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Why are gold stocks undervalued?

Morningstar analysts expect gold prices to bounce back, lack of economic moat and high uncertainty keep these stocks out of 5-star territory.

Ruth Saldanha 27 September, 2018 | 5:00PM
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We recently ran an article on the most undervalued stocks based on our fair value estimates, and found that six of the top-10 names on the list were gold-related stocks. So why are these stocks trading below our fair estimates?

One reason is that the gold price itself has fallen dramatically this year. six months ago, the price was roughly US$1,350 per ounce, and in recent weeks the price has dipped below US$1,200 per ounce. A lot of this has to do with weakening investment demand, says Morningstar Equity Analyst Kristoffer Inton, adding that Morningstar forecasts gold to return to $1,300 by 2020.

"As the Federal Reserve continues to raise rates, the opportunity cost of holding gold rises, making it less attractive for investment purposes. That being said, we think over the next few years, rising jewellery demand (the largest single demand category for gold already) will more than make up for the gap left by investment demand. We anticipate this to be driven by China and India, where rising incomes and strong cultural affinity for gold should drive additional purchases," he noted.

 Eldorado Gold (ELD) trades at the largest discount to our fair value estimate, at a discount of over 50%. However, the company's extremely concentrated mine portfolio, key development projects that still face high uncertainty from Greek government resistance, and moderate balance sheet pressure mean that its valuation changes dramatically under potential outcomes, cautions Inton.

Another noteworthy observation is that all of these stocks have a four-star rating, but none of them have an economic moat.

The only way to earn a moat in gold mining is through a cost advantage, says Inton.

"On an individual mine basis, there are obviously low-cost mines owned by the companies under our coverage. However, it's very difficult for an entire portfolio to be low-cost enough to establish the company as a whole as a low-cost miner. Furthermore, gold miners have historically relied on mergers and acquisitions to add mines to their portfolios, which has led to paying full, if not excessive, prices. This hurts their ability to earn positive ROICs even if the acquired mine is low cost," he said.

So should you consider buying these stocks?

"We don’t think gold prices are likely to stay at these levels in the long-term, so we see value among gold miners. Of the group, we particularly like  Goldcorp (G). The company is undertaking its 20/20/20 growth plan -- a plan to boost reserves by 20%, increase production by 20% and cut costs by 20% -- which we think the market is underappreciating," said Inton.

Name Star Rating Industry Price/FV Moat
Eldorado Gold Corp (ELD) **** Gold 0.46 None
Iamgold Corp (IMG) **** Gold 0.59 None
Goldcorp Inc (G) **** Gold 0.64 None
Agnico Eagle Mines Ltd (AEM) **** Gold 0.75 None
Kinross Gold Corp (K) **** Gold 0.76 None
Barrick Gold Corp (ABX) **** Gold 0.82 None
Data as of Sept. 24, 2018. Source: Morningstar

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About Author

Ruth Saldanha

Ruth Saldanha  is Senior Editor at Morningstar.ca. Follow her on Twitter @KarishmaRuth.


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