Looking for a Golden Gold Miner
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Gold mining is a very particular business, in which having low production costs is perhaps the most determinant competitive advantage. Companies cannot differentiate their products in this industry; they need to accept a price that is determined by the global supply and demand environment. For this reason, production costs become a critical factor to obtain profitability and even survive in times of volatile commodity prices.
Because individual companies have almost no influence on the sales price of the commodity, management needs to be very careful at selecting the most profitable projects and executing operations efficiently. Investments in the sector are long term by nature, so it’s hard to forecast the trajectory of gold prices during the life of the project. Companies that want to maximize value for shareholders have to focus intensively on the capital allocation and resource development part of the business.
Eldorado Gold (NYSE: EGO) has development and exploration businesses in Turkey, China, Greece and Brazil. The company's largest gold producer is its Kisladaj mine in western Turkey; the company obtains almost 40% of its revenue from that low-cost mine. Eldorado is also working on a second Turkish project, Efemcukuru, which is much smaller than Kisladaj but will have even lower production costs.
This gold miner has a very strong presence in China, a country in which most western gold miners have not been able to conduct operations. Eldorado has three low-cost mines in China, and a fourth mine, Eastern Dragon, is expected to start production in 2012. Because of its silver byproduct credits, Eastern Dragon is expected to be another low-cost project for Eldorado.
This focus on the cost of production when deciding to allocate capital to new projects is one of the most positive aspects of Eldorado, and it has produced a solid increase in reserves while at the same time increasing sales and profit margins for the company. The fact that new projects like Efemcukuru in Turkey and Eastern Dragon in China have low cost structures should help the company at expanding profit margins further in the years ahead.
Eldorado had a total unit cash cost of $472 per ounce of gold in 2011, while the average for the industry is around $600. The following chart compares estimated production costs per ounce for the company and other gold miners like Goldcorp (NYSE: GG), IAMGOLD (NYSE: IAG), Kinross Gold (NYSE: KGC) and Agnico-Eagle (NYSE: AEM).
When comparing profit margins, Eldorado shows the biggest gross and operating margins in the group at 58% and 46%, respectively. This should come as no surprise considering that these companies are price takers and cost structure is the main determinant of profit margins. However, it’s comforting to see that management's statements about cost per ounce are supported by the figures reported in the financial statements of Eldorado and its competitors.
In a business like gold mining in which prices are a given variable, a low cost structure is probably the most important competitive advantage. Eldorado has focused its operations on high-quality projects with low production costs, and new developments are following the same criteria. This focus on efficiency makes the company a solid candidate to outperform its peers in the long term.
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