Eldorado Gold: A Troubling 3rd Quarter Results Review

The company produced an upgrade to 2018 gold production. This was the only good news in the report.

I review the release's negative points.

The company is playing fast and loose with the solvency issue.

Eldorado gold (EGO) produced third quarter results on the 25th October and held its conference call on the 26th October. All information in this review comes from the release and the conference call.

The troubled Kisladag project.

Investment Thesis

In July 2018, I wrote that I was a long-term bull of the company for the following reasons (among others),

1. The company's equity is valued at 23% of its balance sheet value. With the sector average being 120%, there is 522% of upside for Eldorado to reach the average valuation.

2. At present, the company produces almost no accounting profit. However, the plan is to increase gold production from a present level of just over 300,000 to 600,000 ounces per year. The plan will not be completed until 2021 but once it is in operation there will be substantial profits.

These 2 reasons have not changed, but the position has become much murkier with the 3rd quarter release. There was one positive development and that is gold production guidance for 2018 was increased from 330,000-3400,00 to 345,000-350,000 ounces at cash operating costs of $600 - 650 per ounce sold. The rest of the 3rd quarter release was in my opinion negative and probably explains the share price fall of 6% since the release and conference call to a new low of 77 cents. The negatives are,

1. The cost of the new mill at Kisladag (which the Board has now approved) has moved up to $520m. The coast was originally estimated in the $400m area but has steadily risen in the last year to the present figure.

2. On the conference call George Burns, the CEO, was asked if the feasibility study for the new Kisladag development had analyzed if the project NPV of $434m had been compared to the NPV of just continuing with the present heap leach pad operation. The answer given was that there was no comparison needed, as the present operation would only last for another 2 years. My conclusion from this answer is that the comparison has definitely not been done. This seems to be a material omission in the planning stage. Let me explain.

The new mill has a projected life span of 9 years at an average production rate of 270,000 ounces and AISC (all in sustaining costs) of $793. Assuming (as the company does for its feasibility study) a gold price of $1300 the gross profit from the operation is 270,000 x 9 x (1300-793) =1,232,010,000 less construction cost of $520,000,000 or $712,010,000.

On the conference call it was revealed that the present operation had now been improved to produce a gold recovery rate of 60%. This has improved from 35-40% from the last quarter of 2017. It was also suggested that the company was presently not using the ore with the highest rates of gold, as these were being saved for the new development. So with lesser quality ore the company has now projected 160,000-170,000 ounces of gold at an AISC of $600-650 per ounce. This produces a gross profit (using mid prices) of 165,000 x (1300-625)=$111,375,000. Let us say, for arguments sake, that the present operation could be made to last for 5 more years and would be able to use the higher grade ore. This would produce a profit of 5 x 111,375,000 or $556,875,000. If this were so, the new operation spend of $520m was being risked for additional profit of $712,010,000-556,875,000 or $155,135,000. This comparison makes the spend, which is stretching the company's balance sheet, seem rather risky. As this research has not been done the company may well be making an incorrect decision.

3. One analyst asked, in the conference call, how the company could sanction the new project, if the finance position of the company had not been resolved. The company has just enough cash with the present cash balance of $385 and a revolving facility of $250 to finance the Kisladag project. However the company has a bond redemption of $600m due in December 2020. At that stage the company would have minimal cash balances and would have drawn a credit facility of $250m. It would therefore be unable to redeem the bonds and would be in default. The new CFO Philip Yee suggested that they were looking at various options, but he was not at all concerned that they would not be able to refinance the bonds. That all seems well and good but that is in today's conditions. What if the gold price falls to $1,000 and there is a recession in 2020. Would the company be able to refinance in those conditions? The Federal Reserve stress tests banks for a very good reason - to make sure that they do not fail. It would appear that Eldorado Gold does not feel the need to stress test this decision. This adds additional risk to the project and therefore the company. It was clear from the conference call that the analyst asking the question considered this a material omission from the feasibility study and I heartily agree.

4. There was a write down of $117.6m (after tax $94.1m) of assets due to the Kisladag project development decision. The rest of the depreciation of the heap leach pad will be expensed over the remaining life of the pad to 2020. This will further hold back accounting profit for the next 2 years (but will have no impact on cash flow).

5. There was no news on the Skouries permits. The market perceives this as a negative, but I am presently ambivalent, as I think the company can quite happily wait (it would almost for me be a positive). The company would not be able to finance the project at this time, so delays are to be welcomed.

Conclusion

For the record, the company's plan of 600,000 ounces of gold in 2021 is still in place and on schedule. This will make the company very profitable at that time. The price to book value is now 17.5% (book value $3501,568,220. shares in issue 794,010,680 @ 77c). This makes the company seem incredibly good value on a long-term basis. However the latest release highlights management omissions in project feasibility and more importantly in financing continuing and future developments. This casts a shadow on the present management capabilities that is very troubling. I still think that the company is a good investment, but the continuing fall in the share price highlights the market concerns, as stated above. I am still positive but with a much more guarded optimism. If the management were to resolve the issues in this review, I would once again recommend the shares. In the meantime, I think they remain a hold but I will not be adding on weakness.

Disclaimer - This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.

Disclosure: I am/we are long EGO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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