Fresnillo PLC (OTCPK:FNLPF) Q4 2019 Earnings Conference Call March 3, 2020 4:00 AM ET
Company Participants
Octavio Alvídrez – CEO
Mario Arreguín – CFO
André Sougarret – COO
David Giles – VP of Exploration
Conference Call Participants
Dan Major – UBS
James Bell – RBC Capital Markets
Richard Hatch – Berenberg
Alan Spence – Jefferies
Amos Fletcher – Barclays
Octavio Alvídrez
Good morning, everyone. I’m Octavio Alvídrez, CEO of Fresnillo PLC. Thank you for coming and attending the preliminary results for 2019.
Here with me, we have Mario Arreguín, our CFO; we have our Chief Operating Officer; André Sougarret; and David Giles, our Vice President of Exploration. Also, we have here one of our board members, Dame Judith Macgregor. Thank you, Judith, and the team in London.
First of all, a word on these disclaimers, forward-looking statements. And this is the agenda we will cover today: investment proposition; 2019 highlights; health, safety, environment and community relations; then followed by the operational performance and how we are doing on the development projects; some comments and slides on reserves, resources and exploration. So before we finish, we’ll cover with detail all the financial performance in 2019. And then we will give you some outlook for the current year.
In 2019, we faced a challenging year. Most of our mines performed or have different operational issues. In Fresnillo, we had a lower-than-expected grade. In Saucito, we performed according to what we were expecting. However, there was lower production and lower wet grade as well. In San Julián, we had some geotechnical challenges that made us change some of the mining sequences, and therefore, we produced lower silver than expected. And then in Herradura, also, we had some issues with some of the projects, specifically the leaching pad number 13 and putting in place some infrastructure as well. And therefore, we produced less gold. Ciénega produced according to plan.
So as I mentioned, and as you can see, I mean, most of our mines had some issues and situations. So we focused last year on stabilizing the operations starting in detail what were the issues at each one of the mines. And therefore, this year, we will have a transitional year in which we continue stabilizing the mines and look for the following years.
However, the fundamentals of the company remain and, as we can see in this slide, high-quality assets, a large resource base, 2.3 billion ounces of silver and 39 million ounces of gold in resources. Although margins at our operations because of higher costs also than expected are strong. We have still healthy margins at our operations. On a consolidated silver cash cost of $8.25 is a reflection somehow of this.
We will see that we have growth in our pipeline. And although we have concentrated to unlock the value of the current operation, that growth is there, and we will see what projects we have and what is the outlook for those as well.
Mining nowadays cannot be understand — understood by — if it is not worked by — in a framework of sustainable business practices, and we will have in detail as well what we are doing in terms of sustainability and comparable mining. And our operations support a strong in our balance sheet. As you can see, we have a low debt-to-EBITDA as reflected in this slide.
Some of the highlights for the year, operational. As I mentioned, the different issues at our operations is reflected here with lower production at 54.6 million ounces of silver, down 11.6% to the previous year. And also on the gold side, we produced 5.1% less than the comparison on the period at 876,000 ounces of gold. That as a summary for the operations.
On the development of the projects and as released in our update for the project Juanicipio, we — and after going through a detailed engineering, we changed some of the original parameters when we approved the project, and we will let you know exactly — we have a slide with all the details, but we changed some of those — that and we optimized what we could do in terms of development, in terms of taking advantage of spare capacity at the Fresnillo district. So we’ll talk about Juanicipio in a few slides.
On exploration side, as Fresnillo having a large concession holding in Mexico and also in Peru and Chile, we are concentrating our efforts as well in exploration around our districts. David Giles will let us know when we are exploring, and we are spending $158 million in 2019, down 8.6% to the previous or the comparison period.
Reserves grades have remained stable since 2017. I know we have some concerns. So you have some concerns about the reserve grade. However, we went and studied in detail this situation. We concluded that our geological models are solid. However, we do have some challenges in terms of dilution and some operational practices in order to achieve better grades at our mines, Fresnillo and Saucito, in particular.
Some of the financial highlights. Gross profit and EBITDA of $462 million and $674 million, respectively, down 40% — almost 41% and 26.3% to the same numbers of the previous year. Mario will walk on all of the financial results with detail. And as I mentioned, some of the other issues that we have at our operations is the higher production cost and therefore lower margins.
Net profit for the period $205.8 million, down 41.2%. As of the end of December, we had $336 million in cash on hand. And we declared a 2019 final dividend of $11.09 per share, which amounts to approximately $87.7 million.
A slide on sustainable business practices. Our purpose is contribute to the well-being of people through the sustainable mining of silver and gold. In terms of safety, we continue implementing the largest effort in safety across our operations. The I Care, We Care program continues to be deployed in all of our operations. We started with the top management. We went through some workshops, the executive committee. And from there, all of the directors and some of the top management at each one of our operations cover approximately 350 middle management. We continue to do so with the supervision, which is the larger base in our company. And also, we included this time most of our contractors. We will continue this year with the deployment of this program. And it’s good to say that it’s been a year without accidents in our underground operations related to our job.
We are also having some specific programs — within this program, some specific details, which has to do with critical risk control protocols. We are focusing on those activities that bear the largest risk of the operations like on ground control, mobile equipment, electricity, and we are focusing on those as we have the larger potential for a serious accident here.
On environment, although we reduced our electricity consumptions from wind power, as the previous year, we had 60%, now we are at 56%. That was because we increased the base for consumption, having the same source, but I’m happy to say that this year, with the new wind power already in operation, we will achieve in the second half around 75% as was our objective in this aspect.
We have continued to roll and review all of our storage — tailings storage facilities with an independent panel that comes every 2 to 3 months to our operations. They review and give us the — what we need to fix, we’ll more — go more in detail. And this is a continuous program that will be in place as we operate. Water as well, which is a fundamental source in our operations, we continue to — as much as we can to re-use water. We are right now developing a project in Herradura, which is in the desert and a very stress area in terms of water, and we are also trying to bring this project to fruition in terms of using sewage water from Caborca and our operations at Penmont.
And in terms of our community, we are also deploying the main projects that we have around education, health and sports and capacity building for the communities of the entrepreneurs around — in our communities around our operations.
I’m glad to report that in terms of the ethics program deployed in our company, we have been recognized somehow in Mexico. We got the top mentioned in ethics programs for the — within the 500 largest companies operating in Mexico. And just recently, we were also included in the Ethisphere more ethical companies, which is a program that goes global.
And with this, I would like to pass the voice to André Sougarret, so that he can tell us about some of our operating performance around gold mines. You can turn into your…
André Sougarret
Good morning. I am going to present the safety results, there are positive results. And this is the largest problems that we have. Our main goal is not to have fatal injury this year. We have been trying to deploy our policy in the different units in I Care, We Care. What we do is try to control the critical risks that exist in all operations by training executive directors but also the workers, the ones who carry the most risk. We are doing training, but not only that, we are also controlling and supervising that the controls are present in each and every activity that we do. We have a gap compared to the rest of the industry in terms of accident or injury time — injuries. The rate is being reduced, but we hope to have better results in the next few years. So this is a continuous work, and we are deeply committed from the high-level direction.
In terms of results, I have already presented this on the total level. The production was 870,000 for gold and 54.6 million for silver. What are we focus is — focusing on in our operations? So those are the 5 items that you have there on the column, operational discipline in order to obtain the best practices in the industry in terms of planning, operation and control of our different operations, particularly in operation.
Second item, improve our medium and long-term plan to look ahead, see what comes in the future and also to have a better infrastructure in order to respond to the difficulties and to use better our assets and to use the information platforms to use better our technology in order to improve our times, our efficiencies, but fundamentally, to understand better our operations in order to improve our performance. And lastly, we have to do continuous training for our workers, who face the challenges, so we can use better our technology.
Now specifically on our operations, Fresnillo. First of all, it’s probably the operation that is — worrying is most now. What are we doing there? We achieved 30 million ounces finally the financial year ’19. There’s been a reduction compared to FY ’18. And this is due to 2 large problems we found: the advance of our development, first; and secondly, to be able to have a control of the operational practices, especially in the dilution of our material when extracting.
We have been reducing the width of our veins. So what have we done? Some of the objectives we have achieved for ’19 will allow us to improve progressively in the next few years. First of all, we have improved our index of development to — in 16%. We have achieved 3,030 meters a month for 2019. We hope to improve the performance. We have new contractors, new international contractors from Peru specifically. They started their operations in December, and we hope that the performance improves during this year.
Since December, we have started developing the main infrastructure through a new tunnel boring machine. As I said, it started working in December, and they have advanced a bit over 80 meters, and we hope to go beyond 300 meters a month. This is the performance we expect from this TBM. And we keep on trying to find the deepening of the shaft. We have 360 meters out of the 400 deepening meter — deepening depth — meters of depth, and we expect to finish at the end of this year.
These are the priorities for 2020: increase the development; get to 300 and — sorry, 3,500 meters a month; and finally, to conclude, part of the infrastructures and main projects that will allow us to have a better production in the next few years.
The flotation plant in [indiscernible] should start working on the second half of the year. And according to production, we are already generation — generating production of 600,000 ounces for this year. We expect to achieve permanently 3 million ounces this year.
Now Saucito. Same idea that we have presented for Fresnillo. Our goal is to be able to implement better practices, increase our development capacity. We have improved in 16% the monthly development, and we have achieved over 3,000 meters a month. And in the fourth term, we expect to achieve 3,600 meters sustainably, and we hope to be able to develop it this year. So we expect to achieve between 3,500 and 3,800 meters a month. We are also advancing the main infrastructure. We are also deepening the shaft of Jarillas in order to sustain the future reserves. We have also advanced there, 230 meters out of 480 meters of depth.
This will be added to the shaft deepening. We will develop new infrastructure, the pumping system, and the water traction in the mine and also the crushing, which will allow us to reduce the material and bring it to the surface more efficiently. Another objective is to be able to bring down the dilution. This is something very important for the future development. Our veins get narrower. So we will be able to keep on reducing the dilution.
On San Julián, we have 2 operations. We have the production coming from the ore body, the massive body. And during 2019 and the beginning of that year, we had problems with the mining sequences from drops from the rock, geotechnical problems that prevented us from achieving our goals for the year.
In FY ’19, we tried to carry out studies in order to find a mining sequence that will allow us to manage that rock drop, and we haven’t experimented more of that drop. So from the second half of this year, we expect to find the levels or to achieve the levels with the best production, as I say, from the second half of this year and next year.
Then another problem that we had to solve in 2019 was the lack of water, which had an impact on the results of FY ’18. We developed some projects in order to give continuity to our operations. We did that during November ’19. And we have reserved in order to give continuity without major problems in the next few years of our operations in San Julián.
What are our priorities in San Julián for 2020? We want to do conclude the infill drilling campaign in the vein system; adjust, as I say, the mining sequence in order to achieve from the second half of the year our goals; get a better productivity. Cost management is one of the efforts we will be doing and also CapEx control. This is part of our investment, and we are controlling this strictly in order not to add — to sustain CapEx. And then future continuity. This is also quite a challenge in order to start the fourth term of the dam — the tailings dam that we have to build.
Ciénega. We have a stable production here in our operation, and the greatest focus for 2019 and will continue in 2020 is the cost control. We have quite a dispersed operation with 2 satellite operations. So in 2020, we will end one of the satellite operation and we will replace part of the material with operations close to our main infrastructure in order to be able to control and reduce costs mainly in haulage and — or in the next few years.
Now on Herradura. It’s an open operation — open vein operation results for 2019. Some of the most important moments was the second line at the DLP that was ramped up as expected. This happened from January 2019 without problems, and we reached the production level for the second line, and this means that we have 2 plants that allow us to process 6 million tonnes per year continuously.
Another very important topic that we’re developing when we are doing a deeper trailing of the pit, the walls and the stabilization of the walls is starting to be quite significant. And therefore, for 2019, we implemented a monitoring plan, the monitoring of the benches. And secondly, also a campaign so that we can have better data about the benches at deep levels and also improving the quality of blasting that will allow us to drill further and to have angles that will allow us to recover as much or as possible at deeper levels. And secondly, another very important event for us was the construction of pad number 13 for leaching to have more continuity in leaching and this was carried out in August. Now it is operating at full capacity.
And lastly, another issue that has to do with costs, as Octavio said, we are also having 27 haulage fleet that are using dual fuel system, and we’re hoping to increase to 41 in 2020, 2021. And on the other hand, we also want to continue sequencing the mine for the future, having reviewed for the long-term plan and also increasing the productivity of our fleet, improving the efficiencies in the use of time, mainly. We have to reach levels of movement of material of 130 million tonnes per year, and that means that we have to maximize the use of our fleet.
And lastly, I would like to say that we are going to implement 2 projects. One of them has to do with Carbon in Column for Herradura to improve gold recuperation and also the installation of grizzly, the vibrating screens so that we can support the capacity of this 6 million tonnes from the leaching plant that I mentioned.
In Noche Buena, just to mention that this is an operation that is closing. So we have projections for this year, we are going to diminish the movement of material, but with regard productivity, we will have an increase in production because we are getting to the deeper parts of the mine to the end of the mine. So we have the possibility to start the ore there. But most of our priorities for 2020 are related to the reduction of costs. The adjustment of our fixed costs that we have in this operation, so that we can adapt it for the coming years, in which we will have the operation of gold recuperation in our ore pads — leaching pads. And also implementing according to standards, the closure of the Noche Buena mine in the coming years.
And lastly, just a few points about cost-cutting program that we have in order to improve our practices to support our geological model through 4 main initiatives. One of them has to do with the extent of dilution, which I commented on beforehand. We are working a lot in order to have the best practices to measure on the one hand, but mainly to adapt our operating practices so that we can reduce dilution is essential for the results in the coming years.
And on the other hand, when we look at the geological modeling, we are improving our sampling and also the in mapping the mine, the sampling procedures. And third element would also be the protocols in our labs, so that we can have better information. And lastly, the geostatistical parameters for the infill drilling spacing.
So this is what we have so far. And now I will give the floor to Octavio, so he continues with presentation of the different projects.
Octavio Alvídrez
Thank you, André. Here are some brief description about our projects. As you know very well, the pyrites plant at the Fresnillo district about to be completed. We expect to start operating this in the second half of this year. With this second leg of the project, the first one being in the Saucito mine, we will achieve the complete project being constructed, 155 million. And as you can see, we will get out ounces — quality ounces at low cost initially, I mean, whenever we have it ready, the tailings out of the Fresnillo, old tailings are those that with a better grade as well.
And we are coping with higher base metals, lead and zinc at the Fresnillo mine, we are about to conclude this year also the increase in flotation capacity at our plant in Fresnillo in 2017. We installed the zinc thickener and then this — after that, and we are about to finish that construction, larger flotation capacity for lead and zinc. And that will be the base for whenever the mine is ready so that we can increase our production to 9,000 tonnes per day.
And there on the right, you see the infrastructure that goes along with this. Our capabilities at our mine. André described that we are commissioning the tunnel boring machine, also the San Carlos shaft deepening, which is quite a piece of infrastructure that will allow us to decrease the cost of production as well. Instead of hauling the ore through ramps, we will have that shaft in an area in which we have a large resource and reserve in the Fresnillo mine. And the rest of the infrastructure that we need to complete and have the mine prepared, so whenever we have achieved all of this, we will be able — and, of course, we will have a position to go to a higher capacity throughput at Fresnillo.
And then on Juanicipio. We had the release the update on our project. As we advance on a detailed engineering, we realized that we were all going to have a higher CapEx coming from ground control at the mine, larger investment also needed at some equipments from the flotation plant. And also another piece of that increase our CapEx estimates was the — that we needed a larger tailings storage facility with the new standards in place. We better went and are designing these tailings storage facility for a larger capacity as well, as well as some contingency that we are including.
So with that, we went from $395 million from January 1, 2018, to $440 million. The construction of the plant, as we flagged in our Capital Markets Day, we thought it was optimistic to finish it by year-end 2020. And right now, our estimate is mid-’21. However, as we are going to be producing ore from development starting in June this year, and as we have idle capacity and the flotation plant in Fresnillo, we will be able to use or process this capacity with Juanicipio ore coming from development exclusively.
We have a couple of days of spare capacity at the flotation plant in Fresnillo, and we will use processing Juanicipio ore coming from development. So that’s something that we have not considered in our original plan, and therefore, it will be — will mean some revenues for the — for Juanicipio already this year.
In ’21, you can see the comparison there. The original plan according to feasibility study was to produce at a 55% rate of capacity, with the average annual production that we have, 11 million — or we have stated 11.7 million ounces of silver and 40 — almost 44,000 ounces of gold. That meant that we were going to — or we were expecting to produce approximately 7.5 million ounces of silver, now with the ore that we are going to process from developments from June this year to mid next year and then ramping up the mine production once we finalize the construction of the flotation plant of Juanicipio, we are planning to achieve some production on that range of 4.5 million to 7 million ounces of silver. It’s quite a wide range somehow, but just to bear in mind that we are producing in the first months, starting this year ore from development, which has some variability and lower — probably lower grade.
And then after in 2022, we are achieving the original nameplate capacity, and the plant ramping up the operation at 95% once we have all in place, the mine being prepared and also the flotation plant being constructed.
In Orisyvo, as we’ve said, this year is about collecting a representative sample from all of the mining blocks and therefore, we will run the test in metallurgy in order to verify if we can achieve the 80%, 82% gold recovery. And after that, we will do a PEA to see how strong this project is in the rest of the year. It’s a large resource, 9.6 million ounces of gold, and we continue at the pace in order to build a strong case for Orisyvo.
We have 1 more gold project, Rodeo. This is very conveniently located in between Torren and Durango, nearby infrastructure, electricity, roads and everything. We continue with our efforts to access land in order to have then the permitting process. So we will concentrate on those activities this year.
And on Guanajuato, which is another one of our projects. These are gold and silver producing projects. We continue to explore. We lowered the pace in terms of mining works this year, and we are concentrating only on exploration from surface through drilling.
And with that, I will pass the microphone to David Giles. David?
David Giles
Good morning. Our reserves and resources are estimated at each one of our mines by a team of geologists and engineers, and then each year, they’re audited by a team of people from the outside audit from SRK who did it very carefully.
This is the first slide shows some of the key changes and conclusions we’ve got from our resource reserve situation. This year, we decided, or in 2019, we decided to use our data to the end of the day, so we could do a detailed review of the reserves and resources during the rest of the year with SRK. This was a year 4 months earlier than the previous year. So that means the results were for 8 months, not the full 12 months.
More stringent criteria was used in the calculation, and we initiated more detailed geotechnical, hydrological and financial models at each wall of the mine. As a result of that, we didn’t finish some of these studies. So all of our reserves are now classified as probable. In the past, we have proven and probable. We have — about 50% of our gold reserves were in proven and 40% were in — the silver reserves were in proven. Now they’re all probable. However, we have this team of engineers and geologists reviewing this, and we expect we’ll return the proven part to — the probable part to proven when we finish these studies at the gold mines in this year, 2020, and the silver mines will do that during 2020 and 2021.
We’ve looked at our geological model. We’ve done extra infill drilling, and we’re very confident in it. At all our mines, the model is checking out where we’re — the reason we’re not doing — producing the grades we want is because of dilution at the mines as André has commented.
The slide shows the silver resources, and our silver resources, you can see up on the top left, a 2.257 billion ounces. The resources in the year were increased 2.4% and that was because of a successful exploration. You can see the bars on the left, the green bars at Saucito, Guanajuato and Juanicipio. However, we have lower resources at Fresnillo and San Julián, which are the red bars on the right, and that’s due to stricter audit criteria, and, of course, the mining, the depletion of these mines.
Taking a look at the gold resources. Our gold resources, a very strong 39 million ounces. You can see on the top left, it’s stable, it’s about the same as 2018. You can see the green bars on the left, where the gold resources were increased at Centauro Profundo, Guanajuato and
Ciénega, and Tajitos, which is a project near Herradura, and our resources, gold resources, were reduced principally at Herradura because of higher stripping in the models. Some of the blocks didn’t make the grade, so that brought down the resources at Herradura. And also low resources at San Julián and Saucito because of stricter audit criteria in the mine. The gold resources are stable.
Let’s look at the reserves. Our reserves, the total silver reserves, as you can see there, 484 million ounces of silver. That’s about 8.9 years of production. We have an increase in our reserves. That’s because new reserves were incorporated at the Juanicipio project, the green bar on the left. And you can see our reserves were reduced at the other mines, the silver reserves. That’s because of depletion, more rigorous dilution criteria and higher cut-off grades. Because of increase in costs, the cut-off grade was higher, and some of the blocks at these mines didn’t reach the economic requirements.
You can see on the left, the silver reserves are split up into 2 parts. In 2018, it was about half-and-half, proven and probable, and temporarily in 2019, you see the bar on the right, these are — the 483 million ounces, those are probable reserves.
Our gold reserves were reduced 16% in the year compared with 2018. We still have a large gold reserve base. It’s 9.248 million ounces. The reserves were including, for the first time, the reserves at Juanicipio, the green bar on the left. We — the reserves at Soledad & Dipolos were reclassified down to resources because we haven’t obtained access to the surface ground there. Of course, when we get access, I think that will be eventually negotiated. Those will go back into reserves. And the reduction at the other mines is because of depletion, and again, Herradura because of the highest stripping.
A comment on our growth pipeline. And you can see on the left side of the slide how we group it, coming down from the mine operations, development projects, advanced explorations, down to prospects in drilling. So I wanted to point out on the right side of the triangle, this is the 2020 Budget. And this year, our strategy has changed, and we’re really focused on exploring around our mines, where we have great potential and a chance to find deposits with large margins.
So you can see on the top part of the triangle, the 60% and the 20%, 80% of our budget this year, $135 million, will be around our mine, so we’re very focused. And one of the reasons is at the Fresnillo mine, I’m happy to say we’ve found some new veins, some with great potential. There were blind veins covered by alluvium, with the geophysics, geochem and mapping that we’ve done that these are very important discoveries. And we’re also doing well at the San Julián mine.
The rest of the triangle going down as prospects in Mexico, Peru and Chile. And I’ll just comment in Chile, we’ve got a good project that we’re drilling now. We’ve got the [indiscernible] gold. This is in Peru and it’s Supaypacha. And in Chile, with this 2 gold projects that we’re drilling and one looks particularly good we built out last year, it’s called Capricornio in the northern part of Chile. Fresnillo has a very strong land position in Mexico, we have 1.2 million hectares. In peru, we have 650,000 hectares and in Chile, we have 15,000, which is very prime selected ground with lots of potential for the company in the future.
With that, I will turn over to Mario.
Mario Arreguín
Thank you. Good morning. If I can do this. All right. This slide shows the income statement for 2019, we compare that to the previous year 2018. And as you can see, all the different profit levels, which are outlined in yellow, have come down quite substantially compared to the previous year.
In the case of gross profit, we see a decline of 41%. In the case of operating profit, we see a decline of 66%. In the case of net profit, we see a decline of 41%. In the case of EBITDA, a decline of 26%.
If you look at the change column, you will see that 2 very important items had an impact on these results. Firstly, the adjusted production cost, which went up by 23% or $221 million and also the depreciation. And by the way, you also see an important effect of the change in inventories, which I will explain.
But before I explain the adjusted production cost in detail, I would like to show you the following slide, which is a breakdown of our sales. And as you can see, in terms of metal participation, 53% of our sales is gold, 34% is silver, 9% is zinc and 4% is lead. So we are more a gold company than a silver company, if you define that by the participation of the metals.
And on the left-hand side, you can see the participation of each one of our mines. We now have 7 mines, if you separate the San Julián mine into the 2 operations that we have there. Currently, Herradura represents 31% of our total sales, Saucito represents 22%, Fresnillo 16%, Ciénega 9%, Noche Buena 8% and the 2 San Juliáns together 16% or 8%, if you look at them separately. What I wanted to point out in this slide is the bottom part. Because when you calculate the cash cost, obviously, you take into consideration the byproducts. And clearly, you can see there that in the case, in most of our mines, except for Herradura and Noche Buena, clearly we have a very well-diversified metal participation. Look at Fresnillo, for example. Of course, the main metal is 53%, but gold represents 17%, lead almost 11% and zinc almost 18%. So when you do the cash cost calculations, all the other 3 metals will be byproducts that you credit back to costs. And depending on the price fluctuation of those metals, you will have a very important impact in the cash cost.
Ciénega is most diversified mine. We consider that 9% to be gold, but it only represents 43%, silver 42% and the base metals. In even San Julián, 65% is silver. The remaining metals represent close to 35%. At the veins — at the San Julián mine, at the veins part of it, silver only represents 44%. So again, you have to be very careful when you analyze those variations and cash costs to take into account this particular factor.
Now we saw an inflation, what we call, cost inflation based on our basket of intakes in 2019 of almost 3.8%. And as you can see there, the main items based on price increases were contractors considering the weighted average, of course, diesel mainly. Now how does that translate into dollars?
In this slide, on Page 33, you can see that the adjusted production cost went up by $221 million, and that is represented by the bar on the right-hand side, the $221 million. And you can see all the remaining bars, which represent the different situations that we had, which contributed to that increase. But inflation is represented by bar number 4. So the 3.8% inflation is translated into an increase in terms of adjusted production cost of $35.4 million. But 2 columns that I think related mostly with the operations are column 1 and column 2.
In column 1, we show the impact of the increase in development at our mines, which increased our cost by almost $57 million. And as you know, one of our priorities has been to assure that we have the flexibility and the number of stopes that we need in order to make our operations efficient. And we have had to dedicate resources towards that objective. And of course, that meant an increase in our costs. Column number 2 is related to the additional consumption of operating materials, additional maintenance and additional contractors. And all of this is associated, for example, in the case of maintenance, with assuring the availability of equipment. One of the issues that we had was that we did not have the equipment ready and available. So we now are incurring an additional cost and maintenance to guarantee that those equipments are there and available, again, to make our mines more efficient. Also, you’ve seen that the haulage distances have increased, which obviously translates into a higher cost. So we represent that with bar number 2, and that represented $46 additional million in terms of production costs.
Third column, as you know, is mostly related to a change in the accounting criteria that we implement in our open pit mines. In 2018, we changed the criteria from 2 to 1 components, which meant that we are now capitalizing less of the stripping and taking more stripping directly into the income statement. But the overall cost, regardless if you capitalize it or take it into the income statement, that didn’t change substantially. So that had an impact of $46 million in our adjusted production cost.
And lastly, column number 5 is related to new operations that either started in 2019 or operated more months in 2019, which is the case of the new pyrites plant at Saucito and also the dynamic leaching plant number 2 at 10 months. And that represented $33.4 million. Fortunately, that cost, obviously, implied as additional profit, which we will see later on.
So these are the 5 main reasons why we had that increase in our adjusted production cost. And during the Q&A, I’m happy to answer any questions that you might have related to this.
In our Capital Markets Day, we said that we would give you bit of a guidance for the first time in terms of costs. So we decided to share this slide with you to show what we are expecting in year 2020 in terms of adjusted production cost on a mine-by-mine basis and also on a consolidated basis. One very important thing that is not included in this slide, which I please ask you to do is to, was as expected, include a plus/minus 5% in there. So we will correct that in our website, but this is important because we don’t want to compromise with a very specific numbers. This is the midpoint of the range, and this is the one that we are showing here in this slide.
For next year, we’re expecting an inflation, cost inflation in terms of prices of our intakes of approximately 4.5%. So if you look at the consolidated number, most of that increase that we are expecting for next year will be basically associated with cost inflation. But of course, we have different things going on at each one of the mines. So in Fresnillo, it’s only 2.2%, the increase that we expect. That’s due to the fact that we are expecting to see some benefits of our efficiency programs and cost-cutting programs. So depending on the mine, you will see different percentages. But at a consolidated level, we expect to see a 4.4% for next year. Again, we didn’t show this in cash cost because we did not want to spend too much time explaining the impact of the relative prices of the byproducts. I think this will be more helpful to you in terms of your analysis.
Okay. Moving on. We thought it would be interesting to show you this graph, which basically segments the — our adjusted production cost in different components. As you can see, contractors represent 29%, but it’s not only labor. They also bring with them their own operating materials and equipment, et cetera. So that’s why we were very careful in pointing out how contractors is broken down into. And as you can see here, operating materials, as a total, represents the most important part of our adjusted production cost, 28%; energy 20%, energy is basically diesel and electricity; equipment 10%; personnel 15% and maintenance 18%.
Okay. Now I would like to spend a little bit of time explaining in a bit more detail the decline that we saw at gross profit, which went down by almost $320 million, or 41%. Again, on the bar at the right-hand side, we basically show the total change, which was $319 million. And then we separate the positive effects, which are the 3 first bars from the negative effects, which are the remaining bars. And as you can see, one of the most important factors, which reduced our profit compared to 2018 had to do with the reassessment of the gold content that are leaching pads. Remember that in 2018, we reassessed the content and increased the inventories by almost 100,000 ounces. And that had a very important effect. The total effect of that, we estimate to be close to $125 million. And most of that benefit was recognized in 2018 and only a small part in 2019. So we pretty much recognize the whole effect in these 2 years, but again mostly in 2018. So when you compare those 2 years, 2018 with 2019, the benefit that we had again in 2000 was much lighter than the one that we had in 2019. And the difference between the two is a $96.1 million that we show in that bar.
And if you would like to go into detail regarding that, I’m more than happy to answer questions during the Q&A, but I don’t want to take too much time at this point. But it is important to point that out because it almost represents 1/3 of the decrease in our gross profit.
The other 2 bars that I would like to point out, bar number 11, which have to do with the lower ore grades that we’ve seen at our — some of our mines, which represented a decrease of almost $81 million. This means that if we have maintained the same ore grade, we would have seen a positive effect of $80 million.
Also worthwhile pointing out is bar number 9, which has to do with the throughput. Remember, we had lower ore grade, but we also saw decreases in our throughput at our mines. And we estimate the impact of that at around $62 million. The other remaining gray bars there are basically related to costs, which I already explained a couple of slides ago. I would only now comment on the positive bars. Of course, we saw higher prices in the second half of the year in 2019. And thanks to that, we saw a benefit, which we estimate at around $128 million.
And as I said on bar number 3, we have these 2 new operations coming in line, the pyrites plant and the dynamic leaching plant. And we estimate those to have had an effect of around $18.5 million. So hopefully, this gives you a clear picture of the plus, the positives and the negatives, and why we saw this decrease in gross profit.
This next slide on Page 37, just shows a little bit more detail where we are allocating our exploration expenses. So as you can see here, the operating units represented more or less 47%, 48% of the total exploration expense and the remainder was allocated in projects or prospects. And just to remind you that the mining rights that we pay in order to maintain those concessions are also considered a part of the exploration expense, which are, in this case, it’s $20 million.
Cash flow. Again, as a consequence of what I explained in the prior slides, you can see that cash generated by operations decreased by 26%. Most important uses of our cash, where purchase of property, plant and equipment, $560 million; dividends paid, $142.2 million and, of course, income tax and profit sharing paid during the year. Remember that here, we’re talking about the taxes that are paid in advance during the year and then are settled in March of the following year.
Let’s see here. On Page 39, we show a little bit of detail in terms of [Technical Difficulty] so the $559 million, as you can see, Fresnillo $176 million, and et cetera.
Lastly, our balance sheet continues to be quite a strong balance sheet. Our cash balance did come down from $560 million to $336 million. We were net cash flow negative because of our investments in CapEx, basically. Hopefully, by year 2021, we might see — start to see net cash positive — a company with a net cash positive. And that’s it from me. Thank you.
Octavio Alvídrez
Thank you, Mario. A review on our chart about the incoming projects. The pyrites plant that we discussed, we’re going to have it fully ready at — in the second half of this year. With that, we will be able to process or reprocess the tailings from Fresnillo and continue processing the current tailings from Fresnillo and Saucito. The base metals increased capacity at Fresnillo plant, as we mentioned as well, second half of this year. That will give us the possibility to better cope with the higher contents of lead and zinc and increasing ore, having a better quality in our concentrates as well. We have more resins time for the process, the metallurgical process. Juanicipio, that we described and optimize new plant, I would say, higher CapEx. However, earlier revenues as well and taking advantage of the spare capacity and producing or processing the ore coming from the development of Juanicipio as well. Ciénega, we continue to explore in the Ciénega area. We do have good results in the Ciénega mine itself. We are about to finish, as André mentioned, the operation at San Julián, and that ore will be substituted by ores coming from Ciénega mine itself with closer infrastructure, which means lower cost as well. And then the Orisyvo project that we described already.
The expected attributable production profile for the next few years, as we mentioned, at the — in our Capital Markets Day, 2020, we are expecting very much in terms of gold and silver, a level production, increasing base metals, lead and zinc. However, this year, as I mentioned, is very important in terms of a transitional year, being able to stabilize our mines, have a good base for a more efficient production and a larger production in terms of silver in the coming years.
Here on the silver side. In 2021, you see 1 full year operation of the pyrites plant, that’s an increase. We are expecting better performance in terms of throughput and in terms of grade in Fresnillo as well, and also Juanicipio production is reflected in 2021. In 2022, increase production in Saucito and also continue operating in the pyrites plant, and also a full year production of Juanicipio.
On the gold side, in 2020, a bit less production expected, but then lower production in ’21 and ’22 as Noche Buena stayed south in the production and then higher base metals, which is adept Fresnillo and Saucito and also the contribution in ’22 of our Juanicipio base metal content as well.
In terms of CapEx, very similar to what we presented in our Capital Markets Day, a little less in terms of 2020 expected CapEx. You will see that the growth CapEx in ’20, which is mainly the share, the largest share of the Juanicipio, and a little bit the last stages of CapEx deployment for the pyrites plant and the base metal increased capacity at Fresnillo. And then in ’21, is all about Juanicipio mainly. Sustaining very much at the 400 million level, let’s recall that our operations veins systems require a lot of development. As we mentioned last time, we are doing 140 kilometers per year of development around our operations, and that would be increased with Juanicipio also.
And before we conclude, I just would like to wrap up some of the main messages today. Safety being our main focus, continue deploying the I Care, We Care program, the largest therefore across our company. Giving good results, better or trending down index — safety indexes as well.
In terms of operational evolution of our mines in these 11 years, of course, presented some challenges in most of our mines. However, we are studying in detail and have been able to define what the issues or the problems are. This year, we are stabilizing the mines, very much. We are expecting better throughput from Fresnillo, a little bit better grade, Saucito, very much leveled off; Ciénega continued performing well, Herradura, we also have a level production, less production coming from the pits, a little bit more coming from the dynamic leaching plant. In Noche Buena, we will enjoy this year a good grade in this 2020 before it is coming to a lower production in the following years. And then San Julián after being able to resolve the technical problems that we have, we are expecting better grade in the second half as well, continue developing the vein systems at San Julián. Also, I would like to mention the infrastructure investment in Fresnillo with the shaft thinking being concluded at the end of the year. That is a big milestone that will give us access and efficiently be able to get the ore with lower costs at Fresnillo. We have an area, we’re accessing that area in which we have 45%, 60% of ore resources there. So that is very important.
Also on the contractors, we were able to increase development rates from the previous years, reaching a little bit over 3,000 Fresnillo on average per month and as well as in Saucito. So the measures there have been able to give us a better results. We were able to confirm, importantly, the soundness of our geological model. And this is about extracting with better operational practices, the ore so that we achieve better grades closer to what our indication of the geological model is.
In terms of projects, I mentioned, very importantly Juanicipio with an optimized plan in place already. Exploration going well in different areas, David mentioned. However, this year is about focusing our efforts, exploring in those areas in which we have better chances to have a success around Fresnillo districts in which we have 5 to 6 different very interesting targets. In San Julián as well, which is very important to increase the resource and reserve base. And in terms of cost, as Mario mentioned, we are giving you a good sound guidance. So that in those, it’s important to say that in that guidance, we are not including some of the projects in terms of lowering cost and control that we are deploying across all of our operations.
And finally, in terms of ESG as well. Very important, all the activities that we do, especially in the context of a new administration in Mexico. But we have a good progress to be deployed there.
And with this, I will open up for questions.
Question-and-Answer Session
Q – Dan Major
Dan Major from UBS. A few questions. Firstly, on costs, very useful, you’re providing some explicit guidance. Can I ask, we have the Capital Markets Day in December, which, I guess, as a management of the business, you should have known broadly how the costs we’re tracking. At that point, I think you suggested the run rate of costs first half versus second half would be broadly similar, actually went up nearly 10%. Did you not know about that? Or what were the main drivers of those unexpected increases in costs? I guess, that’s the first part of the question.
The second part, when I look at the waterfall of what’s driven the increases in costs. It doesn’t feel that any of those are not structural. I mean from what we’ve seen, there’s been a dramatic increase in the cost base of the company over the last 2 years. The only thing that’s going to reduce that going forward is producing slightly higher wins. Are we correct in that in terms of the dollar million cost base should remain flat or actually grow as when the CPA comes through? Is that the right assumption? Those are the questions around that?
Mario Arreguín
Yes, of course. One of the things that — answering your first question. One of the things that we consider for the second half was that we could perhaps see a devaluation of the Mexican peso, which didn’t happen, quite the opposite. It strengthened. So that obviously had an impact on our production costs. And as you know, between 30% to 40% of the total production cost is peso-denominated. And also, we did more development than what we had planned, which is good because, again, this is something that is critical in order to have the flexibility, to have the number of stopes to operate those mines efficiently. So I would say those were the 2 main factors why we were a bit above the first half, comparing the second half with the first half of 2019.
In terms of your second question, you’re right. Most of those increases, if not all, are structural, there to stay, unless we are able to implement more efficiencies and we can apply maintenance more efficiently. But we will continue to develop. I think we’ve gotten — we still think we can develop a little bit more. So the more we develop, you might see a bit more higher production costs.
But largely, I think we’re there. We’re not expecting important increases for next year, as you saw. And the most important reason for the increase that we expect for next year is related to cost inflation, basically, with the price of our intakes.
Dan Major
One quick follow-up on CapEx. So you said there were some higher development costs at Juanicipio. Firstly, can you give us any update on the life of mine sustaining CapEx at Juanicipio? And secondly, as a group, you’ve indicated sustaining CapEx gets about $400 million by 2022, what is the long run number there? You previously indicated somewhere between $400 million and $450 million. Is that still the right sort of number one Juanicipio fully ramps up as long run sustaining CapEx for the group?
Octavio Alvídrez
I think we have a good proxy to Juanicipio with Saucito, but let’s recall that Saucito is a 8,000 tonnes per day. Initial CapEx, sustaining CapEx is lower, as you know, I mean, that’s always the case. But I think what we have at Saucito, being at 8,000 compared to Fresnillo is a good comparison — to Fresnillo is a good comparison. So Orisyvo is probably in between 40 or something around that number.
Dan Major
And the group level is at $450 million is the right sort of number longer term, sustaining CapEx for the whole of the business?
Octavio Alvídrez
For the mix of operations we have, it is the best number around that.
James Bell
It’s James Bell at RBC Capital Markets. Just firstly on dilution. I just wondered if you’ve done any benchmarking versus your international peers in terms of your dilution rates in mining? And is there any — anything you can learn from your peers in terms of technology or things which are being done there to improve dilution? And sort of as an extension to that, should we expect the dilution controls we’re putting in place to bring benefits in 2020? So would we expect to see a great improvement in the second half of this year? Or is there something which is only really going to have a benefit from ’21 going forward?
André Sougarret
So you’re asking if we have done, if we have carried out market studies in dilution control? Yes, we have checked what the practices are in the industry. [Technical Difficulty] in order to measure objectively, the last thing in order to better design the shape of the veins. We are slowly implementing better controls. We’ve done 50% in Fresnillo and Saucito of all the reductions of the production. We hope to do it on this first semester in order to adjust it to our blasting designs. And we hope to go progressively in order to improve the reduction of dilution from the end of this year and into the next few years. So we have to change our practices in our operations in order to do that. We need to train our operators and our supervisors in order to carry out very stringent controls on the blasting.
Mario Arreguín
In addition to that, I mean, there are some quicker measures that we’ve taken already. I mean, like decreasing the size of the hole from 4.5% to 3.5%. So smaller size equipment that is coming already so that we do not have to open a large hole in the mining work, as before. We have a good proxy also in Ciénega with a more specialized narrow vein mining as well. We are bringing some of the operators there to Fresnillo and Saucito to share some practices. However, there are specific conditions to Fresnillo and Saucito. We’re also starting the possibility of a different mining methods as well. So yes, we are going into that [indiscernible].
James Bell
So just in terms of grade, should we think about the second half being better than the first half in terms of operationally this year as a guide. Is that fair? Or…
André Sougarret
Absolutely, absolutely, yes.
James Bell
Okay. And second question is just on Juanicipio. Can you disclose how the tolling agreement or what’s happening in terms of treating or from Juanicipio? Firstly, are you receiving a fee for that? In terms of — or is there some structural payment in terms of obviously, MAG is your JV partner and you’re treating it at your plant? Or is it — are you treating it for free effectively?
Octavio Alvídrez
Cost plus basically, yes to whatever called, we have a flotation plant in Fresnillo and then adding some small fee, yes, which have to be within the, [indiscernible] yes, and the company, company transporting pricing as well. Yes.
James Bell
Okay. Do you believe, will MAG Silver be releasing the terms of that? Or will you guys be releasing specific terms? Or should we just think of it… [indiscernible]?
Octavio Alvídrez
No, no, really. I mean, it’s just I guess, in that.
James Bell
And just one more, if I may. It’s been very quiet on the political front in Mexico. We haven’t seen too many headlines around mining. You obviously had some delays in 2019 on permitting at Herradura. I just wondered if there’s any areas of your operations over the next 12 to 18 months that require permits that you think may be delayed or there could be risk around that? And any comments you have more generally on the environment for mining, particularly would be useful as well?
Octavio Alvídrez
Sure. With the new administration I think we are more — every time we are more and more aligned in terms of the need for the country to grow. And then in mining and specifically in our company having those sort of projects that can support growth in certain areas. There’s been efforts up to now, not very successful from, I mean, the current administration to support growth and more economic growth in Mexico. But I think now more and more, they understand in the case of mining, what we can bring to that aspect. We have a good support in our — on the Secretary of Mines. He understands very well the industry and he supports with initiatives what we can do. Just recently, we went through a list of all the permits in terms of mining industries that are still pending. And there’s been a good effort in order to review those and still add that process as well.
For Juanicipio, I mean, we have had a good response there. The tailings storage facility the initial — the original design that we have is fully permitted already. However, we are building larger capacity there, as I mentioned, we don’t see any problem there. The problems of the issue we have at Herradura, were more with the — that of a specific region and the local administration in general. So I think we have a good alignment between the mining industry, the growth you can bring and the needs of the new administration in that regard as well. And then your other question was, we have another one No.
Richard Hatch
Richard Hatch from Berenberg. And first question is just on production site . Am I right in saying that when you brought forward Juanicipio ounces, the group production for 2020 hasn’t changed. So in that case, are you just having a little bit more conservatism of Fresnillo mine and offsetting it from Juanicipio? Or am I wrong in reading it like that?
Octavio Alvídrez
No. I mean, we haven’t — we didn’t change the guidance. And by the way, I mean, the guidance, I was going to make a comment on that. We haven’t changed because we are confident what we can deliver this year. In terms of gold 815 to 900, wider range than usual. Yes. I mean, we needed to have some — that comfort there. And in terms of silver 51 to 56. As you can see from the graphs, we are expecting level production this year. So this year, what we can achieve coming from — or from development of Juanicipio is this not a large production. So we’ll be within that range.
Richard Hatch
And the second one is just on the reserves and resources. So with the adjustment to May. Should we expect a reserve and resource update in the first half of this year for May 2020? Or will it come into 2020 results? And how comfortable are you — and so you’re working with the geological model at the moment, certainly sounds, but are you comfortable that you won’t have a meaningful reserve or resource downgrade when that does come out?
David Giles
Our next resource calculation will come out at the end of the year, it will be a full 12 months this year. That’s the way we’ll handle that. And yes, we are very confident in our reserves and resources with all the work that we have been doing over the past 2, 3 years.
Richard Hatch
So we next hear resource update at this time next year?
David Giles
Yes. That’s right. For the full 12 months.
Mario Arreguín
Yes. The problem was the first year. This last calculation, this last statement in which we decreased by 4 months where we could reflect in terms of exploration in those — in that process. This new statement that we will release in a year’s time, we will consider 1 full year of exploration compared to 8 months that we needed to do.
Alan Spence
Alan Spence from Jefferies. I got a few. The first one, we’re 2 months through, can you give us a bit of a steer on how you’re seeing the first quarter shape up to help us kind of think about the trajectory or how we should be thinking about production through the year, both silver and gold would be helpful?
André Sougarret
For the first quarter, for San Julián, it would be a bit lower because of the grades. And then from the second quarter, we will see an increase. And Fresnillo, we will also incorporate the Pyrites Plant in the last quarter, we will see at the very end of the year, this implementation, together with an increasing grades. Saucito should also go in the same direction. And with regards to gold, first quarter had a little bit lower and progressively, we will notice an increase towards the end of the year.
Alan Spence
Just clarify, if those lower amounts for quarter-on-quarter or year-on-year? Just [indiscernible]
Octavio Alvídrez
It’s difficult quarter-on-quarter. I mean, what we can tell you right now is that first half, we expect it to be softer compared to the second half. And that’s because, and San Julián, mainly, we are going back to the mine sequencing that we have before technical problems, we will be able to have or access better grades.
In terms of Fresnillo, for example, we will be ramping up a little bit on our throughput and also expect better grades, as André mentioned, that we are controlling or expect to control dilution more and more. So that’s very much. I’ll see those by level. So those will be the 2 factors in terms of silver. And for gold, we do have the new pad a certain leaching pad already in place in Herradura and although we expect less proportion coming from the heap leach and more production coming from the dynamic leaching plant. I think will be quite level somehow.
Alan Spence
Okay. So those are relative weightings within 2020 is how you’re talking about them?
Octavio Alvídrez
Relatively?
Alan Spence
Relative weightings within 2020, you’re speaking kind of first half or second half?
Octavio Alvídrez
Yes.
Alan Spence
And on working capital, nearly $200 million invested in the last 2 years. Is there opportunity to begin — or sorry, nearly $10 million invested. Is there a beginning, an opportunity to release some of that in the coming — whether 2020 or 2021?
Octavio Alvídrez
Yes. I believe there is a good possibility of achieving that. As you know, part of that has to do with the value-added tax that we have pending to recuperate back from the government that has increased in the past 2 years. So hopefully, we will be able to recuperate that during this year and next year. But that has to do with an important part of that working capital increase.
Alan Spence
What is the total balance right now from that?
Octavio Alvídrez
Of the VAT?
Alan Spence
Yes.
Octavio Alvídrez
Almost $200 million.
Alan Spence
Okay. And just a quick clarification, on the cost guidance you gave, what was the Mexican peso FX rate, you assume in that?
Octavio Alvídrez
19%. And right now, bit above, so that if it remains close to 20%, then that will be a better positive effect. But 19 is the one that we assumed.
Operator
[Operator Instructions] We have a question coming through from the line of Amos Fletcher from Barclays.
Amos Fletcher
A couple of questions. Firstly, on CapEx. You reduced the guidance for 2020 despite a CapEx overrun at Juanicipio obviously, you’re under short the guidance for 2019. So my question is what have you cut from your capital budgets?
Mario Arreguín
Compared to what we released in the Capital Markets Day, I believe it was $10 million, $15 million or so? Yes. Right a small cut. We went and review from when we did our budget to be presented in October to what we are doing right now to review some of the equipment that we were trying to bring into our operations, some of the projects and it was a series of a small equipment that we — not why we decreased the CapEx, but nothing major. I mean, it’s a serious of different equipment across our mines. That as to the second review didn’t pass the bar.
Amos Fletcher
Okay. And then, go ahead.
André Sougarret
Just to add something, we also improved the grades of utilization of our equipment so that we could reduce the equipment replacement and also try to improve maintenance. And we have been investing in maintenance as well. These are the 2 elements that will allow us to have this reduction in CapEx.
Octavio Alvídrez
And the growth CapEx in — I mean, it did not change much because at the time of the Capital Markets Day, we have a very good idea what could be the CapEx for Juanicipio. We were putting in place all the different measures in terms of what we could produce in terms of development or and if we were going to have a possibility of processing that ore in Fresnillo and also finalizing the construction program and give a more system data of where we are going to finish the construction for Fresnillo.
Amos Fletcher
Okay. And I just wanted to ask about the reserves and this sort of order, sort of interim order that you produce. I was just sort of referring to the slides in the Capital Markets Day. And if you look at the medium-term reserve grade guidance at all of the mines in terms of head grades, it’s quite materially below the stated reserve grades, at least for the last year’s order. So I just — so a question for David Giles. How confident are you that the new reserve grades are not going to decline, as you mentioned?
David Giles
Our reserve grades, the silver mines over the last years, last 3 years haven’t really changed very much, both at Saucito and Fresnillo just a few grounds maybe at 4 or 5 grounds each year, and some with the cutoff grade. The cutoff grade has gone up, the grade of the reserves that these mines have come up slightly and the reversal of the cost cut-off grade has come down. So really, I would say, our grades have been stable in mines, single grade.
Mario Arreguín
Now the gap, and this is a dynamic process. We are deploying some initiatives in order to control and decrease the dilution. As André mentioned, that it was very good and accurate measure and then putting in place the measures. We believe we can decrease that. But in the end, if we don’t do that after probably 1.5 years or so, André mentioned 18 months last time, we would need to increase the dilution, which is a variable in the calculation of the reserves and resources in our statements. But for the time being, I mean, we’ve studied in detailed that. The geological model is sound, and it’s about decreasing the dilution in order to achieve the grades that we have in the statement.
Amos Fletcher
Okay. And then just last one on the dividend. I was just going to ask sort of philosophically more than anything else. You think it’s sensible to base your dividend on an earnings based payout ratio when you have positive tax P&L accrual. So for quite a while now, we’ve been paying out dividends out of debt despite the business generating negative free cash flow. And is there — did the Board concern at a certain point, that might be a recipe for problems down the line?
Mario Arreguín
Yes. We’ve been applying our dividend policy consistently for the past 11 years since we did the IPO, where we simply follow our principle of balancing growth with returns to our shareholders. And based on that principle, we are paying consistently 50% of net earnings. And I think that’s something that can be maintained. We continue to have a very solid financial position. Our net debt-to-EBITDA ratio, we believe, is quite healthy. So as long as we are able to maintain that situation, I think we will continue to implement our dividend policy.
Amos Fletcher
Okay. So you paid dividends out of debt until such a point as net debt-to-EBITDA goes above a certain level? Is there sort of ratio you’re targeting?
Mario Arreguín
I wouldn’t say we paid dividends out of debt. We incurred debt, we haven’t incurred any new debt, you can allocate cash. We can argue that we are allocating operating cash flow and not debt. So that we issued 5 or 6 years ago. So I’m not sure, I understand what you mean by allocating debt. We haven’t specifically gone out to issue debt to pay out dividends. Is that what you mean?
Amos Fletcher
Yes. No. I guess what I mean is that the business is free cash flow negative. And so the dividends are being paid by draining the liquid resources of the business?
Mario Arreguín
No. I understand what you’re saying now. So again, as long as we continue to maintain a sound financial position. We will maintain our — or we will propose our Board to maintain the dividend policy.
Amos Fletcher
Okay. So — and then a sound financial position, that’s defined by a ratio of net debt-to-EBITDA, you’d say? And what is that ratio?
Mario Arreguín
It’s one of the criterial, of course, currently, it’s around 0.7%. So we consider below 1% to be a healthy situation, and we’re quite below that. Among other things.
Operator
We have no further questions in the queue. [Operator Instructions] There are no further questions. So I will hand you back to your host, Octavio Alvídrez, to conclude today’s conference.
Octavio Alvídrez
Well, we have a couple of questions here. Some more. Thank you.
Unidentified Analyst
Two follow-ups. Following the changes to the reserves and the resources. Can you remind us of the — your modeled mine life at Herradura?
David Giles
It’s a long way to go [indiscernible]
Mario Arreguín
15 to 17. I’ll have to check on this one lately, but it was around 15 to 17.
Unidentified Analyst
Okay. So despite the fact that you reduced the reserves on top of the more than depletion this year. So the mine, the reserve life has reduced somewhat there because I mean, the resource, the reserves went down, but still around 15, 17.
Octavio Alvídrez
Yes.
Unidentified Analyst
Okay. Very clear. And then second slight follow-up from Amos’ question on the tax. Can you give us any guidance on your expected effective tax rate for 2020, both through the P&L and any differential between the cash tax and the P&L tax?
Mario Arreguín
Yes. It’s difficult to try to predict that because this year for a time in, in 2019, if you look at our income statement, you will see that after — profit after tax are greater than before tax, which is quite unusual. And the reason for that is the way in which taxes are calculated. Remember that in Mexico, we maintain peso accounting in terms of calculating the base for tax payments. So whenever you have a revaluation or devaluation of the peso based on the exchange rate as of the end of the year, that will have a very important impact in terms of the effective tax rate. So if you ask me what do I expect in terms of the effective tax rate for 2020. Assuming there is no devaluation, and that the exchange rate on the 31st of December this year is exactly the same as the one we saw in the previous year, it should be close to 30. And remember, we had some incentives the epps on the diesel, which was credited back. That also helps to lower the effective tax rate, but that concluded because the government decided to take that away from us in 2019. So we won’t see that in the year 2020. And we also have a so-called border tax incentives, which stressed incentivize operations near the border and believe it or not, one of our mines falls within the broader line definition. So we’re being benefited at Penmont on that. So that helps lower the effective tax rate, and that will continue in 2020. So excluding the exchange rate factors, I would expect the effective tax rate to be a bit below, at 30%.
Unidentified Analyst
Okay. And then any reason to believe cash tax will be any different than P&L tax this year?
Mario Arreguín
Cash taxes, here I expect it to be, depending on the prices of the models, but I would expect it to be similar to what we saw last year.
Unidentified Analyst
Okay. So at $200 million?
Octavio Alvídrez
Yes. Remember that we pay provisional taxes during the year. And then we settled that in March of the following year, depending exactly on the tax base. So — and that’s based on revenue. So that’s why in terms of cash flow, in terms — we already know the factor that it will be applied. It’s going to be pretty much the same that we saw last year.
Unidentified Analyst
Last one just on, just [indiscernible] what’s the minimum [indiscernible] level of cash and you feel that you need to sustainably keep the business taking it on?
Octavio Alvídrez
I would say, at least, at the very least, 1 month of adjusted production cost, which is around $180 million.
Okay. With no further questions. And just to conclude, and before I probably as [indiscernible] mentioned it before. But on coronavirus, we do have programs in place already. We are letting a campaign across all of our operations, letting them know what the virus is about, what the preventive measures are and monitoring very closely what we have around in terms of infected person around the operation. So far, nothing, there are 5 cases in Mexico that we are really starting a campaign across all of our operations. So if we don’t say shake hands on a goodbye that because of growth measures as well. Now thank you all for attending prelims presentation. Thank you.
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