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Morningstar | Lower Production and Higher Costs Hit Iamgold’s 3Q Results but Development Projects Remain Promising

Iamgold’s third-quarter performance was marred by soft production volumes and higher costs. Total attributable gold ounces were 208,000, down 4% from the prior-year period. Meanwhile, total cash costs spiked 8% to $830 per ounce and all-in sustaining costs (AISC) spiked 12% to $1,086 per ounce. With the average realized gold price falling to $1,207 per ounce during the quarter, the company saw profitability squeezed on both sides as gross profit fell 82% to $7.5 million

One bright spot during the quarter was an improved outlook for the Cote Gold Project following the completion of its feasibility study, which should be publicly filed within 45 days. This would trigger a $95 million payment from mine development partner Sumitomo Metal Mining. The feasibility study boosts average annual production to 367,000 ounces at AISC of $694 per ounce over a 16-year mine life, up from the prefeasibility study estimate of 320,000 ounces. An extended mine plan could potentially extend the mine life to 18 years with an average annual production of 372,000 ounces at AISC of $703 per ounce. Both plans look promising, as they could more than double current production volumes at much lower costs. The construction decision is expected in the first half of next year, with production to follow by mid-2021.

Although the company largely maintained production and cost guidance, we’ve increased our cost forecast given the struggles year to date. This leads us to reduce our fair value estimate to USD 6 per share and CAD 8 per share, down from USD 6.50 and CAD 8.50, respectively. Iamgold’s no-moat rating remains unchanged.

Iamgold shares have fallen roughly 40% since the beginning of August. The company’s operational struggles have catalyzed the decline, but we think shares now fail to properly reflect the promise of Iamgold’s development projects. However, we’d reiterate our very high uncertainty rating, which considers the dependence of our fair value estimate on the opening of new mines and the associated risks of this dependence.

In September 2018, the U.S. Federal Reserve once again raised the federal-funds target rate by 25 basis points to a range of 2% to 2.25%. 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 80% 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 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.