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By Joung Park

Investor concern about the recent acquisition of European Goldfields has brought Eldorado Gold's (NYSE:EGO) stock price down to attractive levels. Eldorado's share price has declined more than 15% since rumors of its bid for European Goldfields first leaked in December 2011. We think the market is concerned about Greece's recent history of environmental opposition to gold mining, as most of European Goldfields' assets are in that country. We do not think there is any need to be wary of Greeks bearing gifts in this case, however, given that the Hellenic mining assets Eldorado acquired from European Goldfields already have the necessary permits (including environmental licenses) in place, and that these mining projects can generate additional tax revenue for financially constrained Athens. While the stock enjoyed a nice rally after management released updates on the acquired mines April 12, we think it still retains significant upside and presents a compelling opportunity for investors to pick up a high-quality gold miner that enjoys a narrow economic moat.

We think investor negativity is not based on the pure economics of the deal, as the European Goldfields transaction brought one operating mine (Stratoni) as well as three medium-size, low-cost gold deposits (Olympias, Skouries, and Certej) into Eldorado's purview at an attractive price. In fact, given European Goldfields' attributable gold reserves of 9.2 million ounces, Eldorado paid just $280 per gold ounce in the ground, a figure well below recent transaction multiples in the industry. In addition to these gold reserves, European Goldfields' properties also contain substantial silver, lead, zinc, and copper reserves that represent material economic value.

Eldorado is not just paying a cheap price for European Goldfields, but also gaining some quality mining assets through this transaction. Stratoni generates only modest amounts of silver, lead, and zinc currently; the real value of the acquisition lies in the Olympias, Skouries, and Certej gold deposits. All three are advanced-stage projects that are essentially shovel-ready and are projected to generate significant gold output at below-average cash costs. Even better, these projects won't require large amounts of initial capital expenditures or long lead times to bring on line. Construction already has begun at Olympias and Skouries, while Certej is at the advanced permitting stage. We project that all three of these projects will be in production by the end of 2014, and we could see first gold output from Olympias as early as 2012.

Investor Concerns Regarding Greece Are Overblown
If the economics of the European Goldfields purchase seem favorable, then why is the market so skeptical? We think the main reason centers on concerns about Greece's historical opposition to gold mining, given that two of the projects inherited from European Goldfields, Olympias and Skouries, are in that country. Before the acquisition, Eldorado already owned one gold development project in Greece, Perama Hill. During the 1990s and early 2000s, Greece was indeed a hostile jurisdiction for gold miners, as environmental activism forced many foreign gold miners operating in the country, such as TVX Gold and Newmont Mining, to shutter their operating mines and suspend development projects. However, we think it's a mistake to extrapolate Greece's history of environmental opposition to gold mining into the present. We have several reasons for confidence that Eldorado will be able to successfully develop and operate its Hellenic gold projects.

The necessary permits are largely secured. Environmental impact assessments for the Skouries and Olympias projects have received approval from Athens, and construction activity already has started at these two sites. Eldorado is awaiting EIA approval for Perama Hill, which was submitted to Athens during the first quarter, and expects all necessary permits for this project to be secured by the end of the year.

Athens' fiscal woes are likely to smooth the process. Greece is desperate for additional foreign investment and tax revenue as it navigates its sovereign debt crisis and fiscal austerity measures. We believe this will motivate Athens to cooperate with Eldorado. Greek environmental minister Giorgos Papakonstantinou is a former minister of finance, which we think can only help smooth the permitting and construction process. Also, the Greek government approved Eldorado's Perama Hill project in June 2011 for the fast-track process, which Athens recently created to expedite the development of strategic mining projects.

Eldorado has experience successfully operating in difficult mining jurisdictions. The company already runs three gold mines in China, which most would regard as a difficult operating environment for a foreign mining firm. Moreover, Eldorado already had exposure to Greece through the Perama Hill project before the European Goldfields acquisition, and management has said it is comfortable operating in the country.

We Believe Eldorado's Current Valuation Is Attractive
As a result of the stock’s poor performance following the European Goldfields purchase, we think Eldorado is undervalued. While the stock doesn't seem cheap from traditional multiples analysis, Eldorado is a very high-quality gold miner that historically has traded at a significant premium to most of its peers. Moreover, we think Eldorado can increase earnings much more rapidly than its peers thanks to its robust pipeline of development projects. Eldorado is trading at less than 18 times our projected 2012 earnings, significantly below its average price/forward earnings ratio for the past five years and not much higher than the industry average. On an enterprise value/reserves basis, Eldorado is trading around $350 per ounce of gold reserves in the ground, which is fairly close to the industry average even though Eldorado's reserves should normally be priced at a premium because of their low-cost profile.

We increased our fair value estimate following the European Goldfields acquisition, as we believe the transaction is value-accretive thanks to the addition of significant future gold output at a bargain purchase price. We think that as the Greek development projects are constructed and start generating gold, the market will recognize the value of these acquired assets, which should serve as a positive catalyst for Eldorado's share price. Some near-term catalysts to watch for include:

Eldorado's publication of its updated mining development plans for the assets acquired from European Goldfields. We had previously identified this update as a potential positive catalyst for the stock, and indeed the stock rallied more than 12% on April 12 after the company released the update.

Start of production at a tailings reprocessing facility at Olympias. This would precede gold production from the main underground ore body at Olympias. Management thinks production from the reprocessing facility could start as early as the third quarter of 2012.

Athens' EIA approval for Perama Hill and the start of construction. Management expects government approval to occur by the end of 2012 and construction at the site to start shortly thereafter.

As is the case with most gold miners, Eldorado's primary risk is lower gold prices. However, we believe the firm's low production costs insulate it more from downward swings in bullion prices than the typical gold miner (although its earnings would still take a big hit in such a scenario). We also believe Eldorado will be able to finance its development projects even in a bearish gold price environment, thanks to its low production costs and a net cash position on its balance sheet. Our fair value estimate of $19 per share incorporates a long-term gold price assumption of $1,200 per ounce, significantly below current spot prices. Eldorado is exposed to execution risk as it is developing multiple projects, which could lead to some delays for certain projects. The company must also contend with geopolitical risk given its operations in nontraditional mining jurisdictions such as China and Greece; however, we think concerns about these risks are overblown, which is the primary reason behind Eldorado's attractive valuation.

Fair Value Sensitivity to Long-Term Gold Price Assumptions

(click to enlarge)
Source: Morningstar

Eldorado Is a Premium Gold Miner With an Economic Moat
Eldorado Gold always has been one of our favorite gold miners, thanks to its attractive combination of rock-bottom production costs and robust growth potential. The company is one of very few gold miners we cover that enjoys an economic moat. We believe it possesses a moat for three main reasons.

Enviable production costs relative to its peers. Eldorado produced gold at average cash costs of $472 per ounce in 2011, which puts the company in the bottom quarter of the gold mining industry. By contrast, the industry average production cost in 2011 was roughly $600 per ounce. We think Eldorado's favorable cash cost position stems from the advantaged geology of its existing mines, meaning that the cost advantage is more likely to persist over time. Most of the company's mining assets enjoy higher-than-average gold ore grades, which helps limit production costs. While Kisladag, Eldorado's largest mine by gold output, is an exception to this rule, it still enjoys rock-bottom cash costs ($398 per ounce in 2011) because it uses heap leaching, a mining technique that relies more on large volume of ore throughput rather than on high gold grades.

Ore Quality Affects Mining Methods and Costs

(click to enlarge)
Source: Morningstar

Long mine life. As gold is a nonrenewable resource, Eldorado's cost advantage cannot last forever--its gold reserves eventually will be depleted unless replaced. However, the firm will be able to sustain economic profits for years, to come given its long mine life. Assuming 2011 production levels, Eldorado's total attributable gold reserves of 28.2 million ounces should last more than four decades.

Prudent capital allocation by management. Eldorado's management team focuses on adding value through its mining and geological expertise by focusing on in-house exploration and development projects. Management has formidable geological and mining expertise; this has helped it develop a proven record in developing new mines on time and on budget, which is crucial for generating high returns. Eldorado does make large acquisitions from time to time, but it has done a good job avoiding value-destructive transactions, unlike many of its peers.

While production growth potential is not one of the pillars supporting Eldorado's economic moat, it is another appealing trait that distinguishes the gold miner from many of its peers that are experiencing slower production growth. We project Eldorado will more than double its gold production during the next several years, from less than 700,000 ounces in 2011 to more than 1.7 million ounces in 2016. This growth will stem from a mix of brownfield expansion at existing mines such as Kisladag, start of production at new mines such as Eastern Dragon, and gold output contributions from mining assets recently acquired from European Goldfields.

Location of Eldorado's Mining Assets

(click to enlarge)
Source: Company presentations

The firm has been able to amass its attractive, low-cost mining portfolio by venturing into mining jurisdictions generally eschewed by other gold miners, including Turkey and China. We think this strategy allows Eldorado to avoid fierce competition so that the firm can pick up economically attractive gold assets on the cheap. The company was one of the first Western gold miners to establish a presence in Turkey when it purchased the Kisladag property in 1996. Eldorado is also a pioneer in the Chinese gold mining industry; it is the only major Western gold mining company operating in the country after acquiring Sino Gold in 2009. We think Eldorado is continuing its unorthodox but lucrative strategy with its acquisition of European Goldfields, which has its major mining assets in Greece and Romania and adds explosive production growth potential, in our opinion. Even disregarding the European Goldfields acquisition, however, Eldorado's legacy portfolio enjoys several avenues of growth, including the start of production at its Eastern Dragon project sometime in 2012, as well as a major planned brownfield expansion at its flagship Kisladag mine.

Market Takes a Negative Stance on European Goldfields Purchase; We Disagree
On Dec. 18, 2011, Eldorado announced a friendly takeover offer for European Goldfields. The deal closed Feb. 24 after receiving overwhelming shareholder support from both companies. The consideration consisted of about 160 million Eldorado shares, resulting in a total price tag of roughly $2.6 billion. While we believe the acquisition will prove to be value-accretive, the market reacted very negatively to the news. Eldorado's shares plunged as much as 25% after rumors of its interest in European Goldfields first leaked Dec. 6. While the stock did enjoy a nice rebound after the company released a favorable mining plan update on the assets it acquired, Eldorado's share price is still more than 15% below its predeal announcement levels.

We think investor negativity is not based on the pure economics of the deal, as the European Goldfields transaction brought one operating mine (Stratoni) as well as three medium-size, low-cost gold deposits (Olympias, Skouries, and Certej) into Eldorado's purview at an attractive price. In fact, given European Goldfields' attributable gold reserves of 9.2 million ounces, Eldorado paid just $280 per gold ounce in the ground, a figure well below recent transaction multiples in the industry. In addition to these gold reserves, European Goldfields' properties also contain substantial silver, lead, zinc, and copper reserves that represent material economic value.

Eldorado is not just paying a cheap price for European Goldfields, but also gaining some quality mining assets through this transaction. Stratoni generates only modest amounts of silver, lead, and zinc currently; the real value of the acquisition lies in the Olympias, Skouries, and Certej gold deposits. All three are advanced-stage projects that are essentially shovel-ready and are projected to generate significant gold output at below-average cash costs. Even better, these projects won't require large amounts of initial capital expenditures or long lead times to bring on line. Construction already has begun at Olympias and Skouries, while Certej is at the advanced permitting stage. We project that all three of these projects will be in production by the end of 2014, and we could see first gold output from Olympias as early as 2012.

Investor Concerns Regarding Greece Are Overblown
If the economics of the European Goldfields purchase seem favorable, then why is the market so skeptical? We think the main reason centers on concerns about Greece's historical opposition to gold mining, given that two of the projects inherited from European Goldfields, Olympias and Skouries, are in that country. Before the acquisition, Eldorado already owned one gold development project in Greece, Perama Hill. During the 1990s and early 2000s, Greece was indeed a hostile jurisdiction for gold miners, as environmental activism forced many foreign gold miners operating in the country, such as TVX Gold and Newmont Mining, to shutter their operating mines and suspend development projects. However, we think it's a mistake to extrapolate Greece's history of environmental opposition to gold mining into the present. We have several reasons for confidence that Eldorado will be able to successfully develop and operate its Hellenic gold projects.

The necessary permits are largely secured. Environmental impact assessments for the Skouries and Olympias projects have received approval from Athens, and construction activity already has started at these two sites. Eldorado is awaiting EIA approval for Perama Hill, which was submitted to Athens during the first quarter, and expects all necessary permits for this project to be secured by the end of the year.

Athens' fiscal woes are likely to smooth the process. Greece is desperate for additional foreign investment and tax revenue as it navigates its sovereign debt crisis and fiscal austerity measures. We believe this will motivate Athens to cooperate with Eldorado. Greek environmental minister Giorgos Papakonstantinou is a former minister of finance, which we think can only help smooth the permitting and construction process. Also, the Greek government approved Eldorado's Perama Hill project in June 2011 for the fast-track process, which Athens recently created to expedite the development of strategic mining projects.

Eldorado has experience successfully operating in difficult mining jurisdictions. The company already runs three gold mines in China, which most would regard as a difficult operating environment for a foreign mining firm. Moreover, Eldorado already had exposure to Greece through the Perama Hill project before the European Goldfields acquisition, and management has said it is comfortable operating in the country.

We Believe Eldorado's Current Valuation Is Attractive
As a result of the stock’s poor performance following the European Goldfields purchase, we think Eldorado is undervalued. While the stock doesn't seem cheap from traditional multiples analysis, Eldorado is a very high-quality gold miner that historically has traded at a significant premium to most of its peers. Moreover, we think Eldorado can increase earnings much more rapidly than its peers thanks to its robust pipeline of development projects. Eldorado is trading at less than 18 times our projected 2012 earnings, significantly below its average price/forward earnings ratio for the past five years and not much higher than the industry average. On an enterprise value/reserves basis, Eldorado is trading around $350 per ounce of gold reserves in the ground, which is fairly close to the industry average even though Eldorado's reserves should normally be priced at a premium because of their low-cost profile.

We increased our fair value estimate following the European Goldfields acquisition, as we believe the transaction is value-accretive thanks to the addition of significant future gold output at a bargain purchase price. We think that as the Greek development projects are constructed and start generating gold, the market will recognize the value of these acquired assets, which should serve as a positive catalyst for Eldorado's share price. Some near-term catalysts to watch for include:

Eldorado's publication of its updated mining development plans for the assets acquired from European Goldfields. We had previously identified this update as a potential positive catalyst for the stock, and indeed the stock rallied more than 12% on April 12 after the company released the update.

Start of production at a tailings reprocessing facility at Olympias. This would precede gold production from the main underground ore body at Olympias. Management thinks production from the reprocessing facility could start as early as the third quarter of 2012.

Athens' EIA approval for Perama Hill and the start of construction. Management expects government approval to occur by the end of 2012 and construction at the site to start shortly thereafter.

As is the case with most gold miners, Eldorado's primary risk is lower gold prices. However, we believe the firm's low production costs insulate it more from downward swings in bullion prices than the typical gold miner (although its earnings would still take a big hit in such a scenario). We also believe Eldorado will be able to finance its development projects even in a bearish gold price environment, thanks to its low production costs and a net cash position on its balance sheet. Our fair value estimate of $19 per share incorporates a long-term gold price assumption of $1,200 per ounce, significantly below current spot prices. Eldorado is exposed to execution risk as it is developing multiple projects, which could lead to some delays for certain projects. The company must also contend with geopolitical risk given its operations in nontraditional mining jurisdictions such as China and Greece; however, we think concerns about these risks are overblown, which is the primary reason behind Eldorado's attractive valuation.

Source: Time For A Rush On Eldorado Gold?