Aggregates Manager Digital Magazine
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28 AGGREGATES MANAGER / July 2016 MINE MANAGEMENT than the other two methods, except in those cases where the quarry is not profitable. For smaller family-owned quarries and mines, it seems this is partly due to the fact that the plant and equipment fleet are relatively old and, therefore, have low fair market values. Market-based approach: This approach is based upon the use of comps to establish fair market value. It is imperative that the selected metric of comparison be appropriate. For example, as illustrated above, using annual sales volume to determine price is not a reliable metric. This is because the use of annual sales volumes does not take into consideration profit margins. Accordingly, a much more reliable metric considers profits such as Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA). There are potential inherent problems with the use of this approach. One drawback is that the selected metric is typically applied to historical performance. Obviously, the quarry's future performance could be similar, better, or worse. Another draw- back is the fact that it is based upon the application of multiples derived from other markets which may, or may not be, more dynamic or less competitive. However, we typically find the use of this methodology yields more reliable results than the asset-based approach. Income approach: It has been our experience that the in- come-based approach yields the most reliable estimate of fair market value. Most of the larger companies rely most heavily on this methodology. This approach is based upon a multi-year projection of future sales and financial performance. Historical performance forms the basis of the financial model in that historical sales volumes, sales prices, costs, and profits are considered. Factors that are evaluated include the following: • Sales performance – adjust historical sales volumes and sales prices in light of expected changes in market demand or the competitive environment. • Reserve characteristics – projected mine life, change in over- burden thickness, or rock quality. • Mine costs – adjust historical mine costs in light of projected changes in labor costs, geologic conditions, or equipment changes. • Capital requirements – consider replacement of worn equip- ment or potential increase to annual capacity. Once the multi-year sales and financial forecast is complet- ed, the resultant cash flow forecast is adjusted by a discount rate. Selection of the appropriate discount rate is a key success factor when employing this approach to valuation. Perhaps too simplistically, the income approach yields the most reliable fair market value estimate because it is based upon a forecast of future cash flows. Future cash flow is ulti- mately what a prospective purchaser is buying. You may have heard the saying "cash is king." How can fair market value be so different? The dissimilarities in fair market values result from material variances in one or more of the factors described previously. First, let's apply these principles towards reconciling the dissimilarities in fair market values between the three 1-million-ton quarries. Figure 3 illustrates there is a $1.40 per ton difference in cash op- erating margin between the highest valued (Quarry A) and lowest valued quarry (Quarry C). Further inspection indicates that $1 per ton can be attributed to a higher average sales price. Quarry A's greater profits account for a little more than 50 percent of the difference in fair market value. Figure 3: Financial Performance Overview of 1-Million-Ton Quarries The remainder of the difference is attributed to the fact that future annual sales and profits will be significantly higher than historical levels. The quarry had just landed a new likely long- term customer who would increase annual sales volumes by nearly 25 percent without an increase in overhead expenses. Also, a three-year road project not only was going to increase annual sales volumes, but permit the sale of previously spoiled cap rock. By contrast, the trend of Quarry C's annual sales vol- umes was negative. As a matter of fact, they decreased nearly 20 percent over the subsequent two years. Similarly, analyzing the dissimilarities in fair market values between the three quarries operating at 600,000 annual tons also illustrates the importance of considering non-financial factors. Considering only the financial performance of Quarry D versus Quarry E one would expect that Quarry E's fair market value to be twice that of Quarry D as its profit margin is nearly twice that of the other quarry, $3.48 per ton versus $1.78 per $0.00 $1.50 $3.00 $4.50 $6.00 Quarry A Quarry B Quarry C Financial Performance ($/Ton) 0. 4. 8. 12. 16. Quarry D Quarry E Quarry F Financial Performance ($/Ton) Avg. Sales Price Cash Ops Costs Cash Margin EBITDA Avg. Sales Price Cash Ops Costs Cash Margin EBITDA