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Share price drop post guidance cut overdone; Maintain OW

Downward revision of 2018 guidance weighed heavily on share price. On 25 May 2018, management revised 2018 production guidance downwards by 11-13% to 505-515k ounces, and cash cost and AISC guidance upwards by 14-16% to USD625-640/oz and USD875-890/oz, respectively. This comes on persisting low grades from the transitional zone in the open pit, combined with a lower underground development grade. Accordingly, we cut our TP by c18%, but maintain our Overweight call (based on a gold price assumption of USD1,315/oz in 2018), given Centamin’s share price dropped by c21% since the announcement. Consequently, the stock trades on a 2018e and 2019e P/E of 20.3x and 17.2x, respectively, c21% below global gold miners and our 20-year life of mine DCF-valuation. It also yields 6% in 2018 vs. average global gold miners’ 1.1%, with prospects for improving dividends beyond 2019e, on improving operations and FCFF generation.

Sentiment to improve towards end-2018. The current share price implies that Centamin’s low-ore mined grade is sustainable, and we accordingly expect negative sentiment to be short-lived, reversing by year-end, should the market see evidence of future grade and production target upgrades. The company should also issue its updated reserve and resource statement around mid-2019, which can further catalyse the stock if there is additional evidence of improved grade. Management’s new guidance forecasts a strong production profile in 3Q18 and 4Q18, which we also see as a sign of improving operations beyond 2018.

Medium to long-term outlook: Open pit mined grade to improve, but underground grade concern lingers. The revised guidance implies an average open pit grade mined of c0.5g/t, c46% below the average open pit reserve grade. We believe this is mainly due to transitioning from one zone to another, indicating unsustainability. On our figures, this should increase to an average reserve grade of c0.9g/t over 2019-20, driving growth (we look for 2018-20e gold production and EPS CAGR of 7.2% and 17.2%, respectively). However, we are concerned that the current underground grade mined is c57% above the average underground reserve grade, which could prove a long-term overhang, absent of additional high-grade ore discoveries.

Valuation sensitivities. We assume a gold price of USD1,315/oz in 2018, rising at 2% p.a., starting 2020. Alone, every 5% higher/lower-than-anticipated gold price p.a. adds/knocks c10% to/off our TP. Additionally, every 5% higher/lower-than-anticipated grade at the open pit and the underground would raise/reduce our TP by 5.1% and 3.3% respectively, all else constant. We value Centamin’s West Africa assets at 1.0x book to represent only 6.0% of our TP.