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Morningstar | Goldcorp's Struggles Continue in 3Q; Trimming Our FVEs

In the third quarter, Goldcorp produced 503,000 gold ounces, down 21% from the prior-year quarter. Even more disappointing, this was another step back from the previous sequential quarter, in which the company produced 571,000 ounces. Costs took an unfavorable turn as well, with all-in sustaining costs, or AISC, reaching $999 per ounce compared to $827 per ounce a year ago. Combined with a 6% lower gold price, lower production and higher costs led to a 40% decline in adjusted EBITDA.

After its tough second quarter, Goldcorp had maintained its full-year guidance of 2.5 million gold ounces at AISC of $800 per ounce. We saw these as unachievable, and another underwhelming quarter has now led the company to reduce its guidance to 2.28 million gold ounces at AISC of $850 per ounce. We still think these targets are lofty, as we forecast full-year production of less than 2.2 million gold ounces at AISC of roughly $875 per ounce. 2018 has been frustrating to say the least, as Goldcorp now expects performance well below its original guidance.

Although the year has been disappointing, key development projects have progressed, keeping the company’s 20/20/20 growth plan within reach. Execution of these projects is key given the struggles at existing operations. After trimming our near-term forecast, we’ve lowered our fair value estimates to $16 per share and CAD 21 per share, down from $16.50 and $21.50 for no-moat Goldcorp.

Shares look undervalued, as the company’s near-term struggles have weighed on the stock. However, the company’s development projects, which still remain on track at this time, support our fair value estimate.

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.