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Morningstar | Trimming Eldorado Gold's FVE as Longer-Term Outlook Remains Weak

On Feb. 22, Eldorado Gold issued full-year results for 2018. The company produced nearly 350,000 gold ounces (including precommercial production) at total operating cost of $650 per ounce and all-in sustaining costs, or AISC, of $994 per ounce. Based on management’s guidance, the near term looks pretty good. In 2019, production will rise to 390,000 to 420,000 ounces and AISC will fall to $900 to $1,000 per ounce, largely driven by the commercial start of Lamaque. 2020 looks even better, as the resumption of heap leaching at Kisladag drives production to surge to 520,000 to 550,000 ounces and AISC to fall to $800 to $900 per ounce.

However, beyond 2020, the company’s outlook dims as any near-term development project is likely to be completed and Eldorado continues to explore options to address production declines at Kisladag. Production falls back down to 350,000 to 380,000 ounces and AISC surges back to $900 to $1,000 per ounce.

As a result of a dimmer long-term outlook than we previously modeled, we’ve lowered our fair value estimates to $8.50 and CAD 11 per share, down from $10 and CAD 13, respectively. Eldorado’s no-moat rating remains unchanged.

With shares currently below $5 per share, Eldorado trades at a meaningful discount to our fair value estimate. However, we reiterate our extreme uncertainty rating on the company. The company’s portfolio is extremely concentrated, so every minor change in an individual mine or development project has a severe impact on our fair value estimate, both up and down.

In December 2018, the U.S. Federal Reserve once again raised the federal-funds target rate range by 25 basis points to 2.25% from 2.5%. This was the fourth rate hike of the year. However, the Federal Open Market Committee appears to be taking a more cautious approach to any future rate hikes. The dot plot shows a meaningful change in expectations, as the December dot plot implied two rate hikes in 2019 compared to three in the September dot plot. Additionally, language in the FOMC statement now takes a softer tone that discussing a more cautious approach to further rate hikes.

The market views the FOMC’s more dovish tone even more bearishly, as current interest rate option prices imply a more-than 90% chance that there will be no rate hikes by the end of 2019, with a higher chance of 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 gold as an investment that we observed over the last few years. However, we would expect that if inflation were to strengthen due to a stronger economy with lesser uncertainty, the FOMC would return to rate hikes. Although the pressure on gold as an investment has lessened, we don’t expect a strong resurgence in investment demand 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 within our forecast for a nominal gold price of $1,300 per ounce by 2020.