As the Gold Miners Index (GDX) buzzed to start 2022, the wheels came off the proverbial wagon, and the sector has been tumbling ever since. Evidenced by the 37% decline of the sector in a period barely 50 trading days or an annualized decline rate of more than 85%. El Dorado Gold (NYSE: EGO) was not spared from the sector-wide selling pressure, down 55% over the same period. Although it was a painful decision for long-term investors, it left Eldorado at 0.35x P/NAV, making it one of the most undervalued producers in the industry.

Just over six weeks ago I was writing about Eldorado Gold, noting that the stock’s pullback below US$8.00 appeared to offer a buying opportunity. While the stock made a slight rebound, it slipped below key support in mid-June and saw a drop of more than 30%. This turned out to be a terrible call from my previous article, with the stock down more than 25%, worsening my brutally early call on Kinross (KGC). However, mistimed calls aside, this cascading decline for EGO appears to have created one of the best buying opportunities for the stock since March 2020 from a valuation perspective. Let’s take a closer look at his recent results below:

Second quarter production results

Eldorado Gold released its second quarter production results this week, reporting quarterly production of approximately 113,500 ounces, down 2% from the prior year period. Although the overall figure did not look great, this was largely due to the slow start to 2022 for Kisladag, where fewer tonnes were placed on the leach pad in the first quarter. Fortunately, Kisladag is expected to rebound in the second half with a strong increase in tonnes stacked at higher grades in the second quarter, which will help bring quarterly production back above the 30,000 ounce mark. Meanwhile, Lamaque helped fill the void in the second quarter, producing around 46,900 ounces, its second-best quarter since Eldorado acquired the asset from Integra in 2017.

Digging a little deeper into Lamaque’s results, we can see that quarterly production was up 32% year-over-year and 42% from pre-COVID-19 levels. The strong performance was driven by higher throughput and grades and exceeded plans, pushing year-to-date production to around 80,300 ounces. This put the mine on track to hit the 170,000 ounce midterm targets, with Lamaque generally having a stronger second half. Importantly, while production continues to increase, this asset is far from its full potential, which could be a production profile of more than 200,000 ounces, with a mine life that could extend into the 2030s with Ormaque.

While the quarter was positive overall, the long-awaited news of a financial package for Skouries has not yet been announced, which the market seems to be waiting for to solidify Eldorado’s medium-term growth plan. Indeed, this Greek asset has the potential to add 140,000 ounces of gold production per year at costs below $100/oz, helping to drive Eldorado’s costs below $900/oz on a consolidated basis. However, until we see if any stream is sold or Eldorado partners on the project, it’s hard to know the exact economics or how much of that growth will be attributed to Eldorado. This could explain why the market has been slow to give Eldorado much credit for Skouries, with no confirmation yet of its funding plans.

Eldorado noted that financing options include project and debt financing through European and Greek lenders, and the European Union’s Recovery and Resilience Fund. In these cases, we will see no change in the economics of the project, whereas a stream would lead to a deterioration of the after-tax NPV (5%), and a partnership would reduce Eldorado’s exposure to the project, resulting in less margin expansion than if he owned 100% of the project.

Gold price and margin impact

Unfortunately, although Eldorado had a much better second quarter and expects a strong second half, the price of gold reversed its considerable outperformance in the first quarter, affected by the strength of the US dollar (UUP) . In fact, the metal slid towards its Q3 2021 trading range, giving up all of its year-to-date gains. After the strength of the first quarter, it looked like the price of gold would average at least $1,875/oz in 2022, but a more cautious outlook could be a gold price of $1,810/oz. , given the recent weakness and trend change.

This gold price correction is a negative development and will impact Eldorado’s margins this year. Assuming Eldorado is just above its median target ($1,135/oz) and the price of gold averages $1,810/oz this year, its overall sustaining cost [AISC] margins will drop to $675/oz. If we compare that to fiscal 2021, all-in sustaining cost margins will decline more than 4% year-over-year from the $706/oz reported in 2021. That said, that doesn’t is not company-specific, and if Skouries is given the go-ahead, Eldorado has a clear path to expanding margins, setting it apart from many of its peers. So while the near-term margin pressure isn’t ideal and has weighed on the stock, I’d be careful not to miss the forest for the trees.

Evaluation

Based on ~184 million shares and a stock price of $5.70, Eldorado trades at a market cap of only ~$1.05 billion, which is below NPV (5%) of its two main combined assets (Kisladag, Lamaque). This gives Eldorado a very cheap valuation, with investors getting its smaller Efemcukuru, Olympias and Skouries mine for free. Even after subtracting about $320 million in corporate G&A and using a conservative P/NAV multiple of 0.80, I see fair value closer to $13.00 per share. Therefore, following this recent correction, I see over 100% upside in fair value for Eldorado Gold, making it one of the most undervalued names in the industry today.

So what’s holding the stock back?

Apart from the recent weakness in the price of gold, which has hit the industry hard, Eldorado Gold has yet to announce its financing plans at Skouries or give the green light to the robust (and partially constructed) project. During the third quarter 2021 conference call, Eldorado indicated that it was aggressively targeting a solution in the first quarter. Now it looks like it could slide towards the end of the third or fourth quarter. With Skouries being one of the most profitable projects in the world and capable of significantly improving Eldorado’s production profile, this is a key catalyst for a reassessment that has yet to come to fruition.

While I expect to see the project finally approved, Eldorado Gold does not stand out from its peers without Skouries and is more or less an average intermediate producer. Indeed, gold production is expected to remain below 2020 levels (~528,000 ounces) even in 2026 without Skouries. Therefore, while I see a fair value well above current levels, it is dependent on board approval and successful financing of Skouries, which would provide a more precise date when we can expect to see this margin expansion. So while I think Eldorado has a huge fair value advantage, I’ve stayed away, favoring producers with more modest growth plans from a capital expenditure perspective.

Technical picture

Moving on to the technical picture, we can see that EGO has broken below the critical support at $7.95, and support levels, once broken, often turn into new resistance. Indeed, some investors who bought at the previous support and held their positions might become eager to exit once they return to equilibrium after suffering a sharp decline. Meanwhile, the next support for the stock only comes in at $4.80, 16% below current levels. Based on a current stock price of $5.70, EGO’s reward/risk ratio is 2.5 to 1.0, below my preferred reward/risk ratio of 6.0 to 1.0 to enter new positions.

So, while EGO is very cheap from a valuation standpoint, the stock is in a tricky position from a technical standpoint, suggesting that even if it is from a decent entry, a pullback closer to $5.00 would be a much more attractive setup. That doesn’t mean the stock has to fall that far, but that’s where the stock would become more attractive, testing a multi-year downtrend line from its previous bear market. To sum up, while I’m bullish from a valuation perspective, I’m currently favoring other names here.

Summary

Eldorado Gold has put together a strong report for Q2, and if we can see Skouries give the green light before the end of the year, the stock should be able to rebound towards broken support near $8.00 (40% upside compared to current levels). That said, in a cyclical bear market for the S&P 500 (SPY), which can translate to above-average downside volatility, I prefer to focus only on the best companies. Eldorado Gold is not on my list of top 10 precious metal names, and it has yet to hit support; and I want to be as rigid as possible with entries if I add exposure in a bear market. This could lead to a missed opportunity, but from an investment perspective, I think there are several better bets elsewhere in the industry.