Over the past few months stocks in the Gold mining sector have been on a downward trend. If you like gold and believe that the price of gold is going to stay around this level then this has provided an excellent opportunity to investigate companies in this sector for investment purposes. One company worth considering is Eldorado Gold Corporation (EGO). While there are many different factors to look at and consider when investing, in the article below I will look at the debt side of the company. I will analyze Eldorado Gold's total debt, total liabilities, debt ratios and WACC. From this analysis we should get an idea if the company is highly leveraged, how much it is paying for its debt, what it's paying in taxes and how much to expect in return for investing in this company over the long term.
Gaining knowledge about a company's debt and liabilities is a key component in understanding the risk of a company. In 2008 and 2009 we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to. Taking into account the debt side of a company might not reveal the "pop" to the upside that an investor would like, but it will help ensure that the company is able to keep its capital and use it for growth in the future.
In February 2012, Eldorado Gold purchased European Goldfields for $2.5 billion. This was a significant purchase for Eldorado Gold as "European Goldfields was a developer-producer with globally significant gold reserves located within the European Union. Eldorado Gold saw many advantages for this purchase. The advantages they saw included "Further diversification of production and cash flow across a robust portfolio of new producing mines and development projects" and it "Solidifies the company's position as one of the industry's leaders in quality and sustainable production growth with an attractive cash cost profile."
It has now been a year after the purchase of European Goldfields, in the article below I will see how the purchase affected the company financially and see what the future looks like for the company aided by the acquisition of European Goldfields.
1. Total Debt = Long-Term Debt + Short-Term Debt
Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt due within one year.
- 2008 - $0 million + $0 million = $0 million
- 2009 - $135 million + $0 million = $135 million
- 2010 - $68 million + $0 million = $68 million
- 2011 - $0 million + $0 million = $0 million
- 2012 TTM - $583 million + $0 billion = $583 million
With Eldorado Gold's acquisition of European Goldfields we can see that the company added some long-term debt to its books. The company posted $0 total debt in 2011 then posted $583 million in 2012. This does indicate an increase in risk to the company from a financial point.
2. Total Liabilities
Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities is the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.
- 2008 - $114 million
- 2009 - $796 million
- 2010 - $724 million
- 2011 - $706 million
- 2012 - $1.999 billion
As indicated in the total debt summary, in looking at the total liabilities we can see how the European Goldfields acquisition had an impact on the books. In 2011, the company reported liabilities at $706 million; in 2012, the company reported liabilities at $1.999 billion. This marks an increase of 183.28%
In analyzing Eldorado Gold's total debt and liabilities, we can see that the company currently has a total debt of $583 million and liabilities at $1.999 billion. When looking at the above numbers we can see how the 2012 acquisition of European Goldfields added to the company's total debt and liabilities. Eldorado Gold put $583 million onto its total debt while total liabilities have increased by 183.28%. As the company's amount of debt and amount of liabilities have increased, the next step will reveal if the company has the ability to pay them.
3. Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2010 - $68 million / $3.685 billion = 0.02
- 2011 - $0 million / $3.960 billion = 0.00
- 2012 - $583 million / $7.928 billion = 0.07
Eldorado Gold's total debt to total assets ratio has increased over the past three years. As the total debt to total assets ratio has increased, this indicates that since 2010, the company has increased its risk on a total debt to total assets basis. As the number is currently well below 1, this indicates that the company has more assets than total debt. Because this number is extremely low, this metric indicates very low financial risk to the company.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.
- 2010 - $724 million / $3.685 billion = 0.20
- 2011 - $706 million / $3.960 billion = 0.18
- 2012 - $1.999 billion / $7.928 billion = 0.25
In looking at Eldorado Gold's total liabilities to total assets ratio over the past three years, we can see that this ratio has also increased. The ratio has increased from 0.20 in 2010 to 0.25 in 2012. As the 2012 numbers are below the 0.50 mark, this indicates that Eldorado has not financed most of the company's assets through debt. As the number has increased, so is the risk to the company.
5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2010 - $724 million / $2.961 billion = 0.24
- 2011 - $706 million / $3.255 billion = 0.22
- 2012 - $1.999 billion / $5.929 billion = 0.34
Compared with 2010, Eldorado Gold's debt-to-equity ratio has increased. The ratio has increased from 0.24 to 0.34. As the ratio is currently well below 1, this indicates that shareholders have invested more than suppliers, lenders, creditors and obligators. 0.34 indicates a low amount of risk for the company. As the ratio is well below 1 and considered low, so is the risk for the company.
6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2010 - $68 million / $3.029 million = 0.01
- 2011 - $0 million / $3.255 billion = 0.00
- 2012 - $583 million / $7.095 billion = 0.08
Over the past three years, Eldorado Gold's capitalization ratio has increased from 0.01 to 0.08. This implies that the company has less equity compared with its long-term debt. As this is the case, the company has less equity to support its operations and add growth through its equity. As the ratio is increasing, financially this implies a slight increase of risk to the company. As the ratio is only 0.08 this implies low financial risk.
7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2010 - $298 million / $68 million = 4.38
- 2011 - $512 million / $0 million =
- 2012 - $295 million / $583 million = 0.51
Over the past three years, the cash flow to total debt ratio has decreased. The ratio has decreased from 4.38 in 2010 to 0.51 in 2012. As the ratio is below 1, this implies that in 2012 the company did not have the ability to cover its total debt with its yearly cash flow from operations.
Based on the five debt ratios listed above, we can see that Eldorado Gold has very little financial risk based on its debt and liabilities. We can see that the acquisition of European Goldfields added risk to the company from a financial point but as the ratios indicate they are very minimal compared to the assets they received with the acquisition. As the price of gold looks to be strong in 2013, Eldorado Gold should be able to make money on these assets and is not burdened by massive amounts of debt and debt obligations moving forward. The next step will reveal how much the company will pay for the debt incurred.
Cost of Debt
The cost of debt is the effective rate that a company pays on its total debt.
As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing.
This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.
8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- Eldorado Gold Corp New 6.125% Rate = 6.125%
- Current cost of Debt as of January February 27th 2013 = 6.125%
9. Current tax rate (Income Tax Total / Income Before Tax)
- 2008 - $12.5 million / $181.25 million = 6.89%
- 2009 - $41.89 million / $146.92 million = 28.51%
- 2010 - $86.94 million / $325.40 million = 26.72%
- 2011 - $165.59 million / $512.81 million = 32.29%
- 2012 - $128.28 million / $446.33 million = 28.74%
2009 - 2012 4-year average = 29.06%
In 2009 - 2012 Eldorado Gold has averaged tax rate of 29.06%.
10. Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 - Tax Rate)
The effective rate that a company pays on its current debt after tax.
- .06125 x (1 - .2906) = Cost of debt after tax
The cost of debt after tax for Eldorado Gold is 4.35%
Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
The cost of equity is the return a firm theoretically pays to its equity investors (for example, shareholders) to compensate for the risk they undertake by investing in their company.
- Risk Free Rate = U.S. 10-year bond = 1.87% (Bloomberg)
- Average Market Return 1950 - 2012 = 7%
- Beta = (MSN Money) Eldorado Gold's Beta = 0.69
Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
- 1.87 + 0.69 (7- 1.87)
- 1.87 + 0.69 x 5.13
- 1.87 + 3.54 = 5.41%
Currently, Eldorado Gold has a Cost of Equity or R Equity of 5.41%, so investors should expect to get a return of 5.41% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.
(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate which is susceptible to daily change and Google finance beta.)
Weighted Average Cost of Capital or WACC
The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.
As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk.
By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances.
For this calculation, you will need to know the following listed below:
Tax Rate = 29.06% (Eldorado Gold's four-year average Tax Rate)
Cost of Debt (before tax) or R debt = 6.125%
Cost of Equity or R equity = 5.41%
Debt (Total Liabilities) for 2012 or D = $1.999 billion
Stock Price = $10.37 (February 27th, 2013)
Outstanding Shares = 714.48 million
Equity = Stock price x Outstanding Shares or E = $7.409 billion
Debt + Equity or D+E = $9.408 billion
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .2906) x .06125 x ($1.999/$9.408) + .0541 ($7.409/$9.408)
.7094 x .06125 x .2125 + .0541 x .7875
.0092 + .0426
Based on the calculations above, we can conclude that Eldorado Gold pays 5.18% on every dollar that it finances, or 5.18 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0518 plus the cost of the investment for the investment to be feasible for the company.
Debt Side Summary
All indications above reveal that Eldorado Gold is a financially stable company on the debt side. Even though Eldorado Gold purchased European Goldfields in February 2012, my analysis indicates that the company could afford the transaction. Having stated that, the analysis also indicated that the purchase did add risk to the company from a financial perspective. Because Eldorado Gold purchased European Goldfields, the analysis indicates a slight increase of risk to the shareholder from a debt point of view. As the risk increase is minimal and the overall risk to the shareholder from the debt side is quite low, the CAPM supports this statement by revealing that the investor needs 5.41% year-over-year over the long term to get good value on their money.
2013 Operational Guidance
In January of 2013 Eldorado Gold reported its operational guidance for 2013. Eldorado Gold is expecting to produce 705,000 to 760,000 ounces of gold in 2013, which is a significant increase over 2012. The company is expecting cash costs for 2013 at $515 to $530 per ounce. Production taxes and royalties are estimated to add $60/oz resulting in a total cash cost of approximately $585/oz.
Looking beyond 2013, Eldorado Gold is expecting significant growth regarding its gold production. Eldorado Gold is expecting production for the years 2014, 2015, 2016 to be approximately 850,000, 1,150,000, and 1,500,000 ounces of gold respectively.
Currently, many analysts have a positive outlook for Eldorado Gold. Over the next few years analysts at Bloomberg Businessweek are predicting Eldorado Gold to have an EPS of $0.60 for FY 2013 and an EPS of $0.67 for FY 2014. Analysts are also estimating Eldorado Gold's revenue to increase to $1.4 billion for FY 2013 and $1.6 billion for FY 2014. In February of 2013, RBC Capital Mkts gave Eldorado Gold a rating of "Outperform" with a target price of $14.00. A $14.00 price target signifies an upside of 33.33% from this point.
The above analysis reveals that Eldorado Gold is a financially sound company on the debt side with upside moving forward. The analysis indicates that even though Eldorado Gold added risk with the purchase of European Goldfields, they did not overextend themselves from a financial point of view. The purchase of European Goldfields currently looks to be a good purchase as it should help the company set itself up nicely for growth in the future. Currently, analysts have a $14.00 price target on this stock. As the chart below indicates, this is an excellent opportunity to invest in a financially sound gold mining company with future prospects and good upside potential.
Chart sourced by Finviz