2023-03-08 05:45:09 ET
Summary
- Equinox Gold continues to be one of the worst-performing gold stocks, down 60% from its 2022 highs and nearly 80% from its 2020 highs.
- While this might seem like a major over-correction given that the gold price sits just $200/oz lower, we've seen severe margin compression, with AISC margins slipping from $758/oz to $162/oz.
- The good news is that Greenstone (60%) will come to the rescue in 2024, but Equinox won't see a meaningful benefit until 2025 once in commercial production.
- So, with another tough year ahead from a margin standpoint and uncertainty related to the ability to fund Greenstone without ATM usage, equity investment sales or non-core asset sales, I continue to see better opportunities elsewhere on a risk-adjusted basis.
Just two months ago, I wrote on Equinox Gold ( EQX ), noting that there was no way to justify paying up for EQX stock at US$4.20, and that rushing in after an 80% rally off a panic low was not a great idea. While the stock levitated a little further into late January with a relentless bid under the gold ( GLD ) price, it's now down nearly 15%, which isn't any surprise given that sentiment in the miners got very over-heated in January which suggested the best move was selling off non-core positions and reducing exposure in weaker miners, not adding exposure into a period of elevated optimism. Of course, Equinox's Q4 & FY2022 results didn't help matters, with production coming in well below guidance and costs coming in well above my ($1,622/oz vs. $1,615/oz).
While the 2022 results certainly left much to be desired, the tepid 2023 outlook didn't give investors much to look forward to, with production expected to come in below 600,000 ounces, with even higher operating costs based using the guidance mid-point ($1,635/oz vs. $1,622/oz in FY2022). It's certainly possible that there's some conservatism baked into these numbers to avoid another disastrous miss like 2022. Still, assuming 600,000 ounces at $1,600/oz in FY2023, Equinox's costs will remain over 20% above the industry average with razor-thin margins relative to its mid-tier peers. Let's dig into recent results below:
Q4 & FY2022 Results
Equinox Gold released its Q4 and FY2022 results last month, reporting quarterly production of ~150,400 ounces and FY2022 production of ~532,300 ounces. The latter figure paled compared to FY2022 production of ~602,100 ounces, and was even more disappointing relative to the initial guidance mid-point of 625,000 to 710,000 ounces of gold, with a 20% miss vs. the guidance mid-point and a double-digit miss even using the low end of guidance. The significant miss was on output was related to underperformance at nearly all operations related to some of the following issues:
- Aurizona : abnormal rainy season limited access to higher-grade ore in Q4, with H2 planned to be better due to improved grades but the inability to access these grades due to inclement weather.
- Castle Mountain : longer leach cycles related to run-of-mine ore placed on the leach pad
- Los Filos : illegal blockade in Q3 and a shortage of explosives related to a strike at a supplier, impacting tonnes moved in the open-pit and underground
- RDM : temporary suspension related to the delayed receipt of permits for a scheduled tailings raise, and the delayed receipt of a license to process ore from stockpiles that further impacted Q4 results
- Santa Luz : slower ramp-up period overall, with difficulty operating the resin-in-leach plant and lower throughput because of ore hardness combined with high sulfur content affecting recoveries in Q4
Given the issues noted above, these five operations combined for ~329,000 ounces in FY2022 vs. an initial guidance mid-point of 480,000 ounces, with the most disappointing asset being Santa Luz which missed its guidance mid-point by approximately 53% (~37,600 ounces vs. 80,000 ounces expected). Fortunately, Equinox noted that it's seeing some improvement in recoveries at Santa Luz and has moved to a new fragmentation plant that's translating to higher throughput and a new blending strategy. So far, recoveries appear to be trending in the right direction in the new year with 62% in January and above 70% in February, with the latter in line with the company's H2-2022 goal following the start of commercial production.
Unfortunately, while 2023 was a rough year for Santa Luz and the rest of the portfolio that struggled to meet output guidance (ex-Fazenda and Mesquite), 2023 isn't expected to be much better. This is based on FY2023 guidance of 555,000 to 625,000 ounces (590,000 ounce mid-point), translating to only an ~11% increase from FY2022 levels assuming guidance is met, o a ~14% increase when adjusting for the sale of Mercedes (~13,600 ounces produced in 2022). Just as disappointing, costs are actually expected to worsen when factoring in a full year of elevated input costs. The only silver lining is that the company is confident that inflation has largely peaked, so at least things aren't expected to get worse, and this is consistent with what we're hearing from some other companies, like Northern Star Resources ( OTCPK:NESRF ).
"On costs, our views that inflation is peaked. But the cost will stay elevated through the year. And you can see that reflected in both our cash and sustaining costs."
- Equinox Gold, Q4-22 Conference Call
"We're not seeing significant cost reductions, albeit we are seeing some reduction. So, for instance, we're seeing it on our energy prices, particularly diesel. And also some of our input costs that are indexed around steel prices."
- Northern Star Resources, Fiscal Q2-23 Conference Call
Costs & Margins
Moving over to costs and margins, the results weren't much prettier. This was evidenced by Q4 AISC of $1,523/oz despite this being the best quarter of the year and FY2022 AISC of $1,622/oz, above my estimates of $1,615/oz and well above initial guidance of $1,330/oz to $1,415/oz. While this significant miss on operating costs wasn't company-specific and even some of the companies with the best track records and exceptional assets struggled to deliver into guidance. This increase in costs year-over-year (FY2021: $1,350/oz) and the significant miss was related to stickier than expected inflationary pressures sector-wide and exacerbated by the production misses leading to a lower denominator and a spike in unit costs.
Given the disappointing production and cost performance combined with no help from the gold price, it's no surprise that the financial results left much to be desired. For the full year, revenue came in at $952.2 million (down 12% year-over-year), operating cash flow fell more than 45% to $144.3 million and net debt increased to ~$627 million with significant spending on Greenstone and limited cash flow generation. From a margin standpoint, AISC margins fell to just $162/oz (FY2021: $441/oz), and this isn't expected to improve much in FY2022 using the guidance mid-point ($1,635/oz) and assuming an $1,825/oz gold price. In fact, even in a more bullish gold price scenario ($1,900/oz), AISC margins will still be well below FY2021 levels ($265/oz vs. $441/oz).
So, is there any good news?
Fortunately, Equinox had the foresight to enter gold collar contracts with a put strike price of $1,900/oz and an average call strike price of $2,065/oz for 10,644 ounces per month from February 2023 to March 2024. Although this represents just ~22% of forward-12 month production, it was a smart move to protect against downside volatility in the gold price like we have seen since the February 2022 peak, and a prudent move for a company with a heavy-capex schedule that is seeing a strain on cash flow because of elevated operating costs across its operations. That said, this is only a minor win in what has been a difficult two years, and while it provides some protection, I would have preferred to see more hedging, given the favorable environment for hedging in late January.
The other good news is that by somewhat of a miracle and to Equinox's credit from a credibility standpoint (it has continued to state it's on time and budget and has delivered on that promise), Greenstone continues to remain on budget and on track, an incredible feat in an environment where massive capex blowouts or upwards revisions are the norm (Magino, Cote, Valentine), not the exception. As of year-end, Greenstone was at 65% complete (over 70% currently), with the 14-kilometer natural gas pipeline complete and production still slated for H1-2024, suggesting a ramp up to commercial production in late 2024 or early 2025.
Based on Equinox's 60% interest and a first five year attributable production profile of ~240,000 ounces at sub $800/oz AISC, this will certainly provide a nice boost to cash flow beginning in Q1 2025 once commercial production is reached.
Valuation & Technical Picture
Based on ~363 million shares and a share price of US$3.70, Equinox trades at a market cap of US$1.34 billion and an enterprise value of ~$1.97 billion. If we compare this figure to other producers of a similar size, like Alamos Gold ( AGI ) and SSR Mining ( SSRM ). However, both companies have stronger balance sheets and much lower cost profiles, with Equinox sitting with a net debt position north of $600 million and limited cash flow generation at current gold prices because of the steady trend higher in operating costs. Obviously, Greenstone will help to drive Equinox's costs down once in commercial production, but this is a 2025 opportunity, not a 2024 opportunity, with a mid-2024 production start and what I would expect to be at least a six-month ramp-up period, with barely 100,000 ounces of gold production in FY2024.
Looking at the chart below, Equinox has historically traded at well over 10.0x cash flow and peaked at ~14.0x cash flow (August 2020) which might have made some sense when investors saw it on a path to becoming a 1.0 million-ounce producer at sub $1,100/oz AISC without a weak balance sheet and without risk of share dilution. Today, that situation is very different, with a relatively weak balance sheet, risk of further share dilution, and while the 1.0 million ounce production status is achievable, the more conservative cost profile looks to be $1,300/oz even with Greenstone. Hence, I think a more fair multiple is 7.0 FY2024 cash flow estimates ($0.68), translating to a fair value of US$4.75 per share.
Although this points to a 27% upside from current levels, I prefer a minimum 40% discount to fair value when it comes to small-cap producers to adjust for their higher volatility and increased risk, especially in EQX's case when it has a short-term liquidity crunch while it completes its share (60%) of Greenstone construction. After applying this discount, the ideal buy zone for EQX comes in at US$2.85 or lower, roughly 20% below current levels. Obviously, there's no guarantee that the stock gets this low, but I prefer to simply get the right price that bakes in an adequate margin of safety or pass, and I don't see that setup just yet.
Finally, if we look at the technical picture, Equinox continues to trade in the upper portion of its support/resistance range despite the violent decline from its January highs. This is based on strong support at US$2.35 and resistance at US$4.85, translating to $1.15 in potential upside to resistance and $1.35 in potential downside to support from a current share price of US$4.85, or a reward/risk ratio of 0.85 to 1.0. I prefer a minimum 4.0 to 1.0 reward/risk ratio for small-cap producers, corroborating the view that this is not yet a low-risk buy zone for EQX. For EQX to drop into a low-risk buy zone, the stock would need to dip below US$2.90.
Summary
Equinox Gold had a rough FY2022 with misses across its portfolio and while some of these issues were out of its control (RDM permit delays, Los Filos blockade), this isn't the first time Los Filos had issues, an asset that has proven to be challenging to operate since the LeaGold merger in 2019. The good news is that Equinox has an incredible asset in the wings that will drag down its company-wide AISC, which should drop more in line with the industry average post-2024 (~$1,300/oz). The bad news is that investors will have to endure another tough 18 months before Greenstone contributes meaningfully, meaning risk of some share dilution and significant leverage to the gold price, plus a bit of a liquidity crunch if gold prices don't improve (~$340 million still remaining on Greenstone to completion).
Given this difficult situation and less favorable outlook, I am surprised that the company hasn't explored a non-core asset sale, especially given that there appears to be an appetite for assets out there despite the flat gold price environment and we've seen a positive reaction to this decision from companies like Iamgold ( IAG ). Not only would this reduce the liquidity crunch as Equinox heads towards the home stretch at Greenstone, but it would also clean up a portfolio that is relatively large considering the production profile. Based on non-core asset sales being a low priority and the stock still not being oversold, I remain neutral, but I would get much more interested below US$2.90, where much of this negativity would be priced in once again.
For further details see:
Equinox Gold: Another Tough Year Ahead