Eldorado Gold: Update After The 9% Fall
Eldorado Gold shares fell almost 9% after the latest press release.
The company has submitted a preliminary short form base shelf prospectus with the securities regulatory authorities.
This article explains the effect of this submission.
The Skouries mine - The reason for the latest application?
Overview
Anyone who has read any of my previous articles will know that I am bullish on the outlook for the gold price. This outlook leads to a bullish outlook on the gold miners, as if the gold price appreciates, the bottom line of gold companies increases at a greater rate than the price of gold, leading to out sized gains for the miners. In general I have suggested miners that have low all in sustaining costs (AISC) and an increasing production profile. Eldorado Gold (EGO) does not really fit either of these criteria. However it has one redeeming feature that makes it the largest holding of my gold mining portfolio. The shares trade on a substantial discount to book value.
The latest press release
The latest press release is an application to the securities regulatory authorities to allow the company to raise up to $750m in common shares, debt securities, convertible securities, warrants, rights, subscription receipts, units or any combination thereof over the 25 months after permission is granted.
The implication
In July, The New Democracy party gained power in Greece. They have suggested that they are open to the new development of the mine at Skouries and in the latest conference call, CEO George Burns confirmed that the company had formed a committee with representatives of the Greek government to progress the project. It would appear that after many years of false starts, the project may be getting close to getting the remaining permits to enable Eldorado to restart the development of the mine. So what about the latest application you ask? The Skouries mine development costs are stated at $689.2m. The terms of the latest refinancing package (TARCA) that the company used to repay its $600m notes due in December 2020 states (page 12 of the latest financial statements):
The TARCA contains covenants that restrict, among other things, the ability of the Company to incur additional unsecured indebtedness except in compliance with certain conditions, incur certain lease obligations, make distributions in certain circumstances, sell material assets or carry on a business other than one related to mining.
The exact covenants are not explained, but I would suggest that the company is not going to be able to raise substantial extra debt. It would therefore appear that the only way to finance the mine, that is about to get the permits it needs, is through an equity raise. The company filing makes this possible and the share price fell almost 9% on the threat of equity dilution.
Conclusion
I have said on several occasions that the management of Eldordo gold is not a reason to buy the shares. The company hemorrhages money through mine security. finance costs, share bonus schemes and general costs. The management has said on several occasions that they will reduce costs, but this has not happened so far. The mishaps have not stopped, as evidenced by the latest problems with Efemcukuru.
The last remaining reason to buy the shares is the price to book value. Gold shares sell on price to book ratios that average:
Junior gold miners 0.7 Mid tier Miners 1.0 Senior miners 1.2The present book value for Eldorado Gold(a mid tier miner) is as follows:
Book value (latest accounts) = 3,333,904,000
Equity value
158,417,331 shares @ $7.84 per share = 1,241,992,000
The price to book is 37%
At present the shares still look substantially undervalued and would need to appreciate to $21.19 per share to reach a price to book of 1 (the average for the sector). However if the company were to issue $750m of new shares the price to book would change as follows:
Book value 3,333,904,000 + 750,000,000 = 4,083,904,000
Equity value 1,241,992,000 + 750,000,000 = 1,991,992,000
The price to book value is now 48.8% and the shares would only appreciate to $16.06 to be in line with the industry average for a mid tier gold miner.
It is clear why the shares have fallen. The equity dilution is quite considerable. However the company has $115m cash at present and is cash flow positive. It is therefore likely that it will not have to raise the full amount of $750m to complete the development at Skouries. It would be incredibly helpful if the company were to release a potential cash flow analysis assuming that Skouries permits are forthcoming, so that the dilution that the shares will suffer is clear for all to see. In the absence of this, the question is: Are the shares still good value? The grant of the permits to continue the development of Skouries would be a very constructive development, which would propel the shares higher.
The dilution will not take place unless the Skouries project is granted the permits to continue, so there is no risk of dilution unless good news is forthcoming. The diluted share price is still less than half the book value and for me, this is enough value to keep holding my nose, as the management burns cash. If the capital raise is less than $750m, the dilution will be less and the potential value of the shares will increase. The shares are not the bargain that they once were, but they are still cheap. If the management could stop burning cash and sell peripheral assets, the shares would once again become outstanding value. At present they are still a hold and a strong hold at that.
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.
Additional disclosure: 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.
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