We’re more than three-quarters of the way through the Q1 Earnings Season for the Gold Miners Index (GDX), and one of the first companies to report its results was Eldorado Gold (NYSE:EGO). Unfortunately, it was a very rough quarter for the company, plagued by a government-mandated power outage, COVID-19-related absenteeism, and inclement weather. The good news is that some of these headwinds are in the rear-view mirror, and EGO is set up for a much stronger H2. With Eldorado Gold trading at a deep discount to net asset value, the stock is now approaching a low-risk buy zone.
Just over five weeks ago, I wrote on Eldorado Gold, noting that I didn’t see any reason to be chasing the stock above US$12.25 into what would be a very weak Q1 report. Since then, the stock has plunged more than 30%, with this correction shaving more than $700 million off the stock’s market cap. While the stock did not belong at US$12.25, heading into a weak Q1 report with negative free cash flow and lower year-over-year sales, the sell-off is now looking overdone, with the stock trading near US$8.00 per share. Let’s take a closer look at the quarter below:
Production & Costs
As the chart below shows, Eldorado Gold (“Eldorado”) had a very soft Q1 performance, reporting gold production of ~93,200 ounces at all-in sustaining costs of $1,347/oz. The lower production to start the year was not a surprise relative to H1 2021. This is because gold production was guided to be back-end weighted in 2022 with processing tie-ins at Olympias, the ramp-up of the HPGR circuit at Kisladag, and lower grades at Kisladag. However, the company did not plan for COVID-19-related absenteeism across operations and more severe weather than expected in Turkey and Greece, exacerbating what was already going to be a soft quarter.
At Lamaque, this led to delayed development of high-grade stopes, impacting grades in the quarter at this key asset resulting in grades being roughly flat year-over-year (5.27 vs. 5.17 grams per tonne of gold). At Kisladag, fewer tonnes were placed on the leach pad in Q4 during the commissioning of the HPGR circuit, and tonnes placed were lower than planned in Q1 due to snowfall and freezing temperatures that impacted productivity. The good news is that despite the weather-related headwinds and the three-day government-mandated power outage, the HPR circuit is performing according to plan, with recovery rates in line with expectations.
The good news is that even though Eldorado is tracking at ~19.6% of its FY2022 guidance mid-point, it has reiterated its production guidance, in line with the expectation that production will improve considerably in H2. Unfortunately, given the much lower sales in Q1 (~94,500 ounces), all-in sustaining costs spiked to $1,347/oz, a 36% increase from the year-ago period. This more than offset the higher gold price in Q1 ($1,889/oz vs. $1,732/oz), translating to a sharp decline in AISC margins ($542/oz vs. $737/oz).
The sharp rise in operating costs was partially related to inflationary pressures, impacting labor, reagents, electricity, and fuel. Fortunately, Eldorado’s mines are less sensitive to increases in diesel prices, given that 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 were offset by the devaluation of the Turkish Lira. Meanwhile, though costs were up at Lamaque and labor could be pressured due to labor tightness in the Abitibi region, the growing production profile should help to claw back some of this increase in unit costs.
While the sharp increase in costs might appear alarming, it’s important to note that this was partially related to higher sustaining capital in 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 on a full-year basis even if costs come in above the high end of guidance ($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 come in at $1,180/oz in FY2022.
Moving to Eldorado’s financial results, the company saw a sharp decline in revenue year-over-year, which was of little surprise due to the double-digit decline in gold sales. This combination of lower revenue and higher costs and capital expenditures translated to an adjusted loss in the period and negative free cash flow of $26.8 million vs. (+) $33.4 million in Q1 2021. While disappointing, we should see a significant improvement in free cash flow and revenue in H2 2022 as production increases above the 125,000-ounce mark on a quarterly basis.
Unfortunately, while I was previously expecting a meaningful improvement in revenue due to the stronger start to Q2 for the gold price, this no longer looks to be the case. This is because the gold price’s quarter-to-date average has swung from $1,950/oz to $1,910/oz following the recent weakness, and the average gold price looks like it will come in closer to $1,895/oz for Q2. Assuming this is the case, this would not represent much of an improvement from Eldorado’s average realized gold price of $1,889/oz in Q1 2022. Hence, while the financial results should improve sequentially, I wouldn’t expect a drastic improvement.
So, why even bother with a mid-tier producer with average costs operating in Turkey, Greece, and Canada?
While Eldorado’s current production profile may not be all that exciting with ~475,000 ounces of production at $1,150/oz plus costs, it’s the future production profile that is highly desirable. As it stands, Eldorado hopes to increase production to ~525,000 ounces in FY2026, representing 10% growth from the FY2022 guidance mid-point. While this doesn’t move the needle significantly, the company’s partially constructed Skouries Project in Greece could see construction restarted in H2 of this year, subject to Board approval and financing.
For those unfamiliar, Skouries would be a game-changer for any company, but especially for a company of Eldorado’s size. This is because the project is capable of producing ~312,000 gold-equivalent ounces [GEOs] per annum at negative all-in sustaining costs. Given the inflationary pressures we’ve seen and the fact that production will not begin until at least H2 2025, I think it’s safer to assume all-in sustaining costs of $150/oz. Still, even at these figures, Skouries would be one of the lowest-cost mines globally.
As production ramps up towards full capacity, Eldorado would transform into a ~750,000-ounce producer in FY2026 with costs below $950/oz. Once the mine reaches full capacity, Eldorado’s production profile could improve to 800,000+ ounces at all-in sustaining costs below $870/oz. This would make Eldorado one of the sector’s lowest-cost gold producers. In my view, this could help Eldorado to justify a P/NAV multiple closer to 0.90x vs. the depressed multiples it currently trades at relative to peers, translating to a fair value north of US$13.50 per share.
In addition to the significant upside from a valuation standpoint (assuming Skouries is green-lighted), the recent pullback has improved the technical picture for Eldorado. This is because the stock’s reward/risk ratio has improved to 9 to 1, with projected support at $7.85 and no strong resistance until $10.85. If we compare this to a current share price of $8.15, this translates to $0.30 in potential downside to support and $2.70 in potential upside to resistance. Given the stock’s undervaluation and attractive technical setup, this looks to be a low-risk buy point.
Eldorado may have had a rough start to the year, but after a nearly 35% correction, the stock trades at a massive discount to fair value at less than 0.65x P/NAV. Hence, for investors anxious to start a position in the stock, I see this pullback below US$8.15 as a low-risk buying opportunity. Given that 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 may look to start a position in the stock from a swing-trading standpoint.