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Morningstar | Eldorado’s First-Quarter Sharp Sales Drop Should Be Temporary; We Reiterate Extreme Uncertainty. See Updated Analyst Note from 03 May 2019

Eldorado Gold shocked the market with a nearly 40% drop in revenue, sending shares down 17% as we write. However, the market reaction seems a bit overdone, as gold production was only down 7% to 82,977 ounces and realized gold prices down 5% to $1,265 per ounce. The bulk of the drop was a delay in gold sales at Efemcukuru amid a customer dispute and challenging port weather. However, gold is a commodity, and the company has already negotiated the sale of the disputed volumes to other customers. Gold sales volumes will exceed gold production in the next few quarters, so the ultimate financial impact of Efemcukuru headwinds will be modest.

The company’s operations performed largely as management expected, leading Eldorado to maintain its full-year outlook of 390,000 to 420,000 ounces at AISC of $900 to $1,000 per ounce. We see these targets as achievable, largely driven by the start of commercial production at Lamaque.

We’ve made minor changes to our forecast but have revised our exit multiple assumption to 4.5 times from 6 to reflect a lower free cash flow conversion rate than we previously anticipated. Given the company’s limited production and near-term development projects, we think additional capital would be needed to even maintain current production levels. As a result, we’ve lowered our fair value estimates to $6.50 and CAD 9 per share, down from $8.50 and CAD 11. Eldorado’s no-moat rating is unchanged.

Shares are trading roughly 50% below our fair value estimate, but we reiterate our extreme uncertainty rating. Given the company’s concentrated portfolio, small changes in assumptions lead to dramatic changes in valuation. Our fair value estimate assumes a 50% chance that the long-contested Skouries project in Greece eventually opens. Dropping that assumption to 0% cuts our entire fair value estimate by nearly half.

In December 2018, the U.S. Federal Reserve once again raised the federal-funds target rate by 25 basis points to a range of 2.25% to 2.50%. This was the fourth rate hike of the year. However, the Federal Open Market Committee appears to be taking a more cautious approach to future rate hikes. The dot plot has reflected a meaningful change in expectations. The December dot plot implied two rate hikes in 2019 versus the three hikes that had been implied back in September. Additionally, language in the FOMC statement now takes a softer tone, indicating a more cautious approach to further rate hikes.

The market has taken a bearish view on the FOMC’s more dovish tone. Current interest rate option prices imply a more-than 90% chance that there will be no rate hikes by the end of 2019. Additionally, they reflect a higher probability for a rate cut than a rate hike by the end of the year.

All else equal, a slower rate hike path reduces the downward pressure on investment demand for gold that we’ve observed over the last few years. However, the FOMC would likely return to rate hikes if inflation were to strengthen due to stronger economic growth. Although pressure on investment demand for gold has softened, we don’t expect a strong resurgence in the near future.

On the back of stabilizing investment demand, gold prices have settled in the high-$1,200 to low-$1,300 per ounce range, falling roughly in line with our forecast for a nominal gold price of $1,300 per ounce by 2020.