2024-01-15 08:55:10 ET
Summary
- The Gold Miners Index has had a disappointing start to the year despite record gold prices.
- Equinox hasn't been able to sidestep this selling pressure with a third consecutive year of missing its annual guidance midpoint on production as reported last week.
- In this update we'll dig into the Q4/FY2023 production results, the 2024 outlook, and whether Equinox is finally offering enough margin of safety to consider it from an investment standpoint.
It's been a bumpy start to the year for the VanEck Gold Miners ETF ( GDX ) in what's typically the best month of the year from a seasonal standpoint, with an average return for the sector of ~2.6% in January over the past 30 years. This is certainly disappointing for investors, especially with the metal's price notching a record seven weekly closes above the $2,000/oz level and it can be explained by continued negative sentiment towards miners. Unfortunately, Equinox Gold Corp.'s ( EQX ) FY2023 production results haven't helped to reverse the downside momentum with the company reporting a third consecutive miss against its annual guidance midpoint. In fact, the company has missed its guidance midpoint by a median of ~25,000 ounces (past three years), with the most significant misses under the previous CEO (left in Q3 2022).
Gold Bugs Index - Monthly Returns & Percentage Of Time Positive - Author's Data & Chart
In this update we'll dig into the Q4/FY2023 production results, the 2024 outlook, and whether Equinox is finally offering enough margin of safety to consider it from an investment standpoint.
Q4 & FY2023 Production
Equinox Gold released its Q4 and FY2022 results last week, reporting quarterly production of ~155,000 ounces, a 3% increase from the year-ago period. The lower production was related to lower output at Mesquite, Fazenda, Castle Mountain, and Santa Luz, with increased ounces from Los Filos, RDM, and Aurizona able to offset this softness. That said, annual production came in at just ~564,500 ounces which was down on a two-year basis (FY2021: ~602,100 ounces), and this marked the third consecutive year missing its annual guidance midpoint (FY2023: 590,000 ounces).
Equinox Gold Quarterly Production - Company Filings, Author's Chart
Digging into the production results a little closer, Los Filos had a solid finish with production of ~42,200 ounces, but still came up shy of FY2023 guidance of 160,000 to 180,000 ounces (actual: ~159,100 ounces). Meanwhile, Aurizona also had a better quarter year-over-year with output of ~34,100 ounces, but also came in at the low end of its guidance of 120,000 to 130,000 ounces (~120,600 ounces). Finally, Mesquite hit the high end of guidance at ~87,800 ounces (guidance: 80,000 - 90,000 ounces), but this was offset by misses at smaller mines like Castle Mountain (well below guidance), Santa Luz (below bottom end of guidance), and RDM (low end of guidance). The result was that Equinox's production came in right in line with my FY2023 expectations at ~565,000 ounces based on estimates of roughly 155,000 ounces in Q4.
"Looking at how Equinox is tracking in relation to guidance, the company has produced just ~409,500 ounces year-to-date, suggesting that it will come in well below its guidance mid-point for a second consecutive year and with production down on a two-year basis. This is because even if the company produces ~155,000 ounces of gold in Q4, this would still place production over 4% below its guidance mid-point of 590,000 ounces of gold."
- Equinox Gold: Margins Up, But Output Tracking To Low End, November 1st, 2023.
Equinox Quarterly Production by Mine - Company Filings, Author's Chart
Circling back to the performance vs. guidance, FY2023 came in over 4% below the initial guidance midpoint of 590,000 ounces, and this was the third year in a row of misses. Worse, these misses were not small, with an average miss of over 50,000 ounces since 2021. This is based on the guided average annual three-year production of ~620,000 ounces adjusted for the Pilar sale (2021-2023) and actual three-year average production of ~566,000 ounces. These results are shown in the below chart, and investors will have to hope that Equinox can start managing expectations better to ensure the successful delivery of guidance or it will continue to be difficult to trust company projections. That being said, Greg Smith (new CEO) is relatively new to his role at Equinox and the company has certainly had a tough time at Los Filos with blockades that haven't been an issue recently, so I am cautiously optimistic in a better 2024 relative to the past three years that have been underwhelming to say the least vs. the annual outlook.
Equinox Gold - Annual Production vs. Initial Guidance Midpoint - Company Filings, Author's Chart
2024 Outlook
Moving to Equinox's 2024 outlook, the company should enter Q4 2024 with a new mine in commercial production, with Greenstone expected to pour its first gold in H1 of this year ahead of a multi-month ramp-up period. This should translate to at least 105,000 ounces of attributable production from Greenstone next year, helping to lift production to 700,000+ ounces and a record year for the company. Just as importantly, this will increase Equinox's percentage of production coming from Tier-1 ranked jurisdictions (Greenstone is in Ontario, Canada), and the mine carries far higher margins than its legacy assets meaning we should see a material improvement in costs in 2025 with the first year of full production from this asset. However, I am not as optimistic about the 2024 outlook, which will only see a partial contribution from its 60% stake in Greenstone. In fact, I would not be surprised to see similar costs year-over-year for Equinox, with costs likely to come in above $1,600/oz.
Equinox Gold - Annual Production & AISC + FY2023/FY2024 Estimates - Company Filings, Author's Chart & Estimates
These higher costs can be partially attributed to limited contribution from Greenstone to help improve margins, what should be a higher strip ratio and lower grades at the Los Filos Open Pits (its #2 asset by size), and relatively low production with what I would expect to be higher capitalized stripping at RDM. Meanwhile, the sector continues to see an impact from inflationary pressures, even if the rate of change has cooled from peak levels in 2022, suggesting that some cost creep would not be overly surprising. On a positive note, Equinox is benefiting from lower diesel prices to start the year, which benefits it as a relatively high-volume and low-grade producer. In summary, while I would expect a much stronger year in 2025 once Greenstone is firing on all cylinders, investors hoping for significant margin expansion in 2024 might be disappointed.
Recent Developments
As for recent developments, the major one is Greenstone construction progress, with commissioning now underway (*2022 AIF noted a 6-month commissioning period*) to pour gold in the first half of 2024. This is an exciting development for investors and the company has done an excellent job delivering to budget and schedule to date, far better than IAMGOLD Corporation's ( IAG ) delivery of Cote Gold which has been massively over-budget. And for those unfamiliar with Greenstone, this is a mine that's expected to produce ~407,000 ounces of gold in its first five years or ~244,000 ounces attributable to Equinox, making this Equinox's largest and highest-margin mine with all-in sustaining costs likely to come in below $925/oz even when baking in conservatism to adjust for inflationary pressures. Hence, this is certainly a major fundamental change for the company, helping Equinox to morph from a high-cost producer into an average-cost producer in 2025.
*The project timeline contemplates approximately two years of construction and six months of commissioning, with the first gold pour targeted for the first half of 2024.*
Greenstone Project - Company Presentation
As for other recent developments, the company's timing has certainly been fortunate with its Greenstone Project construction, with Greenstone set to enter commercial production before year-end just as the gold price is hugging all-time highs. Not only is this a benefit from a sales standpoint with the potential for Equinox to generate over $1.8 billion in revenue in 2025, but it's also a positive from a margin standpoint as many of its mines have $1,600/oz AISC or higher. And while the outlook for free cash flow at these mines wasn't great under a $1,800/oz gold price assumption, it's a much better setup with lower oil prices and the gold price hovering above $2,000/oz. In fact, the gold/oil ratio continues to make higher highs and higher lows, a solid backdrop for the producer space as a whole as we look toward Q4/Q1 results for GDX.
Gold/Oil Ratio - StockCharts.com
Finally, as for capital allocation, many producers have turned to M&A and are scooping up juniors at fire-sale prices, with recent deals for Marathon, Osino, and half of Windfall. Unfortunately, Equinox is not in a position to acquire given its high debt load ($700+ million in net debt), and while hoping for a takeover if share prices remain depressed might be an angle investors in other gold companies, I don't see Equinox being a compelling takeover target. This is because it has a relatively small production profile for the number of mines it operates (majors seem to prefer large 250,000+ ounce assets and ideally upwards of 300,000+ ounces), and many of these mines are marginal operations, making it less appealing to a major producer. That being, the stock has upside at some of its operations and doesn't need to acquire to grow, with expansion potential at Los Filos and Castle Mountain that could push Equinox's production above 1.0 million ounces long-term if green-lighted (subject to mine life extensions at shorter life assets).
Valuation
Based on ~394 million fully diluted shares and a share price of US$4.70, Equinox trades at a market cap of ~$1.85 billion and an enterprise value of ~$2.19 billion. This makes Equinox one of the lowest capitalization names in the sector among those producers with the potential to produce upwards of 500,000 to 900,000 ounces in 2026, with its enterprise value being significantly below that of Alamos Gold Inc. ( AGI ), Evolution Mining Limited ( OTCPK:CAHPF ) and Lundin Gold Inc. ( OTCQX:LUGDF ). That said, Equinox has one of the weaker balance sheets among its peer group, significantly weaker margins than its peer group, and a less attractive jurisdictional profile. In addition, the company's delivery against guidance has been pitiful relative to sector leaders like Alamos and Lundin, with Lundin beating guidance by an average of ~30,000 ounces (~9%), while Equinox has missed by an average of 50,000+ ounces or ~9%. In my view, this justifies the lower multiple and there's no reason to believe we should see a re-rating overnight without better delivery on expectations.
Equinox Gold - EV/EBITDA Multiple & Valuation/Margins vs. Peers - TIKR, FinBox
Meanwhile, Equinox's portfolio generates significantly less free cash flow than smaller peers like Alamos and Lundin, with Equinox set to have another year of negative free cash flow in FY2024 while Alamos and Lundin generate a combined $500+ million in free cash flow. This is precisely why looking at scale alone is not enough to determine where a stock should trade, with the more important metrics to watch being free cash flow generation, per share growth and the overall track record. Finally, while some investors believe that 2024 will be a transformative year from a margin standpoint, I don't see this being the case, with 2024 being a high-cost year at LFOP and RDM as highlighted previously, offsetting a partial year of contribution from Greenstone. And as stated earlier, I not be surprised to see 2024 AISC come in closer to $1,630/oz, leaving EQX's margins well below the peer average yet again in 2024.
Equinox Gold - Sales, Cash Flow, Free Cash Flow & Net Debt - Company Filings, Author's Chart Gold Producers Universe 2022 AISC - Company Filings, Author's Chart
So, what's a fair value for the stock?
Using what I believe to be a fair multiple of 0.90x P/NAV and 7.0x FY2024/FY2025 average cash flow estimates and a 65/35 weighting [P/NAV vs. P/CF), I see a fair value for Equinox of US$5.85. And while this fair value estimate points to a 21% upside from current levels, I am looking for a minimum 35% discount to fair value for mid-scale multi-asset producers to ensure a margin of safety. So, while a rising tide may lift all boats, I don't see nearly enough margin of safety here for EQX relative to its low-risk buy zone of US$3.82 or lower. Obviously, I could be wrong and the stock may not reach these levels, but when other names like K92 Mining Inc. ( OTCQX:KNTNF ) are available at half the enterprise value (~$1.1 billion vs. ~$2.2 billion) and will generate significantly more free cash flow than Equinox in 2025/2026 with far higher AISC margins (~60% vs. ~25% at $2,000/oz constant gold price), I prefer to focus elsewhere.
Summary
Equinox Gold had another disappointing year in 2024 relative to guidance, marking its third consecutive year of missing its guidance midpoint and by one of the widest margins relative to its peer group (~9% three-year average). On a positive note, Greenstone commissioning is underway and even having 60% of this asset is transformative relative to Equinox's portfolio of high-cost mines with several marginal assets. That said, the transition to free cash flow generation and margin improvement won't occur until 2025 given the ramp-up period at Greenstone combined with higher costs at a few of its legacy assets this year. In summary, while the investment thesis for Equinox has improved, I still don't see the valuation as attractive enough, and I continue to prefer names like K92 Mining (high-margin industry-leading growth with massive exploration upside), and Argonaut Gold Inc. ( OTCPK:ARNGF ), a turnaround story at less than 2x FY2024 P/CF vs. Equinox at ~11x P/CF.
For further details see:
Equinox Gold: Another Miss On Annual Guidance Midpoint