Eldorado Gold: All Eyes On Skouries (NYSE:EGO)

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Thesis

Eldorado Gold (NYSE:EGO) is at a turning point in its history as the Skouries project located in Greece is expected to reach first production in Q3-25. Even though Eldorado’s portfolio is currently composed of four operating assets, the impact of Skouries will be substantial and bring free cash flow generation to a new level. The simple fact that Skouries is expected to produce an average of 140,000 ounces of gold at an average cash cost of -$365 over its 20-year mine life is enough to illustrate the point. As discussed in more detail below, market participants could be underestimating the impact of Skouries, especially if gold prices continue to be well bid.

Having said that, the main risk that I see hovering around is jurisdictional in nature. Earlier this week, Turkey announced its intention to join the BRICS nations which is an important pivot for a country part of NATO. It is a key development for Eldorado’s shareholders as most of the current free cash flows come from assets located in Turkey. In a scenario of escalating tensions between the BRICS and NATO, Eldorado’s assets in Turkey could be on a fault zone.

In my view, the Skouries project and the increasing geographical risk for Western investors around Turkey are two key forces that will impact Eldorado’s share price in the coming quarters. Investors will have to decide for themselves at what price they are properly compensated for this risk/return proposition. In this article, I will try to answer this question for myself as I am attracted by the world-class asset that is Skouries while also keeping in mind that bringing a new mine into production could present some challenges along the way.

Description

Eldorado is an intermediate gold producer with four producing assets including two of those in Turkey. Based on the latest mineral reserves report published in December 2023, the company’s portfolio is estimated to contain 11.7 million ounces of proven and probable gold at an average grade of 1.04 g/t. The company is also expected to produce between 505,000 and 550,000 ounces of gold in 2024 at an all-in sustaining cost between $1,190 and $1,290 per ounce. The free cash flows generated by the current operations will continue to be used to advance the Skouries development project further.

Kışladağ Open Pit Mine

Kışladağ is the largest gold mine in Turkey and also the largest producing asset in Eldorado’s portfolio. It is a bulk-tonnage open pit mine that uses heap leaching for gold recovery. The deposit is estimated to contain 3.76 million ounces of gold at an average grade of 0.67 g/t which is equal to 32.1% of Eldorado’s proven and probable reserves. With a production guidance of 187,500 ounces of gold for 2024, Kışladağ is expected to represent 35.4% of the global production.

Kışladağ declared commercial production in July 2006 and the expected remaining mine life is still estimated at 13 years despite being in operation for almost 20 years. It is a well-oiled asset not only from an operational perspective, but also from a reserve replacement perspective. With expected all-in sustaining costs below the $1,000 threshold for 2024 and only $12.5 million of sustaining capital expenditures required, Kışladağ is the main source of free cash flow in Eldorado’s portfolio.

Lamaque Complex Underground Mine

Although the Lamaque Complex located in Quebec is expected to produce a similar amount of gold than Kisladag in 2024 at 182,500 ounces, the sustaining capital required is estimated at $90 million. Even though the cash costs at Lamaque may actually be lower than at Kışladağ, the sustaining capital required for the underground mine development put it far behind when it comes to free cash flow generation.

To illustrate the difference in the capacity to generate free cash flows, let’s look at a mine’s relative contribution to total production versus its relative need of sustaining capital. The Lamaque Complex is expected to produce 34.4% of total ounces, and to do so, it required 67.7% of the global sustaining capital invested so far in 2024. In comparison, Kışladağ should contribute a pretty similar amount to global production at 35.4%. However, the key point is that Kışladağ required only 8.4% of the global sustaining capital invested so far in 2024. What makes Kışladağ so important in Eldorado’s portfolio is not so much its low production costs, but its minimal capital needs. It is the key pillar that enables Eldorado to invest elsewhere, and by that, I mean to invest at Skouries.

Efemçukuru Underground Mine

The Efemçukuru underground mine is located in the Izmir Province in western Turkey which is adjacent to the Usak Province where Kışladağ is located, so this Turkey’s western corner is absolutely key for Eldorado on a geographical standpoint. Moreover, only the Aegean Sea separates this corner of Turkey from the Skouries project in Greece, so the vast majority of the company’s net asset value sits in this circle of a few hundred kilometers in diameter.

Efemçukuru is expected to produce around 80,000 ounces of gold in 2024 representing 15.1% of the global production guidance. Meanwhile, Efemçukuru required only 11.5% of the total sustaining capex invested so far in 2024. With all-in sustaining costs expected to be around $1,340 in 2024 combined with low capital requirements, Efemçukuru is an important contributor to free cash flows despite being the third-largest asset in terms of production.

Although Efemçukuru and Kışladağ are very different when it comes to mining method, they are pretty similar from an economic point of view. Commercial production at Efemçukuru was declared in December 2011 and mine life is estimated at 6 years. Similar to Kışladağ, there is a long history of operational performance at Efemçukuru, although the reserve replacement portion may be a bit more difficult.

Olympias Underground Mine

Olympias is a gold-silver-lead-zinc mine located in the Halkidiki Peninsula in northern Greece. This region is key for the future of Eldorado as it also hosts the Skouries deposit. The assets in Greece are owned and managed by the fully owned subsidiary Hellas Gold. The complex including the Olympias mine and the Skouries project is referred to as the Kassandra Mines. Commercial production at Olympias was declared in December 2017. Little exploration has been conducted at Olympias outside of the confines of the known ore body, so nearby areas have exploration potential. The deposit is open down plunge and numerous brownfield targets exist that have had little or no drill testing, which is good news when it comes to reserve replacement and mine life.

During the construction phase, numerous violent protests occurred in the region. With the mine now in operation, my guess is that the opposition could simply be under the surface now and has potentially not disappeared. On that note, management reported in the Q2-24 conference call that a 17-day labour-initiated work stoppage occurred during the quarter. Eldorado added that the negotiations for a new collective bargaining agreement are now in the final stages.

When it comes to community relations, I would consider Olympias and Skouries as higher-risk assets. As we have seen during the quarter, this risk can materialize in the form of unplanned work stoppages or other forms of delay. Tense relations with the local community are a risk worth keeping in mind.

During the quarter, we did have a small impact to production as a result of a labour-initiated work stoppages at Olympias, totalling 17 days in the quarter during negotiations on a new collective bargaining agreement. Currently, we are in final stages of negotiating a mutually acceptable CBA with our unions.” Q2-24 Conference Call

Skouries Project

Skouries is a high-grade copper and gold porphyry deposit that will be mined using a combination of conventional open pit and underground mining techniques. Based on the 2021 Feasibility Study, Skouries is expected to produce an average of 140,000 ounces of gold and 67 million pounds of copper over its initial mine life of 20 years. In my view, Skouries is likely to be in production for much longer, as new mineralized zones could be to the reserves estimate over time.

The feasibility study assumes gold and copper prices of $1,500 per ounce and $3.85 per pound, respectively. The price assumptions are 40.8% lower than the current gold price and 8.8% lower than current copper prices, but even with the assumptions in the study, the average cash costs and all-in sustaining cost for gold production over the life of the mine are estimated at -$365 and -$6.0 per ounce, respectively. In other words, the important copper production that will come along should pay for all the operational and sustaining capital expenditures while leaving most of the annual gold production of 140,000 ounces as free cash flows.

The initial capital costs are estimated at $845 million in the feasibility study, but were revised higher at $920 million in February 2024. A time-lapse of two years occurred between the publication of the feasibility study in January 2022 and the 8.8% increase in capital costs announced in early 2024. Considering the strong inflationary pressures that happened worldwide in the meantime, I am actually surprised that capital costs increased by less than 10.0%. Cost overruns are a risk worth keeping in mind until the start of commercial production. The fact that 73% of the construction was already completed in the first quarter of 2024 mitigates that risk.

Balance Sheet

A transformative moment for the balance sheet was the closure in April 2023 of a €680 million financing package for Skouries. The package secures 80% of the funding required to complete Skouries and leaves only the remaining 20% to be funded by Eldorado. Assuming initial capital costs of $920 million as discussed previously, we are talking about $184 million that must come from Eldorado’s balance sheet. At the end of Q2-24, Eldorado had $595 million of cash sitting on the balance sheet. On top, Eldorado’s equity commitment is backstopped by a letter of credit in the amount of €190 million issued under the revolving credit facility. Even if capital costs were to increase again before the completion of the project, the impact on the balance sheet would be muted. In my view, the largest consequence would probably be on the share price.

Once the capital requirements associated with Skouries are over, the next important liquidity need will come in September 2029 when the $500 million 6.25% senior unsecured notes become due. Skouries should be in full production at that time and with the significant free cash flows coming with it, so refinancing should not be an issue in my opinion.

Valuation

When it comes to extractive industries, price-to-cash flow (P/CF) multiples can be misleading in some cases as they do not take into account reserves life, which is a fundamental concept in mining. Let’s imagine a scenario in which a company with only a few years left of reserves trades at a low multiple, while a competitor with decades left of reserves trades at a much higher multiple. The company with decades left in reserves with a high multiple could actually be cheaper than the company with a few short years left and a low multiple. The company trading at a low multiple could actually be expensive if investors are not able to recoup their capital before the reserves are exhausted. In this example, the cash flows generated by the mine would be more about a return of capital than a return on capital.

With price-to-earnings ratios (P/E), a key issue with extractive industries is the depreciation line on the income statement. In the case of a world-class deposit depreciated over the length of its initial mine life, depreciation expenses could be overestimated as large deposits have a long history of reserve replacement or even growth. The company would then appear unprofitable, although the reality could be quite different.

When it comes to a price-to-NAV (P/NAV) ratio, the key drawback is the amount of assumptions required. Even if those assumptions are based on the most recent mineral reserves report, my guess is that even geologists inside the company do not really know the grade of ore that will be mine 10 years from now, and that is only one of the many variables required for a complete net asset value calculation.

The strength of a net asset value calculation is that it relies on technical reports like feasibility studies or recent mineral reserves estimates. In my view, those documents are the basis for any valuation work on a mining company.

My favorite way to value a gold producer is to compare its enterprise value to the amount of proven and probable ounces in the ground. Any ratio using the enterprise value instead of the market cap removes from the equation the impact of a different capital structure. In my opinion, the capital structure should be evaluated independently of the valuation work. When they are mixed together, distressed companies on the edge of bankruptcy generally have the lowest multiples, although it does not mean they are cheap, but simply that the capital structure is problematic and could be on the verge of a restructuring.

By using proven and probable reserves, there is no judgment call about potential discoveries, which, I believe, is a good thing as I consider those variables as optionality. Paying upfront for discoveries that may or may not come does not fit my style of investing. Moreover, proven and probable reserves are estimated in mineral reserves reports, and they do not rely on my own judgment.

As indicated in the table below, Eldorado sits in the middle of the pack when it comes to intermediate gold producers. Except perhaps the Fruta del Norte mine owned by Lunding Gold (OTCQX:LUGDF), I considered Skouries as one of the best assets among those producers and I also considered that its copper production should deserve a certain premium versus other deposits.

Based on the current share price around $16.00, Eldorado is trading at approximately $300 per proven and probable ounce in the ground. As mentioned in the introduction, I see two important and opposite forces at play on this multiple. The first force putting upward pressure on the multiple is the world-class asset that is Skouries which should enter production in the next year or so. On top of that, Skouries will add a copper weighting to Eldorado’s portfolio, and considering the sentiment around copper right now, it could also put some upward pressure on valuation.

However, the fact that Turkey announced its intentions to join the BRICS countries highlights the potential geopolitical risks involved in Eldorado especially for Western investors if tensions continue to escalate. Moreover, when it comes to community relations, the construction of the Olympias mine in Greece was marked by multiple violent protests in the region and the Skouries project is located in the same area. The past demonstrates that it is an important variable to keep in mind.

Relative Performance

With a 1-year price performance of almost +80.0%, Eldorado is the 7th best performer among the 65 gold producers that I track. In my view, this compelling performance could be attributed to the market’s strong appetite for copper assets in stable jurisdictions. There is a shortage of new copper assets coming online, and the associated copper production at Skouries fills an important gap in that sense.

However, the construction is not completed yet and first production is expected only in the third quarter of 2025. In the mining industry, operational issues, construction delays or challenges associated with metallurgy are not the exception, but the norm. This is especially true for new projects coming online and even if the management team is of high quality. Considering the strong price performance over the last year, the expectations are high and Eldorado must deliver a flawless performance when it comes to operational performance and the completion of Skouries.

Conclusion

Once in full production, the free cash flows generated by Skouries will be transformative for Eldorado. Kışladağ will then pass the baton to Skouries when it comes to being the key pillar in the portfolio. Skouries will also be adding a copper component to Eldorado’s portfolio and, considering the current sentiment about the supply and demand fundamentals of copper, it could introduce some investors primarily in copper to Eldorado’s story.

However, the announcement that Turkey plans to join the BRICS countries should be a reminder to western investors of the geopolitical risks are at play here. Gold mines in Turkey could sit on a tectonic plate between two superpowers that are the NATO countries and the BRICS countries. On top, the history of the Olympias mine is a reminder of the importance of having stable and solid relations with local communities.

Once those two opposite elements face each other, we get the current valuation that is an enterprise value roughly equal to $300 per proven and probable ounces in the ground which is in the middle of the pack when it comes to intermediate producers.

I will continue to follow closely the progress at Skouries, but considering the importance of the asset base in Turkey, I would need a better compensation to carry this risk in my portfolio. In the event that the share price goes back to the low teens or to a valuation closer to $200 per proven and provable ounces, I may decide to carry the geopolitical risk.

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