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Morningstar | Slightly Increasing Agnico-Eagle’s Fair Value as Near-Term Outlook Improved; Shares Undervalued

Third quarter production of 421,718 ounces at all-in sustaining costs (AISC) of $848 per ounce brought Agnico-Eagle’s performance back on track after an underwhelming second quarter. After a solid third quarter and a more promising outlook at the Nunavut development projects, the company slightly raised 2018 production guidance to 1.6 million ounces and expects to hit the lower half of its previous AISC guidance of $890 to $940 per ounce. Based on year-to-date performance, we think guidance is well within reach. Agnico-Eagle also expects to reach 2019 production above the midpoint of its prior guidance of 1.63 to 1.77 million ounces.

Agnico-Eagle continued to make progress during its current investment cycle as it works to complete expansion projects. With development projects progressing as expected, we think the company will grow production 25% to 2 million ounces annually by 2020. These new mines should also help bring the company’s AISC back down towards $800 per ounce.

With an improved outlook, we’ve slightly raised our profit forecast. As a result, our U.S. dollar-denominated fair value estimate increases to USD 46 per share from USD 45. Our Canadian dollar-denominated fair value estimate increases to CAD 60 per share from CAD 59. Agnico-Eagle’s no-moat rating is unchanged. Shares have traded lower in recent months, providing a rare opportunity for investors to acquire shares in one of the most consistent gold operators at an attractive risk-adjusted discount.

In September 2018, the U.S. Federal Reserve once again raised the federal-funds rate by 25 basis points to 2.25% from 2%. This was the third rate hike of the year. Most central bank officials expect one additional rate hike in 2018 and three in 2019. The market appears to be largely in line with this view, as current interest rate option prices imply a more than 70% chance that there will be at least one more hike by the end of 2018.

All else equal, the prospect of higher inflation adds to gold's investment appeal, which is one reason ETF gold holdings rose through most of 2018 and spot prices remained above $1,300. However, as we had anticipated, higher inflation has emboldened the Fed to pursue rate hikes at a quicker pace, which lifts the real interest rate and, in doing so, increases the opportunity cost of holding gold.

Historically, we've observed a strong inverse relationship between the real interest rate and the price of gold. When the former rises, the latter tends to fall. We thought it was only a matter of time before gold investment adjusts to the higher opportunity cost, not only leading to slowing investment demand, but also outflow of gold from ETFs back into the gold market. Our prediction has proven true, as ETFs have seen net outflows since June through September.

On the back of weak investment demand, gold prices have fallen to a nearly $1,200 per ounce. Nevertheless, we still believe gold has a promising future and we forecast a nominal gold price of $1,300 per ounce by 2020. We expect that, in the long term, Chinese and Indian jewelry demand will fill the gap left by waning investor demand.