Eldorado Gold Stock: Much Better H2 Ahead (NYSE:EGO)
We are more than three quarters into the first quarter earnings season for the Gold Miners Index (GDX), and one of the first companies to report results was Eldorado Gold (NYSE: EGO). Unfortunately it was very difficult quarter for the company, plagued by a government-mandated power outage, absenteeism related to COVID-19 and inclement weather. The good news is that some of those headwinds are in the rearview mirror and EGO is set up for a much more powerful H2. With Eldorado Gold trading at a steep discount to NAV, the stock is now approaching a low-risk buy zone.
Just over five weeks ago I wrote about Eldorado Gold, noting that I saw no reason to chase the stock above US$12.25 in what would be a very weak first quarter report. Since then, the stock has plunged more than 30%, with the correction slashing the stock’s market capitalization by more than $700 million. While the stock didn’t belong at US$12.25, heading into a weak Q1 report with negative free cash flow and declining year-over-year sales, the sell-off now looks exaggerated, with the stock trading near US$8.00 per share. Let’s take a closer look at the quarter below:
As shown in the chart below, Eldorado Gold (“Eldorado”) had a very weak performance in the first quarter, reporting gold production of approximately 93,200 ounces at all-in sustaining costs of $1,347/ oz. The fall in production at the start of the year was not a surprise compared to the first half of 2021. Indeed, gold production was guided to be weighted forward in 2022 with processing links at Olympias , the rise of the HPGR circuit in Kisladag, and the lower grades in Kisladag. However, the company did not forecast any COVID-19-related absenteeism in its operations and worse than expected weather conditions in Turkey and Greece, worsening what was already going to be a soft quarter.
At Lamaque, this delayed the development of high-grade stopes, which impacted grades during the quarter at this key asset, resulting in roughly flat grades year-over-year (5.27 against 5.17 grams per ton of gold). At Kisladag, fewer tonnes were placed on the leach pad in the fourth quarter when the HPGR circuit was commissioned, and tonnes placed were lower than expected in the first quarter due to snowfall and freezing temperatures which had an impact on productivity. The good news is that despite weather-related headwinds and the government-mandated three-day power outage, the HPR circuit is operating as expected, with recovery rates in line with expectations.
The good news is that even though Eldorado is around 19.6% off its median target for fiscal 2022, it has reiterated its production guidance, in line with the expectation of a significant improvement in production in the second half. . Unfortunately, given much lower Q1 sales (~94,500 ounces), all-in sustaining costs climbed to $1,347/oz, a 36% increase over the prior year period. . This more than offset the higher gold price in the first quarter ($1,889/oz vs $1,732/oz), which translated into a sharp decline in AISC margins ($542/oz vs $737 $/oz).
The sharp rise in operating costs was partly related to inflationary pressures, affecting labor, reagents, electricity and fuel. Fortunately, Eldorado’s mines are less sensitive to increases in diesel prices, as three of its operations are relatively high-grade underground mines. Meanwhile, although Kisladag is a high-volume, low-grade operation, some of the cost increases have been offset by the devaluation of the Turkish lira. Meanwhile, although costs have increased in Lamaque and labor may be under pressure due to labor shortages in Abitibi, the growing production profile should help recover some of this increase in unit costs.
While the steep increase in costs may seem alarming, it is important to note that this was partly related to higher holding capital over the period and looked much worse due to the lower denominator (fewer ounces sold) . However, Eldorado expects to see all-in sustaining costs below $1,180/oz over a full year, even if costs exceed the forecast cap ($1,075/oz – $1,175/oz). Even at the $1,180/oz figure, these costs would be in line with my estimates for the industry average, with the average AISC for gold producers likely to reach $1,180/oz over the course of the year. financial year 2022.
Turning to Eldorado’s financial results, the company saw a sharp drop in revenue year over year, which is unsurprising given the double-digit drop in gold sales. This combination of lower revenues and higher costs and capital expenditures resulted in an adjusted loss during the period and negative free cash flow of $26.8 million versus (+)33.4 million dollars in Q1 2021. While disappointing, we should see significant improvement in free cash flow and revenue in H2 2022 as production tops the 125,000 ounce mark on a quarterly basis.
Unfortunately, while I previously expected a significant improvement in earnings due to the strong start to the second quarter for the price of gold, that no longer appears to be the case. Indeed, the quarterly gold price average has moved from $1,950/oz to $1,910/oz following the recent weakness, and the average gold price seems to be approaching $1,895/oz for the second trimester. Assuming this is the case, this would not represent a large improvement over Eldorado’s average realized gold price of $1,889 per ounce in Q1 2022. improve sequentially, I wouldn’t expect a drastic improvement.
So why even bother with a medium-sized producer with average costs operating in Turkey, Greece and Canada?
While Eldorado’s current production profile may not be so exciting with approximately 475,000 ounces of production at $1,150/oz plus costs, it is the future production profile that is highly desirable. As it stands, Eldorado expects to increase production to ~525,000 ounces in fiscal year 2026, representing 10% growth from the midpoint of guidance for fiscal year 2022. that does not move the needle significantly, the partially built Skouries project in Greece could see construction restart in the second half of this year, subject to Council approval and funding.
For those unfamiliar, Skouries would be a game changer for any company, but especially one the size of Eldorado. Indeed, the project is capable of producing ~312,000 ounces of gold equivalent [GEOs] per year, or 140,000 ounces of gold. Given the inflationary pressures we’ve seen and the fact that production won’t start until at least the second half of 2025, I think it’s safest to assume all-in sustaining costs of $150/oz. Yet even at these figures, Skouries would be one of the cheapest mines in the world.
With input from Skouries, assuming 100% ownership is maintained (no partnership to fund the project), Eldorado would transition to a 650,000+ ounce producer in FY2026 with costs below 975 $/oz. This would make Eldorado one of the cheapest gold producers in the industry. In my view, this could help Eldorado justify a P/NAV multiple closer to 0.90x compared to the depressed multiples it is currently trading against its peers, translating to a fair value north of $13.50 US per share.
In addition to the significant upside from a valuation perspective (assuming Skouries gets the green light), the recent pullback has improved Eldorado’s technical situation. Indeed, the stock’s reward/risk ratio has improved to 9 to 1, with projected support at $7.85 and no strong resistance up to $10.85. If we compare this to a current stock price of $8.15, this translates to a potential decline of $0.30 for support and a potential rise of $2.70 for resistance. Given the stock’s undervaluation and attractive technical setup, this seems like a low-risk buy point.
Eldorado may have had a rough start to the year, but after a nearly 35% correction, the stock is trading at a massive discount to its fair value at less than 0.65x P/NAV. Therefore, for investors looking to start a position in the stock, I view this pullback below US$8.15 as a low-risk buying opportunity. Since I see other very attractive bets elsewhere in the sector, I remain on the sidelines for now. However, if we were to see a pullback below US$7.85, I might consider starting a position in the stock from a swing trading perspective.