TomasSereda
Given the recent second consecutive poor quarter reported by Equinox Gold (NYSE:EQX) and my earlier published analysis, I wanted to provide an updated viewpoint. Equinox has been hammered by a confluence of negative factors.
A lot has happened since I recommended the stock on April 29th. EQX is down 42%. Talk about terrible timing. I never professed to be a trader or market timer, but I admit this was one of my worst timed investments ever.
The iconic investor Peter Lynch said,
People who succeed in the stock market also accept periodic losses, setbacks and unexpected outcomes. They realize the stock market is not pure science. If seven out of ten of my stocks perform as expected, then I’m delighted.”
Will EQX be one of the three or one of the seven? Recent events have caused me to reassess.
Below I’ll recap highlights of recent developments, revisit my original thesis, and explain why I rate the stock a Hold.
Equinox Looks a lot Different Than It Did Only Three Months Ago
In April when I performed a screen on mining stocks, the following positive factors brought Equinox to my attention:
- The stock traded at a bargain price, at only 0.7 times Net Asset Value (NAV); price was down 13% over the previous 12 months.
- The company generated a whopping $555M in profit on $1.08B in revenue in 2021
- Production growth was running at 26% per year with sights set on 1M ounces per year within several years
- The company had potential to reduce its costs, bolstering profitability
- Strong insider ownership, greater than all but one other comparable mining company
I saw the story as a long-term one, with growth at an attractive price. There was significant upside due to revaluation, production growth, an improving cost picture, and potential wind in the sails from a rising gold price. In my view, these were all long-term expectations, not two or three month trends. But the market is impatient. Investors want to know “what have you done for me lately?”
A Confluence of Negative Events
As noted in my original analysis, EQX isn’t for widows and orphans. Unfortunately, several of the risk factors that I cited have come to pass in a very short time. There are many troubling lowlights that occurred during the last two quarters.
Net loss in Q2 was $78.7M, or $0.26 per share, compared to $325.74M and $0.96/share in Q2 2021. Revenues declined to $224.6M, down 0.7% versus Q2 2021. All In Sustaining Costs (AISC) shot up to $1657/oz from an already above-industry average level of $1,350 in 2021. Earlier management guidance for 2022 was $1,330-1415/oz. That’s a huge and unexpected cost hit of 20%, dramatically undermining earnings.
Another risk factor that came to light is the fact the company operates just seven mines. If any single mine has significant operating disruptions or subpar production, it can have a large effect on earnings. Rainy weather hurt production during Q1 at the Aurizona mine. There were regulatory issues and a crusher outage at the RDM mine. That was followed by a mine operations suspension, eventually restarted in July. Overall production in Q2 dropped 3% versus Q2 2021. Los Filos mine production was up, but costs rose to $2,141/oz.
Last week CEO Christian Milau announced he was leaving the company, to be replaced by current President Greg Smith. Strangely, Mr. Smith didn’t attend the meeting due to being “on holiday.”
The mining sector has been hammered since April 29th. The GDX ETF was down 22.9% and junior miner GDXJ was down 19.2%. Gold was down 5.8%.
I reviewed the earnings report and attended management’s webcast last week. The following were key themes that I took away:
- Higher than plan unit costs due to inflation and lower than plan production.
- A series of mine disruptions, delays and slower ramp-ups.
- Management change at the top with CEO Christian Milau leaving.
- The company emphasized second half improvement and long-term growth. Equinox expects 60% of production to come in 2H.
Original Bullish Thesis is Still Largely Intact
Equinox is now in a much different situation than what I saw in late April. The company is clearly going in the wrong direction.
Some of the Recent Problems Have Been Out of Management’s Control
On the positive side, the following recent issues were largely outside management’s control:
- Inflation cost pressures
- Regulatory and weather impacts hampering production
- Mining sector stocks have been hammered and investor sentiment is negative
- Gold has trended lower, but mostly stuck in a trading range
However, the blockade at the Los Filos mine in 2021 was labor-related. This presents an additional element of systemic risk for the company. Fortunately, the company can mitigate this via improved ESG and management practices. Indeed, Equinox has placed stronger emphasis on this and appears to be making progress. MSCI Research assigns an average ESG score to the company, citing environment as a lagging component. This is common for mining stocks.
As I reevaluate the stock, the key question is whether my original thesis for the stock is still valid. I believe this boils down to: 1) production growth, 2) profitability, 3) valuation and 4) the outlook for gold.
Production Growth Prospects Appear Reasonably Good
On the positive side, management has cited total upside production growth from all assets of an incremental 600K oz per year. The company has shown progress with the Greenstone project. Construction is on time and budget, with first pour expected in 2024 and production ramping to 240,000 oz/year. Another positive in the recent quarter was a sharp increase in production at the Mesquite mine, along with lower costs. Based on best available information, I am inclined to trust management’s guidance about production upside potential, but would like to see tangible progress soon.
Verdict: Thesis still valid pending evidence of performance.
Profitability is a Wild Card
The company has limited control over input costs that have been subject to unpredictable inflation. Some are calling for peak inflation in the U.S. but inflation in Brazil (where the company has four mines) recently exceeded 10%. As production ramps, Equinox unit costs should decrease. Capital costs are trending down, further supporting lower AISC. Management is also taking additional steps to curb costs. It’s very possible the worst of the cost pressures are over. But much depends on inflation and management and operational effectiveness, which are highly uncertain. Given its youth, the company doesn’t have a long term track record of profitable operations.
Verdict: Thesis valid pending evidence of performance.
Valuation Screams Buy
The junior miner sector has a Price/Book of 1.16. EQX has a Price/Book of only 0.48. At less than 50% of book value, with promising growth potential, there are cheap assets here. The company has 16.077 million ounces of mineral reserves. As of June 15th, the P/NAV was 0.6. Trading then at $5.48/share, NAV was $9.13/share. Using today’s trade at $4.10/share with an unchanged NAV would give us P/NAV of an ultra-cheap 0.45. Of course, someone must demonstrate the ability to generate profitable and reliable earnings from these assets. Usually, when a company reaches this stage, it becomes a turnaround story. That sometimes results in new management, new ownership or both. Alternatively, the company fails. Equinox’s financial position remains strong, mitigating the latter outcome.
Verdict: An even stronger case to buy.
Gold Looks Favorable Long-Term, But Near-Term May Continue to be Pressured
The other obvious element of company profitability is the realized price for gold sales. I am long-term bullish on gold, and have described my view on potential upside of $5000. Mining shares have proven to be a good, yet volatile, contributor to portfolio performance over the long-run. This year, gold has been flat and in a trading range. Near-term, interest rate and strong dollar pressures may continue, but long-term factors are bullish in my view. Again, this is not a month to month or quarter to quarter kind of play.
Verdict: Original thesis still intact.
More Upside Than Downside
Weighing all the evidence, my view is that the stock has considerably more upside than downside. I believe the downside is limited by the intrinsic value of its assets. Barring a total collapse of the company and/or the price of gold, it’s hard to foresee the market paying much less than 50% of underlying assets. Yet, as demonstrated over the past two quarters, risks remain high.
As to upside, if the company can begin to demonstrate a positive trend beginning in Q3, the stock can advance towards my original target near $12 per share in two to three years. A triple on a stock with limited downside looks like a compelling risk-reward tradeoff to me.
Price Action and Sentiment
I personally don’t put much weight on technical indicators, but here are a few observations. One would think given last week’s report, sentiment is about as bad as it can be. The stock was punished immediately after the earnings release, down 8%. After bouncing around near $3.90/share, it has since recovered to $4.10. The decline since the pre-earnings announcement price close on August 3rd has been only 5%. This could signal underlying strength in the stock. Indeed, as of August 6th, Recognia reported strong short-term (2-6 weeks) sentiment. Yet they report weak mid-term (6-9 weeks) and long-term (9 months to 2 years) sentiment. Social Market Analytics reports neutral social media sentiment.
Conclusion
Equinox has been hammered due to poor performance, caused in part by factors outside management’s control. Uncertainty is now even higher than before. The company is now in a turnaround situation. Share price performance will likely be dependent on management’s ability to reverse negative trends and show progress in the coming quarters. The original thesis for the stock remains largely intact, pending demonstrated better performance.
I will be looking carefully at production growth, costs and management effectiveness. We will probably have to wait until the third quarter earnings report to gauge progress, at which time I will reevaluate. In the meantime, the upside outweighs the risks and uncertainty, leading me to rate the stock a Hold. I will continue to track and comment on any significant developments.
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