procure long – term assets which is lower debt – equity ratio. This indicates that it has a stable cash flow debt that can be paid at a shorter period of time.

c) Times interest earned ratio – measures the firm’s ability to make contractual interest payments.

 Time interest earned = earnings before interest & taxes (EBIT)/ Interest Expense
                                               
                                 =  US$ 80 700 000  / US$(1 400 000 + 6 200 000) = 10.2
                                   
 Lihir time interest earned is 10.2. As a rule, a value of 3 to 5 is a good margin for safety from shrinking and liquidation. However Lihir has exceeded that margin and indicates that Lihir is able to fulfill its interest servicing.

d) Fixed payment coverage ratio – measures the firm’s ability to meet all fixed – payment obligations such as loan interest ,principal, lease payments and preferred stock dividends

Fixed payment coverage ratio
=  EBIT + Lease payments / (  Interest + lease pmt + { ( prin.pmt + preferred stock div) x (1/(1-T))})
   
=   *(US$ 80 700 000 + 0  )/ (      US$ 1 400 000 + 0 +{( 30 600 000 + 0) x (1/(1 – 0.3))}) = 1.7

Note: Principle payment is obtain from year 2005 and PNG Income tax is 30%. No lease payment and no preferred stock dividend for year 2006.

iv. Analyzing profitability 

a) Gross profit margin – indicates the efficiency of management in turning over company’s goods into profit.

Gross profit Margin = (Sales - Cost of Goods sold)/Sales
                                 =   (US$ 310 400 000 – US$ 268 100 000 )/ US$ 310 400 000 = 13.6 %

Exploration expenses = US$ 6000 000 is an expense

Therefore Gross profit Margin= US$310.4M – US$(268.1 - 6)M/   US$ 310.4= 15.56 %
                                                             

The gross profit margin in 2005 is -4.57% or the company has received less revenue. However it has improved in 2006 with gross profit margin of 15.56%.

b) Net profit margin – measures the profit produced by each dollar of sales.

 Net Profit Margin = Net profit after taxes/  Sales  =  US$ 53 800 000 / US$ 310 400 000   = 17.35 %
                                                           
In 2005, the company has net profit margin of 19.0 % and in 2006 with the net profit margin of 17.35%. So in 2005 there is slightly improvement in profit produce by each dollar of sales.

 c) Return on assets (ROA) – measures the overall effectiveness of management in generating profits with its available assets.

 Return on Assets = (Net profit (before extraordinary items) + income tax + Interest )/Average total assets
= (US$ 53 800 000 + US$ 22 100 000 + US$ 1400 000 )/((US$ 1496 000 000 + US$ 1319 400 000)/2)
 = 5.5 % Return of assets
This shows that company has profit earning power using its limited available assets.


d) Return on equity 

Return on equity = net profit – preference dividend /Average stockholders’ equity
                               
                            = ( US$ 53800 000 - 0 ) / (US$1496 000 000 + US$ 1319 400 000)/2   = 3.8%
                               

For every dollar of strockholders’ equity, there is 3.8% return accruing to the stock holder.

 e) Earnings per share – use by stock investor to compare different companies on the basis of earning power of the firm’s each outstanding share on common stock.

Earnings per share = net profit (before extraordinary items) – preference dividend
                                             Number of ordinary shares issued (outstanding)
                     
                                 = (US$ 53 000 000 – 0 )/1284 049000
                                 =US$ 0.041
The EPS of US$0.04 represent dollar amount earned on behalf of each shareholder by the company using each shareholder’s equity.

 f) Price/earnings (P/E) Ratio – is the ratio use to assess the future financial performance of the firm.

Price / earnings = market price per share of common stock earnings per share.
                       
                          = Selling Price / EPS
                               

Note: The Selling price was hardly found in the given data (may be not given in the data) so the Ratio was not calculated.


SUMMARY STATEMENT OF LIHIR GOLD MINE 

A) Liquidity 

Liquidity or Lihir’s ability to meet short term obligations is reasonably not stable and unsecure and there is a short term liquidation problem as observed from liquidity/solvency analysis. It is seen that it will take a long time for Lihir to pay its debt. This is shown by current ratio 0.64 and quick ratio 0.277. Mining’s CF is highly predictable so current ratio of over 1 or 2 is acceptable. Thus Lihir has no short term debt paying ability because current ratio is less than 1. Quick ratio> 1 is desired, so Lihir has no immediate ability to meet current debts.

B) Activity

 Lihir’s inventory appears to be in bad shape and the firm faced problems with account receivables of 103.45 days. Average payment is unacceptable and total assets turnover is not good. However, the average collection period of 5.3 is indicative of good managed credit collection or credit department.

C) Financial Terms

Lihir Mine’s indebtness increase over the year 2005 to 2006. It has no lease payments and the amount of debt is small and can be paid within a short period of time.

 D) Profitability

 Compared to year 2005, Lihir has made great improvement and its net profit was greater than previous year.

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Consumer Price Index(CPI) - Mineral Economics Questions and Answers

                          CPI for USA  from Year 1990 to 2010

Year	Jan	Feb	Mar	Apr	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2010	216.687	216.741	217.631	218.009	218.178	217.965	218.011	218.312	218.439	218.711	218.803	219.179	218.055
2009	211.143	212.193	212.709	213.24	213.856	215.693	215.351	215.834	215.969	216.177	216.33	215.949	214.537
2008	211.08	211.693	213.528	214.823	216.632	218.815	219.964	219.086	218.783	216.573	212.425	210.228	215.303
2007	202.416	203.499	205.352	206.686	207.949	208.352	208.299	207.917	208.49	208.936	210.177	210.036	207.342
2006	198.3	198.7	199.8	201.5	202.5	202.9	203.5	203.9	202.9	201.8	201.5	201.8	201.6
2005	190.7	191.8	193.3	194.6	194.4	194.5	195.4	196.4	198.8	199.2	197.6	196.8	195.3
2004	185.2	186.2	187.4	188	189.1	189.7	189.4	189.5	189.9	190.9	191	190.3	188.9
2003	181.7	183.1	184.2	183.8	183.5	183.7	183.9	184.6	185.2	185	184.5	184.3	184
2002	177.1	177.8	178.8	179.8	179.8	179.9	180.1	180.7	181	181.3	181.3	180.9	179.9
2001	175.1	175.8	176.2	176.9	177.7	178	177.5	177.5	178.3	177.7	177.4	176.7	177.1
2000	168.8	169.8	171.2	171.3	171.5	172.4	172.8	172.8	173.7	174	174.1	174	172.2
1999	164.3	164.5	165	166.2	166.2	166.2	166.7	167.1	167.9	168.2	168.3	168.3	166.6
1998	161.6	161.9	162.2	162.5	162.8	163	163.2	163.4	163.6	164	164	163.9	163
1997	159.1	159.6	160	160.2	160.1	160.3	160.5	160.8	161.2	161.6	161.5	161.3	160.5
1996	154.4	154.9	155.7	156.3	156.6	156.7	157	157.3	157.8	158.3	158.6	158.6	156.9
1995	150.3	150.9	151.4	151.9	152.2	152.5	152.5	152.9	153.2	153.7	153.6	153.5	152.4
1994	146.2	146.7	147.2	147.4	147.5	148	148.4	149	149.4	149.5	149.7	149.7	148.2
1993	142.6	143.1	143.6	144	144.2	144.4	144.4	144.8	145.1	145.7	145.8	145.8	144.5
1992	138.1	138.6	139.3	139.5	139.7	140.2	140.5	140.9	141.3	141.8	142	141.9	140.3
1991	134.6	134.8	135	135.2	135.6	136	136.2	136.6	137.2	137.4	137.8	137.9	136.2
1990	127.4	128	128.7	128.9	129.2	129.9	130.4	131.6	132.7	133	133.8	133.8	130.5

1.  PRODUCTION

Data-

30 000 000 tonnes Cu ore/day for 350 days for 20 years

Mill recovery 87% for every 1 tonnage mined

Cu grade is 0.8% tone Cu per mill tonnage produce.

The price of Cu is projected to be US$1.25/lb

Production = 30 000 x 350 x 20 = 210 000 000 metric tones of Cu ore for 20 years.

Mill trough put Recovery =  87% x 210 000 000 = 182 700 000 Mill tonnage

                                               100

 Cu ore grade is 0.8% tonne Cu per mill tonnage produced

                0.8% x 182 700 000 = 1 461 600 tonnes Cu produced

               100

Price of Cu is projected to be US$ 1.25/lb

1 lb = 0.4535924 kg = 0.000453924 tonnes (Using Calculator Conversion)

                       US$ 1.25 = 0.000453924 tonnes                                                                                 

                          xUS$   = 1 tonne

                      1 tonne    = US$ 2755.778095

Therefore price of Cu projected is US$ 2755.778095/tonne

 Gross Revenue = US$ 2755.778095 x 1 461 600 tonnes of Cu = US$ 4 027 845 264  

2. Capital Cost

Data-

Capital cost projected to be US$600 million (1990)

Working Capital is US$ 70 million (1990)

NB: expected to be incurred in year 2

 Salvage value is 20% of the capital cost.

Capital Cost – 60% debt with 12% interest

                     -  40% equity raising 

Real escalation is 4%

Calculation

·         Inflation in 2010 =   CPI Dec 2010  - 1       =   US$ 219.179 - 1 =  63.81 %

        CPI Dec 1990                   US$ 133.80

                                           = 63.81%  nominal inflation in 2010

    

·         Nominal escalation    = (1+ inf 1990 -2010)* (1 + real esc.)ⁿ -1

= (1+ 0.6381)* (1+0.04)²⁰ – 1

= 258.9 % over the 20  years period

Therefore,

·         Capital Cost (Dec 1990) US$ 600 M x (1+2.589) = US$ 2 153 400 000 (Dec 2010)

·         Working Capital ( Dec 1990) US$ 70M x (1 + 2.589) = US$ 251 230 000 (Dec 2010)

·         Capital Cost financed through debt  60% with 12% interest

      60%/100 x US$ 2 153 400 000 =  US$ 1 292 040 000 with 12% interest

·         Capital cost financed through equity of 40 %

      40% / 100 x US$ 2 153 400 000 =  US$ 861 360 000

·         Salvage

20%/100 x US$ 2 153 400 000 =   US$ 430 680 000

Annual Interest plus principle payment

A = P x    i x (1 + i) ⁿ = US$ 1 292 040 000 x 0.12(1 +0.12)¹⁰ =  US$ 228 670 619.5

                 (1 + i)ⁿ – 1                                      (1 + 0.12 )¹⁰ -1

                                   = US$ 228 670 619.5

Principle = US$ 1 292 040 000 = US$ 129 204 000

                            10

Interest = Annual payment – principle

             = US$ 228 670 619.5  – US$ 129 204 000 = US$ 67 201 632.5

3.      Operating Cost

i)              Mining Operation Cost

Data

Total ore & waste tonnage is 90 000 tonnes mined per day for 350 days for 20 years

 It cost US$1.0/tonne to remove both waste and ore.

Total cost = US$ 1.0/tonnes x 90 000 x 350

                  =US$ 31 500 000 (1990 value)

Therefore;

·         Mining operating Cost

 (Dec 1990) US$ 31 500 000 x (1+2.589) = US$ 113 053 500 (Dec 2010)

ii)             Milling, Severance and administration operating cost

 a)      Milling

Milling Cost = US$1.60/tonne x 30 000 x 350 = US$ 16 800 000 (1990 value)

        (Dec 1990) US$ 16 800 000 x (1 + 2.589) = US$ 60 295 200 (Dec 2010)

b)      Severance

Severance Cost = US$0.10/tonne x 30 000 x 350   = US$ 1 050 000 (Dec 1990)

                 (Dec 1990) US$1 050 000 x (1 + 2.589) = US$ 3 768 450 (Dec 2010)

c)      Administration

Administration Cost = US$ 0.20/tonne x 30 000 x 350 = US$ 2 100 000 (Dec 1990)

                        (Dec 1990) US$ 2 100 000 x (1+2.589) = US$ 7 536 900 (Dec 2010)

d)     1 tonne Cu smelter-charged is imposed on every 0.87 tonne mill production =

  1tonne/ 0.87tonne x US$1.60 x 30 000 x 350 =US$ 19 310 344.83 (Dec 1990)

           (Dec 1990) US$ 19 310 344.83 x (1+2.589) = US$ 69 304 827.59 (Dec 2010) 

Total Operating Cost = US$ 253 958 877.6

4. Development Cost (Capital Cost)

     Year 0 to Year 1 amount used is US$300 million (1990)

  (Dec 1990)US$ 300M x (1+2.589) = US$ 1 076 700 000 (2010 value)

Year 1 to Year 2 amount used is US$300 million (1990 value)

    (Dec 1990)US$ 300M x (1+2.589) = US$ 1 076 700 000  (2010 value)

5. Royalty

 2% + 0.25% = 2.25% from Year 2 to Year 12

2.25% - 0.25% = 2.0 % from Year 13 to Year 22

 6.      Income Tax

 PNG Income Tax rate is 30% of the corporate income.

7.      Depreciation

Year 2 – 14 Apply Double Declining Balance Method (1/2 convention)

Year 15 – 22 Switch to Straight line depreciation.

 i)                    Double Declining Balance Method

Year	Method	Rate x Adjusted Basis	Depreciated Amount  (US$)
1
2	1.5 DB	1.5/13 x 2,153,400,000  x 1/2	124,234,615.4
3	1.5 DB	1.5/13 x 2,029,165,385	234,134,467.5
4	1.5 DB	1.5/13 x1,795,030,918	207,118,952
5	1.5 DB	1.5/13 x1,587,911,966	183,220,611.5
6	1.5 DB	1.5/13 x1,404,691,355	162,079,771.7
7	1.5 DB	1.5/13 x 1,242,611,583	143,378,259.6
8	1.5 DB	1.5/13 x 1,099,233,323	126,834,614.2
9	1.5 DB	1.5/13 x 972,398,708.8	112,199,851
10	1.5 DB	1.5/13 x 860,198,857.8	99,253,714.36
11	1.5 DB	1.5/13 x 760,945,143.4	29,267,120.9
12	1.5 DB	1.5/13 x 731,678,022.5	84,424,387.21
13	1.5 DB	1.5/13 x 647,253,635.3	74,683,111.76
14	1.5 DB	1.5/13 x 572,570,523.5	66,0665,829.64

ii)                  Straight Line Depreciation

      Annual Depreciation = US$ 41 064 561.09 = US$ 5 133 070.137/year

                                                  8 years

8.      Discount Rate

Step 1

   E(R_i) = R_f + ß_i [E (R_m – R_f )]

             =  5% + 1% * [ 6% – 5% ]

            =  6% is expected rate of return on the stock investment

Step 2

  WACC =   E(R_i) *     D    +      D      *  (1 – t )* i

                               (D + E)   (D + E)

  WACC = 6% *        60        +           60       * (1 – 0.3)*  12      

                            (40 + 60)           (40 + 60)

             = 8.64%

Therefore the discount rate is 8.64%

                                           Summary of the Calculation

·         Gross Revenue   US$ 4 027 845 264

·         Royalty -  2%  + 0.25% = 2.25% from Year 2 to Year 12

-          2.25% - 0.25% = 2.0 % from Year 13 to Year 22

·         Capital CostUS$ 2 153 400 000

                i) US$ 1 076 700 000  (Year 0-1)

               ii) US$ 1 076 700 000 (Year 1-2)

·         Operating Cost  US$ US$ 253 958 877.6

·         Working Capital - US$ 251 230 000

·         Salvage Value - US$ 430 680 000

·         Depreciation

·         Interest Expense

·         Tax  30%

·         Discount Rate  8.64%

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